I want to talk to you today about a problem many of my clients are facing. They want to protect their assets, including retirement funds, in a trust like an irrevocable or convertible trust. Many Americans have much of their savings tied up in traditional Individual Retirement Accounts (IRAs) or 401ks painting an asset picture that is “Qualified Fund Heavy”. That means their funds are locked in tax qualified funds like traditional IRAs or 401ks. These retirement savings products seem like a great idea at first. They allow you to set aside money each paycheck, pre-income tax, and allows that money to grow. You are not taxed on the gains or in other words, there are no capital gains taxes on the growth of the investments inside of the IRA package. However, you are penalized 10% for any withdrawals you make prior to age 59 and you must start taking distributions from the IRA at the age of 72. The distributions from your qualified retirement assets can provide much needed income well into your retirement. However, these types of assets (401ks and IRAs) cannot be legally protected with estate planning tools like trusts. Simply put, your traditional IRA or 401k cannot be moved into a trust to be protected; not in their current form, at least. To be placed into a trust they would need to be liquidated first.
Why use a trusts to protect assets like retirement funds?
I know a statistic that should scare you. Seventy percent (70%) of those over sixty-five (65) years old today will need some type of long-term care during their lives. Long-term care costs can be in excess of $100,000 per year. For most of us, those costs far exceed what we can save during our lives. Therefore, our savings, retirement and homes can be threatened by this high cost of care. Trusts can be great legal, estate planning tools in which assets can be placed to be preserved for a family during their lives and then the remaining assets passed on to the children and grandchildren. Certain types of trusts can protect assets from being spent down to pay for long-term care if a benefit like Medicaid is used.
What types of trust are effective at protecting assets?
- Revocable Living Trust: When we are looking at activating a Medicaid benefit to pay for long-term care you need to use the right type of trust. A revocable trust is a trust where you are the trustee and have the right to revoke or otherwise cancel the trust. Because of this control over the trust and therefore the assets in the trust, when applying for a Medicaid benefit to pay for long-term care, those assets in this type of trust is still a countable asset to you and thus subject to the so-called “Medicaid Spend-Down”.
- Irrevocable Trust/Medicaid Asset Protection Trust: An Irrevocable Trust, however, let’s say one written specifically for long-term care Medicaid qualification, called a Medicaid Asset Protection Trust, would be a trust where you would not be the trustee and would not have the ability to revoke or cancel the trust. You are not in control of the assets, so to speak, but the trust has specific instructions written within for the trustee to maintain the assets within the trust for your use and benefit during your lifetime. You may also draw the income off any invested assets within the trust. The benefit of this type of trust is protection. The drawback is that you are not in control of the assets within the trust. You are not the trustee. Many clients will appoint the duty of Trustee to a trusted child or family member. In some cases this duty is undertaken by an attorney. In either case, there is a legal, fiduciary duty written within the trust for the trustee to maintain the investments and real estate within the trust for the use and benefit of the Grantor(s), you or you and your spouse, during your life or lives. Then the property in the trust would avoid probate and pass directly to beneficiaries of your choice or be held in trust for their use and benefit also under your instruction. This type of trust can be a great asset protection tool to protect retirement benefits, homes and other savings and real estate.
- Convertible Trust: Want the control of the revocable living trust with the asset protection of an irrevocable trust? A convertible trust may be for you. Some clients aren’t ready to relinquish control of their home and other assets to a third party trustee but they still yearn for the asset protection qualities, long-term, of an irrevocable trust. A convertible trust allows a couple or individual to be their own trustee and then, like the name implies, converts to an irrevocable trust when either the grantor (you) elects by signing a short amendment or a grantor becomes incompetent or incapacitated. In the case of a grantor becoming incompetent or incapacitated the trust will shift to become irrevocable to protect the assets within for the use and benefit of the grantor but also to protect the assets from a future long-term care Medicaid spend-down. This trust can present a great option for those who are not yet ready to give up control but also want future asset protection for assets within the trust. It can truly present the best of both worlds.
Why won’t Qualified Funds like IRAs and 401ks fit into a trust?
Tax qualified funds like traditional IRAs and 401ks are already wrapped in a “special deal” where there are advantages for keeping the money, an early withdrawal penalty of 10% prior to 59 years old and a mandatory annual withdrawal starting at 72 years old. Withdrawals are taxed at the income tax rate of the individual that particular year. Traditional IRAs or 401ks cannot be placed into a trust mainly because the money has to be moved out of those assets prior to the leftover, post-taxed funds being placed into the trust. Once in the trust the money can be invested into most any investment vehicle like stocks, bonds, etc. These investments can then be managed by yourself or a financial planner. The grantor of the trust, even if the trust is irrevocable, can still take the income distributions from the invested assets in the trust. So the question becomes: Do I leave the retirement funds alone and vulnerable to a long-term care spend down or do I liquidate those funds and move them to an irrevocable or convertible trust?
What is the best plan?
We work with clients daily to develop comprehensive plans to protect homes, other real estate, savings and yes, retirement. Here are some key points to focus on when deciding to move your tax qualified retirement funds to an irrevocable or convertible trust:
- Tax rates are historically low right now and may rise in the future. Tax rates have recently been at historically low levels. Due to recent crises do you think an income tax increase is in the cards for the future? The government controls the income tax rates and therefore how much of a bite they can take out of your traditional IRA or 401k distributions. If you wait until income tax rates are higher to withdraw your funds then you could be sacrificing a larger portion to taxes than if you acted to start taking withdrawals and moving funds into a trust now. If you did start now that would certainly put you in control and take you out of the position of falling victim to higher tax rates later.
- If you do not have long-term care Insurance your traditional IRA and 401k assets are exposed and unprotected. Certainly, seeking long-term care insurance would be a great answer if available to protect retirement assets and to allow you to private pay for any in-home, nursing home or assisted living care you may need as you age. However, the reality is that many can simply not afford long-term care insurance. Long-term care insurance may turn you down as you reach a certain age limit or with pre-existing conditions. If you do not have long-term care insurance and your retirement assets are not protected in a legal, estate planning tool like an irrevocable trust, then know that it is exposed. The retirement assets are subject to being used to self-insure against a long-term care crisis or be subject to a Medicaid spend down if that benefit is to be used.
- Developing a plan to move the money into an irrevocable trust now or over a few years may save the money in the long run and the taxes paid on withdrawals now may be lower than taxes paid after a tax increase. The benefit being protecting the retirement asset versus losing it to a long-term care crisis. Planning and taking control is essential to peace of mind and to financial health over the long term. A move of assets from a tax-qualified asset into a trust may be immediate or it can be planned and spread over a period of years. Consider the chart below:
* this chart does not factor or show income tax payments based on withdrawals. For an estimate of income tax payments due after withdrawals from a traditional IRA or 401k please consult your income tax professional.
Is it time to start a move from an unprotected retirement asset to a protected trust investment fund?
We at McIntyre Elder Law would be glad to meet and discuss just that question in an effort to help you reach the right answer for you. We are offering FREE consultations to discuss these matters. Please call out office at 704-749-9244 or go online to: mcelderlaw.com/bookfreeconsult to schedule a FREE consult with an attorney.
Greg McIntyre Elder Law Attorney
Elder Law Attorney