How to Use a Trust in Medicaid Planning

With careful Medicaid planning, you may be able to preserve some of your estate for your children or other heirs while meeting Medicaid's low asset limit.

The problem with transferring assets is that you have given them away. You no longer control them, and even a trusted child or other relative may lose them.

A safer approach is to put them in an irrevocable trust. A trust is a legal entity under which one person – the trustee – holds legal title to property for the benefit of others – the beneficiaries. The trustee must follow the rules provided in the trust instrument. Whether trust assets are counted against Medicaid's resource limits depends on the terms of the trust and who created it.

A revocable trust is one that may be changed or rescinded by the person who created it. Medicaid considers the principal of such trusts (that is, the funds that make up the trust) to be assets that are countable in determining Medicaid eligibility. Therefore, revocable trusts are of no use in Medicaid planning.

Income-Only Trusts in Planning for Medicaid

An irrevocable trust is one that can't be changed after it has been created. In most cases, this type of trust is drafted so that the income is payable to you (the person establishing the trust, called the grantor) for life, and the principal can't be applied to benefit you or your spouse. At your death, the principal is paid to your heirs. This way, the funds in the trust are protected and you can use the income for your living expenses.

For Medicaid purposes, the principal in these trusts is not counted as a resource, provided the trustee can't pay it to you or your spouse for either of your benefits. However, if you do move to a nursing home, the trust income will have to go to the nursing home.

You should be aware of the drawbacks of this arrangement. It is very rigid, so you can't gain access to the trust funds even if you need them for some other purpose. For this reason, you should always leave an ample cushion of ready funds outside the trust.

You may also choose to place property in a trust from which even payments of income to you or your spouse can't be made. Instead, the trust may be set up for the benefit of your children or others. These beneficiaries may, at their discretion, return the favor by using the property for your benefit if necessary. However, there is no legal requirement that they do so.

One advantage of these trusts is that if they contain property that has increased in value, such as real estate or stock, you (the grantor) can retain a "special testamentary power of appointment" so that the beneficiaries receive the property with a step-up in basis at your death. This will also prevent the need to file a gift tax return upon the funding of the trust.

Remember, funding an irrevocable trust within the five years prior to applying for Medicaid (lookback period) may result in a period of ineligibility. The actual period of ineligibility depends on the amount transferred to the trust. Learn more about Medicaid's asset transfer rules.

Testamentary Trusts

Testamentary trusts are created under a will. Medicaid rules provide a special "safe harbor" for testamentary trusts created by a deceased spouse for the benefit of a surviving spouse. The assets of these trusts are treated as available to the Medicaid applicant only to the extent that the trustee has an obligation to pay for the applicant's support. If payments are solely at the trustee's discretion, they are considered unavailable.

Therefore, these testamentary trusts can provide an important mechanism for community spouses to leave funds for their surviving institutionalized spouse that can be used to pay for services that are not covered by Medicaid. These services may include:

• Extra therapy
• Special equipment
• Evaluation by medical specialists or others
• Legal fees
• Visits by family members
• Transfers to another nursing home if that becomes necessary

But remember that if you create a trust for yourself or your spouse during life (i.e., not a testamentary trust), the trust funds are considered available if the trustee has the ability to use them for you or your spouse.

Supplemental Needs Trusts

The Medicaid rules also have certain exceptions for transfers for the sole benefit of disabled people under age 65. Even after moving to a nursing home, if you have a child, other relative, or even a friend who is under age 65 and disabled, you can transfer assets into a trust for their benefit without incurring any period of ineligibility. If these trusts are properly structured, the funds in them will not be considered to belong to the beneficiary in determining their own Medicaid eligibility.

There is one notable drawback to supplemental needs trusts (also called special needs trusts). After the disabled individual dies, the state must be reimbursed for any Medicaid funds spent on behalf of the disabled person. Read more about special needs and supplemental needs trusts. 

To find out whether a trust is the right Medicaid planning strategy for you, talk to your elder law attorney. Find an attorney near you today.