by Thomas D. Begley, Jr., CELA
(Originally published in the June issue of “The Straight Word”) Under a Children’s Trust typically a parent transfers assets to an irrevocable trust for the benefit of her children and reserves no right to access to either income or principal. One or more children usually serve as trustee. The trust document authorizes the trustee to distribute income and principal to children, subject to the approval of a trust advisor who is not a trust beneficiary. The trust advisor may be a spouse of a trust beneficiary or even an attorney or law firm. A beneficiary of the trust cannot serve as trust advisor. Upon the death of the parent(s), the document provides for distribution of the remaining principal and accrued income, if any, in accordance with the parent’s wishes. There are seven considerations in all Medicaid Planning trusts. These are:
- Transfer of asset penalty
- Payback provision
- Tax considerations, including income, gift and estate
- Estate recovery
- Elective share
Let’s examine the seven planning considerations in the context of a Children’s Trust:
The assets in the Children’s Trust would not be available. Since there is no retained income or access to the principal by the parent, neither the income nor the principal are available.
Transfer of Asset Penalty
The original transfer of the assets to the Children’s Trust would be subject to a transfer of asset penalty for both Supplemental Security Income (“SSI”) and Medicaid. There would be no transfer of asset penalty for a transfer from a Children’s Trust to a third party.
In a Children’s Trust, there is no Medicaid payback on the death of the parent for medical assistance paid on behalf of parent during the parent’s lifetime.
Many clients who use Children’s Trusts as part of their Medicaid planning are non-crisis planning clients. They either have an early diagnosis or are elderly but in good health. They are doing advance planning and want a sense of independence. They do not want all of their assets in a trust. Good practice dictates that the lawyer have a discussion with the client and determine how much the client feels should be kept out of the trust to give the client a feeling of comfort. The client should understand that the funds retained outside the trust are at risk, unless they are transferred to children to be held pursuant to the terms of a Family Agreement. Ideally, the trust will be funded with the least amount of assets possible. In calculating how much to put in the trust, the client can carve out assets that can be used in the future for the following:
- Amount of Community Spouse Resource Allowance (CSRA)
- Amount of the anticipated spend down as set forth in the client’s Asset Protection Plan
- Key money to gain admission to a facility
- Any amount of money the client is willing to lose. Typically, a single client will want to retain $50,000 – $100,000 of assets and risk losing that amount in order to preserve a sense of independence. To a certain extent, this will be determined by the medical condition of the client.
Ideal assets to fund a Children’s Trust would include appreciated real estate, such as a primary residence or a vacation home, or appreciated securities. There are significant tax advantages in utilizing trusts for these assets as opposed to transferring outright to children. Careful consideration must be given to rental real estate, because the parent would no longer be entitled to the rent after the property is transferred to the Children’s Trust.
Bad assets to use in funding trusts include retirement accounts, deferred annuities, and government bonds with significant accumulated interest. The problem is the transfer of those assets would result in immediate income tax. To the extent possible, these assets should be left outside the trust.
A Children’s Trust can be designed as a grantor trust so that the grantor pays the tax on any income, or .a non-grantor trust where the income is taxed either to the trust itself or to the beneficiary, depending on the design of the trust.
A Children’s Trust can be designed so that the Grantor retains a limited power of appointment over the trust corpus. The limited power of appointment would enable the Grantor to appoint the remainder of the trust to a limited class of people. Limited power of appointment could be either testamentary or inter vivos.
If the trust is designed as a grantor trust, then the assets in the trust will be included in the estate of the grantor for estate tax purposes. The Children’s Trust can be designed so that it is not a grantor trust and the assets in the trust would be excluded from the estate of the grantor for estate tax purposes. In determining how to draft the trust, the capital gain tax saving resulting from a step-up in basis must be weighed against any estate tax savings. Usually, payment of the New Jersey estate tax is the lesser of the two evils.
There is no estate recovery from a Children’s Trust, because there is no retained interest.
State Medicaid agencies require that a Medicaid recipient who is predeceased by a spouse assert the Medicaid recipient’s right to an elective share against the estate of the predeceased spouse. Failure to do so is considered a transfer of assets subject to the Medicaid transfer penalty rules. If a Children’s Trust for the benefit of the community spouse provides for distribution to the children on the death of the community spouse, then these assets would be subject to the elective share provisions. The surviving Medicaid recipient would, therefore, have an obligation to assert his or her right to the elective share against the trust assets. Failure to do so would constitute a transfer for Medicaid eligibility purposes. The solution would be to have both parents join in the deed or other document contributing the assets to the trust.
Comparison Between Transfers to Children’s Trusts and Transfers to Individuals
The following chart compares the advantages and disadvantages of an outright transfer of assets and putting assets in a Children’s Trust.
|Trusts v. Transfers Comparison|
|Look-Back||Five Years||Five Years|
|Step Up in Basis||Yes||No|
|Principal Residence Exclusion||Yes||No|