Irrevocable Income-Only Trusts for University of California Employees and Retirees

What Is It?

Many of the University of California employees and retirees that we speak to have never heard of an Irrevocable Income-Only Trust. Therefore, we must first answer the question of what it is before we can explain how it's useful and if it's right for your unique situation.

What Is an Irrevocable Income-Only Trust?

An irrevocable income-only trust may allow an applicant to qualify for Medicaid benefits while preserving assets for family members or other beneficiaries. It is a legally enforceable arrangement that allows you to transfer property to someone else (the trustee) who holds the property for you (the beneficiary of the trust). Although you name yourself as a beneficiary of the trust, you are entitled to receive only the income from the trust; you cannot access the trust principal.

How Can This Trust Help You Qualify for Medicaid

To qualify for Medicaid, both your income and the value of your assets must fall below certain limits (which vary from state to state). An irrevocable income-only trust helps you qualify for Medicaid because it makes some of your assets (the trust principal) inaccessible to you. Assets that are truly inaccessible to the Medicaid applicant are not considered, so in the case of an irrevocable income-only trust, the trust principal (but not the trust income) will not be counted. As for the trust income, most of it must be 'spent down' to subsidize your nursing home care; Medicaid will pay the rest. This allows for University of California employees and retirees, who wouldn't normally be able to qualify, receive Medicaid benefits

Can Using This Trust Cause Any Problems?

There are certain issues that University of California employees and retirees can experience when using this kind of trust. Transfers to an irrevocable trust create a waiting period or period of ineligibility before you can start collecting Medicaid benefits. Assuming you transferred assets to an irrevocable trust during the 60-month look-back period, you would be subject to a period of ineligibility (based on a formula set by the state) before you could receive Medicaid benefits.

When Can It Be Used?

Timing is a very important factor for University of California employees and retirees to consider when trying to utilize this kind of trust to qualify for Medicaid.

You Want To Preserve Otherwise Countable Assets, And You Anticipate The Need For Long-Term Care

Generally, the irrevocable income-only trust helps you qualify for Medicaid. It's used when you expect to need long-term nursing home care in the future and want to take steps to preserve assets ahead of time. Because there's a 60-month look-back period for transfers to an irrevocable trust, such transfers will cause a delay before you can receive Medicaid benefits. Therefore, timing the transfer and predicting when Medicaid benefits might be needed are important considerations.

Caution: Some states have an income-cap requirement that forbids a 'spend-down' of income. In such cases, if money received from the irrevocable income-only trust exceeds the income limit by even one dollar, an applicant could be considered ineligible to receive Medicaid benefits.

Although an irrevocable income-only trust is an important planning tool for many people who anticipate long-term care, it is not for everyone. For instance, because the very wealthy can afford the cost of long-term care, it makes little sense to transfer money to such a trust; the monthly trust income would likely be more than enough to cover the nursing home bills.

Strengths

Potentially Preserves Them for Loved Ones

Nursing home care is expensive and can easily exhaust your assets. An irrevocable income-only trust may provide a means of qualifying for Medicaid benefits while still preserving some assets for the benefit of your loved ones.

Example(s): Assume Robert transfers all of his assets to an irrevocable income-only trust, naming himself as income beneficiary and an unrelated party as trustee. Under no circumstances may the trustee give principal to Robert. When Robert enters a nursing home six years later and applies for Medicaid. Robert will likely qualify for Medicaid and, upon his death, will have effected a transfer of his protected assets for his daughter. Whatever income is payable to Robert is treated as actual income to him for Medicaid purposes.

Provides You with a Present Income Stream

Because such a trust is often established long before entering a nursing home, it is often necessary to provide a sufficient flow of income during the interim for normal living expenses. Unlike a straight irrevocable trust (in which the creator of the trust is not a beneficiary and can access neither principal nor income), the income-only version provides some flexibility. Moreover, even when you apply for Medicaid, a certain amount of periodic income is permitted. Only amounts in excess of the allowance must be 'spent down' on care. A steady stream of income has been very valuable to many of our University of California employees once they enter a nursing home.

Specifies Where the Trust Principal Goes After Your Death

When you establish the trust, you decide who the income beneficiaries will be. For instance, you could name yourself, your spouse, and one of your children as present beneficiaries. In addition, you can specify what happens to the trust principal at your death. This ability to control the money post-death is an important feature to some people.

Tip: Of course, because this is an irrevocable trust, your decisions generally cannot be changed once the trust has been established.

Avoids Probate

Probate can be expensive and time-consuming. If all of your assets are contained within a trust, the probate of these assets may be avoided and your property will be disbursed without undue delay.

