We as attorneys, and sometimes even our clients, hear so much about trust funding, but rarely is it truly understood. I would like to outline a few essentials when doing trust funding to ensure that the underlying estate plan works as intended.
The first key step in any trust funding strategy is to identify what type of estate plan the client is pursuing. A traditional revocable living trust is an estate plan wherein the client identifies who gets to benefit from the client's assets when the client is well, disabled, and after death. A critically important point to funding a revocable living trust is if all assets funded in the trust are still 100 percent available to creditors, predators, and long-term care costs of the grantor while alive. The assets can continue to be made available to the creditors and predators of the beneficiary after the death of the grantor without proper planning (more on that later). In the alternative, if a client has opted to do an irrevocable trust for asset protection and/or current or future benefits eligibility (we call these IPUG® trusts) then funding is much more important, because assets are not protected from third-party predators until funded, and they're not protected from long-term care costs until funded and any related penalty period for the conveyance of the trust has expired.
Therefore, funding in asset protection or benefits eligibility is significantly different. Finally, if the client has done a trust predominantly for estate tax planning to ensure that assets are not included in the grantor's taxable estate, or to minimize the taxes on them, funding takes on yet another unique importance. Finally, regardless of what type of planning, we also need to look at the types of assets we are funding. For example, funding a home has several options as well as funding an IRA or other tax-qualified assets. So examine the differences and determine how to fund properly.
The first questions we must ask are, what type of planning has the client done and what type of assets is the client funding? If a client has done a revocable living trust, then funding is important to ensure that the trustee actually has the authority over the client's assets to administer them in the manner that has been identified by the client in the trust. If funding is not completed or properly done, a "pow will" usually cleans up any missed items at death by ensuring that any assets not funded that go through probate name the trust as beneficiary. Unfortunately, if the client doesn’t die but instead becomes incapacitated, failure to fund a revocable trust has more dire consequences. In addition, failure to fund assets to the trust does not eliminate probate, one of the primary benefits of having a revocable living trust to ensure the plan is carried out without the excess costs, delays and frustrations of probate to the client’s family.
In stark contrast to revocable trust planning, when planning for asset protection or benefits eligibility, funding becomes the most critical element to which all protection occurs. For example, if an asset is funded into an irrevocable asset protection trust today, it is protected from any and all claims that arise after the funding. More definitive, if planning for benefits eligibility, the funding of the last asset becomes most critical, as all assets funded to a trust will be subject to Medicaid's review of that transfer for up to 60 months. At Lawyers with Purpose, we call this the "look forward™" period. When funding an irrevocable trust for benefits planning, the look forward on the final conveyed assets will trigger protection of the assets. For example, if a client has $500,000 to fund and only funds $450,000 of it, and two years later remembers to finally fund the last $50,000, the $450,000 conveyed initially will have a 60‑month look forward, but the $50,000 conveyed two years later will have its own separate 60-month look forward that will extend years beyond the expiration of the previous trust transfer. That is why it's essential when benefits eligibility planning that funding be done in a timely and effective manner to ensure that the look forward is minimized.
For estate tax planning, obviously the funding of assets becomes critical by use of the Crummey power if life insurance or any gift-discounting techniques are being used, since the funding must be used to pay the insurance premium and must specifically relate to any special valuations that are obtained at the time of funding.
Although funding is a critical element in each type of planning, what can complicate it further is the type of assets being funded. For example, let's consider funding a home. For a typical revocable living trust, the funding of the home ensures that there will be no probate on the home but still makes the home available to creditors (if not protected by some other state statute while tenancy by the entirety), or it can become a recoverable asset after death if Medicaid benefits are received. While the home is exempt for married and single applicants, it can be subject to estate recovery after death for all funds paid on behalf of the applicant during their lifetime. See my related article on Estate Recovery - What Can (And Can't) They Get. Finally, a recent case in Massachusetts suggests that having a trust that allows the grantor to reside in the house makes the entire value of the house an available resource in determining the client's eligibility for benefits. See my post on Nadeau v. Thorne – No Reason To Fear. This adds additional complications in funding, since attorneys may now choose to reserve a life estate in the deed rather than fund the entire property to the trust and risk its loss as an available resource. Finally, transferring a house or second home to a qualified personal residence trust is a gift-discounting technique often utilized by those subject to estate tax. Again, the funding of these properties into the trust, and the subsequent survival of the grantor during the term in which the interest is held, is essential to maximize the estate tax reduction.
The other major asset to be considered in funding is the IRA. The Supreme Court in Clark v. Rameker decided in June 2014 that IRAs are not protected for those who inherit them. There is an obvious exception for an IRA that names a spouse beneficiary, who then combines it with an existing IRA. While this ensures IRA protection from general creditors, an IRA is not exempt in determining one's eligibility for Medicaid, and therefore, leaving an IRA to a spouse can expose the entire IRA balance to the surviving spouse's nursing home costs. Federal Medicaid laws are absolute: an IRA is an available resource, unless it is annuitized. Although some states have liberalized the interpretation of annuitization (i.e. many states deem they were payouts of RMD to satisfy the annuity executor) it is not the federal law, but merely state policy, which could be changed at any time without notice. Over the last few years, several states have changed their policy, thus making assets that were presumed to have been protected immediately available for long-term care costs.
The naming of a beneficiary of an IRA and other qualified or beneficiary designated accounts to the trust is now essential to maintain the asset protection intended. For example, even for a young couple with no assets, a $250,000 life insurance policy that pays to the spouse at death could be a catastrophe, as young people often get remarried or make unwise decisions. One should be cautious and ensure that all or part of a life insurance policy for a young couple names a separate share trust under a will for the benefit of the minor children, so as to ensure that the surviving spouse does not squander the proceeds, and that they are used as intended by the client. Finally, as we look at trust funding, it is essential to have a key system in place to ensure that your funding is done in a timely and appropriate manner. How assets are funded, the timing of assets funding, and the beneficiary designation utilized in funding for after death, are essential to ensure that the underlying goals of the client are achieved.
To have learn more about the support and systems to fund clients' plans properly, contact Lawyers with Purpose now. If you want to learn more about who we are consider joining our FREE webinar this Thursday, April 21st. Discover how to build a thriving Estate, Elder and Asset Protection practice that attracts higher quality clients, generates an endless supply of referrals and continuous exposure in the community … without working 80 hours a week or breaking the bank! Reserve your spot today, just click here now.
David J. Zumpano, Co-founder – Lawyers With Purpose