A Medicaid asset protection trust (MAPT) allows someone who requires long-term nursing home care to qualify for Medicaid benefits to pay for that care without first going broke. Medicaid is the only government program that pays for long-term care. Medicare and private health insurance don’t. Financial products such as long-term care insurance and life insurance “hybrids” alone are not enough. In contrast, Medicaid covers the full cost of care without any dollar caps or time limits. BUT you’ve got to be broke in order to qualify. Assets in a MAPT are not considered as part of a Medicaid applicant’s resources even though the applicant retains access to and control over the trust fund. Consequently, a MAPT is the legal tool of choice for those who want to incorporate long-term care as part of their retirement and estate planning.
But beware: not all MAPTs are the same. The challenge to the attorney who drafts such a trust is to achieve Medicaid protection while also ensuring maximum access to and control over the trust fund by the “settlor” (also sometimes called the “grantor”), the person who creates and funds the trust and who, in the case of a MAPT, is the beneficiary of the trust. Here are some key features of a properly-drafted MAPT.
Access to and control over Income and Principal
Assume John and his wife, Mary, transfer their home and some of their investments to their son, Sam, who holds these assets as Trustee for the benefit of his parents. John and Mary, in accordance with a use and occupancy agreement with Sam, continue to live in their home, rent-free, provided they also continue to pay for all the costs of maintaining the home, just as before. They receive all the interest and dividends from the investments, and also rent and royalties, if any. The capital gains remain protected in the Trust but are taxed to John and Mary on their federal income tax return rather than at a potentially higher Trust tax rate. The Trustee may not distribute the principal to them or use it to pay any of their financial obligations. But actually, they do indirectly retain access to the principal as well. That’s because they retain the power to direct Sam, the Trustee, to distribute all or part of the trust fund to anyone other than themselves. Persons who receive such distributions (which are tax free), perhaps their daughter or other close family member, can choose, if they wish, to spend those assets for John and Mary’s benefit. But they are not legally required to do so. Since the recipient is not legally obliged to spend the money on John or Mary, the trust fund is not considered an available resource if Medicaid is later sought. This measure does not work in all states. But it does work in Pennsylvania.
Ability to Terminate the Trust
The Settlors, John and Mary may not “revoke” the Trust. But their son, Sam, the Trustee, in accordance with special provisions in the Trust, may “terminate” it if it no longer remains beneficial to his parents. Alternatively, John and Mary may effectively terminate the Trust by directing Sam to transfer all the assets of the Trust to anyone they designate, except to themselves or their creditors. As noted above, those persons receiving the trust fund do not incur taxable income and, if trustworthy, will voluntarily transfer the assets back to John and Mary without John and Mary incurring income tax liability.
Income Tax Advantages
Because John and Mary retain “strings” over the trust principal as described above, in addition to receiving the Trust’s income, they are treated as owners of the entire trust fund under the Internal Revenue Code for purposes of federal income taxation. The Trust is classified under the tax code as a “grantor” trust. Grantor trust status is financially beneficial to a settlor and beneficiary unless the settlor’s estate is so large as to generate a federal estate tax upon the settlor’s demise. In 2022, each individual has a $12.06 million lifetime exclusion amount against federal gift and estate taxation. Double that for a married couple. Grantor trust status is generally preferable for taxpayers who do not exceed this threshold.
In the case of our hypothetical couple, John and Mary, after both of them have passed away the Trust will terminate and become distributable to the remainder beneficiaries, their children, Sam and Susie, the same as their other assets distributed under their wills. Since the MAPT is a “grantor” trust, the remainder beneficiaries pay no federal income tax on the capital gains realized within the Trust. They receive these assets at a “stepped-up” basis. If John and Mary had gifted these assets outright to their children, Sam and Susie, then at the time those assets are later liquidated, Sam and Susie would each be liable for payment of income taxes on the capital gain, at potentially staggering amounts.
As regards their home, if John and Mary decide they want to move and sell their home, their son, Sam, the Trustee, will sell it and, if John and Mary wish, can use the proceeds to buy a new home for his parents to occupy, same as before. The new home is protected in the Trust same as the old one was. Because the Trust enjoys “grantor” trust status, when the home sells, the MAPT will have the same $500,000 capital gains exclusion as would be available to John and Mary had they retained ownership of the home and sold it.
In most states, including Pennsylvania, someone cannot transfer assets into a trust, retain the right to use and benefit from the trust fund, and then also protect trust assets from the reach of creditors. But a properly structured MAPT will protect trust principal from the settlor’s creditors. That’s because the settlor retains no legal right to it. But as noted earlier, the settlor can potentially gain access to the principal in multiple ways short of retaining legal authority to demand it.
Prudent retirement and estate planning takes into account the possibility of chronic incapacity as we age – long-term care planning. An essential component of long-term care planning for all but the very wealthy includes measures to qualify for Medicaid. A properly-structured Medicaid Asset Protection Trust is an important tool. It enables one to retain beneficial use of assets in a tax- friendly manner, with protection from creditors, and ultimately to qualify for Medicaid benefits, if necessary, while preserving the financial security of loved ones. Contact the lawyers at Vasiliadis Pappas Associates to see if this asset protection measure is appropriate for you.