May Postpone Federal Gift and Estate Tax

With a special testamentary power of appointment, you include a provision in your trust document reserving the right to name in your will those people (from among a specified group, such as your children) who will receive the balance of the trust upon your death. According to federal tax law, you have not made a completed gift of the property at the time of the transfer to the trust if you reserve the right to determine who will receive your property at some later time.

Thus, federal gift and estate tax is avoided at the time of the transfer. However, because you retain the right to receive income from the irrevocable trust during your lifetime, the full value of the trust property may be includable in your estate for federal gift and estate tax purposes at the time of your death.

Tradeoffs

There are several tradeoffs that University of California employees and retirees should consider before engaging in this type of trust.

Featured Video

Articles you may find interesting:

Control Over Your Assets Is Lost

One of the biggest downsides to University of California employees and retirees is the loss of control this trust demands. The trust must be irrevocable in order to be an effective Medicaid planning tool. This means that once you have designed the trust provisions and transferred your resources to the trust, you have no further control over the money and assets and are powerless to change or terminate the trust. This can be a serious problem if you establish the trust many years before you enter a nursing home; your assets will be indisposed indefinitely. For this reason, it is probably not a good idea to transfer everything to the trust. However, these University of California employees should see below for a possible solution to a family cash crisis.

A Substantial Waiting Period Can Cause Problems

The waiting period can also cause issues for University of California employees and retirees. The look-back period for Medicaid with respect to irrevocable trusts is 60 months, and the value of assets transferred to the trust will affect how long you must wait before you can start to collect Medicaid benefits. Protection of expensive assets, therefore, will help to create a longer waiting period.

Moreover, if you establish an irrevocable trust and take ill before the end of the look-back period, you will be left without funds to pay your nursing home bills, and Medicaid won't pick up the tab in the meantime. For this reason, it is advisable to keep some assets out of the trust or to purchase long-term care insurance to cover yourself during the waiting period.

Might Be Ineffective In an Income-Cap State

If the amount of periodic income you receive from the irrevocable income-only trust is above a certain amount, your trust might be ineffective in an income-cap state. A number of states currently restrict Medicaid eligibility to those persons who have income below a specified amount. If you live in such a state, you will be ineligible to receive Medicaid benefits if your monthly income exceeds the threshold. In non-income-cap states, on the other hand, your eligibility would not be precluded; you would simply spend down the excess income on your medical care.

Is Ineffective If Your Net Worth Is Especially High

An irrevocable trust is not for very applicable for University of California employees with a high net worth. In fact, it's useless if you're extremely wealthy.

Example(s): Assume Alice transfers $1 million to an irrevocable income-only trust. Even with a 6 percent rate of return on the trust, Alice could more than cover the cost of a $3,000 per month nursing home on her own, since she'd be receiving $5,000 per month. Thus, Medicaid would not be obligated to subsidize her nursing home bills. Additionally, she'd lose control over the trust principal.

The Trust's Ability to Preserve Assets Varies By State

Although an irrevocable income-only trust can usually shield assets from the state while you are alive and preserve them for your loved ones after you die, this form of trust is not always effective; certain states will still have the ability to take away a portion of your trust.

Federal law gives states the option to adopt an expanded definition of 'estate' for Medicaid lien purposes; this definition can include both probate and nonprobate assets (to the extent of your legal interest in these assets at the time of death). Therefore, if you are the income beneficiary of an irrevocable income-only trust, the state could (in some cases) be entitled to collect the present value of your income interest at the moment of your death as reimbursement for the money it gave you over the years.

The Trust Property May Be Includable In Your Estate for Federal Gift and Estate Tax Purposes

Because you retain the right to receive income from the irrevocable trust during your lifetime, the full value of the trust property may be includable in your estate for federal gift and estate tax purposes. However, your applicable exclusion amount will shelter a certain amount.

How to Do It

If you are interested in setting up an irrevocable income-only trust, there are a number of steps you should follow:

Gather Your Information

Prepare a list of all your assets (and those of your spouse), indicating how title is held, the tax basis, and how much you paid for the asset.
Prepare a list of your (and your spouse's) income from all sources.
Indicate whether your resources are, for Medicaid purposes, exempt, not exempt, or inaccessible.
Prepare a list of all assets transferred within the last five years, whether by way of gift, trust, or otherwise. Indicate date of transfer, transferee, purpose, and consideration (what you received in return).

Consult A Medicaid Law Attorney

We recommend all University of California employees and retirees who are considering setting up this kind of trust consult a Medicaid law attorney. In recent years, Medicaid laws have undergone a number of changes. Indeed, because certain planning vehicles have been eliminated and most rules tightened, it is reasonable to expect that further changes will occur in the years ahead. It is vital, therefore, for University of California employees to consult an attorney experienced with Medicaid planning if they are interested in planning an irrevocable income-only trust.

An attorney will advise you of your options, make recommendations, and draft the actual trust document to best suit your needs. Moreover, your attorney should review your circumstances yearly to ensure that family circumstances (or a newly enacted, retroactive law) do not warrant a planning change.

Ascertain Your Cash Flow Needs

Because you are losing forever the right to your trust principal, make sure that your present cash needs will continue to be met through the receipt of trust income and/or the use of other assets that are not deposited to the trust. It's impossible to predict when or if you might require the services of a nursing home, so it is important to retain enough assets to cover normal living expenses in the meantime.

Also, because a transfer of assets to the trust during the look-back period will create a period of ineligibility before you can obtain Medicaid assistance, you must retain sufficient funds to pay your own nursing home bills if your health takes a sudden and unexpected turn for the worse during the look-back period.

Tax Considerations

Income Tax

Because an irrevocable income-only trust is a grantor trust, all income is taxable to the grantor (creator of the trust). The trust does not pay a separate income tax if you (the grantor) or your spouse is a beneficiary.

Federal Gift and Estate Tax

Questions & Answers

Below are answers to questions that many University of California employees will likely encounter when making the decision to set up this kind of trust.

What Are The Consequences When The Trustee of an Irrevocable Income-Only Trust Has Discretion to Give Both Income And Principal to The Donor-Beneficiaries But Chooses To Give Only Income? Will The Beneficiary Still Qualify For Medicaid?

The trust must specifically prohibit invasion of the principal for the benefit of the Medicaid applicant. Creditors (including the state) can reach the maximum amount of money that the trustee, under the terms of the trust, could have paid to the beneficiary.

Therefore, if the trustee has the discretion (or authority) to give trust principal to the beneficiary, the principal will be deemed an accessible resource, even if principal was never actually distributed to the beneficiary. That could disqualify you from receiving Medicaid benefits.

If Income From an Irrevocable Income-Only Trust Is Paid to a Husband And Wife Jointly, Is It True That The Healthy Spouse Is Entitled Only to One-Half of The Income When The Institutionalized Partner Applies For Medicaid?

That's generally true, but a planning opportunity exists in some states.

Tip: With respect to a married couple, an irrevocable income-only trust may provide that income shall be payable to husband and wife until such time as one spouse enters a nursing home. At that time, the institutionalized spouse's income distributions shall cease, and all the income shall be payable to the healthy spouse for life and then to the survivor for life. Upon the death of both, the trust will end, and the balance will be paid over to the trust's beneficiaries. There is no penalty for such an arrangement, since transfers between spouses are permissible. Absent such a provision, however, the healthy spouse could be entitled to only one-half of the income after the other entered a nursing home and applied for Medicaid.

If You Foresee A Need For Long-Term Nursing Home Care In The Near Future, Should You Transfer All Of Your Resources To An Irrevocable Income-Only Trust And Simply Live on The Income?

Probably not. Transfers into an irrevocable trust within 60 months of your entry into a nursing home and application for Medicaid will cause a waiting period or period of ineligibility before you can start collecting benefits. The more valuable the assets, the longer the waiting period. It is wise, therefore, to retain sufficient assets to pay your own way at the nursing home (if need be) until such time as the waiting period has expired and Medicaid can kick in.

If You Transfer Cash Into An Irrevocable Income-Only Trust, When Will You Be Eligible to Collect Medicaid Benefits?

It depends on whether the transfer occurred during the 'look-back' period or not. If the transfer occurred outside of the look-back period, you would qualify for Medicaid immediately (assuming all of the other eligibility requirements were met). If the transfer occurred during the look-back period, however, your eligibility for benefits might be delayed.

Example(s): Assume that Ralph used $144,000 to create an irrevocable income-only trust, naming himself as beneficiary and his son as trustee. Although Ralph is entitled to receive all of the income generated by the trust, he is precluded from receiving any principal. Two years later, Ralph entered a nursing home and applied for Medicaid. The average estimated cost of nursing home care in his state is $3,000 per month. Because Ralph transferred assets to a trust during the 'look-back' period (60 months), he will be ineligible to receive Medicaid benefits until 48 months have elapsed ($144,000 divided by $3,000 equals 48 months).

What If A Family Crisis Occurs Sometime After You Establish The Income-Only Irrevocable Trust? Is There Any Way To Access Principal If You Need Substantial Cash?

It is possible to build a 'safety valve' of sorts into the terms of the trust. With a married couple, for instance, the trust could give the trustee (a third party) discretion to make occasional distributions of trust principal to the couple's children. The trust could conceivably be dissolved (by the trustee's distribution of the entire principal) if family circumstances warranted it. It is important to note, however, that a trust established during the 'look-back' period cannot be used as a personal bank. Medicaid will review deposits into an applicant's bank accounts and construe excessive deposits (gifts from your relatives) as proof that the irrevocable nature of the trust was illusory.