Estate planning is all about flexibility. If you cannot anticipate future contingencies and adjust accordingly, then you’re going to be stuck. When you’re stuck, you cannot protect either your assets or yourself. So how do implement flexibility in your estate plan to prevent from getting stuck? The answer is it’s all about the tools you use.
Trusts are one of the most valuable estate planning tools simply because of their ability to be flexible. Specifically, trusts allow you to integrate terms to anticipate just about any significant risk. But not all trusts are created equal. Just because a trust can be flexible, does not mean that all trust are flexible. Before we dive into what we mean by flexibility, let’s take a look the two main types of trusts.
The Revocable Trust
You may have heard this type of trust called the “living trust” or the “family trust”. Ultimately, regardless of the name, they tend to have a similar function. The best way to explain a revocable trust is it’s just a pot where you can put your stuff. Just like a pot, you can put things in and take things out as you please. The principal benefit of having a revocable trust is twofold.
First, the revocable trust avoids probate. And, while all trusts allow for probate avoidance, the revocable trust is the simplest method to consolidate assets for probate avoidance without otherwise tying those assets up.
Second, the revocable trust allows for you to plan creatively. You may have a plan for your estate that is more ambitious than the plain ol’ transfer of assets to spouse or children. For example, you may want to set up an education fund for your grandchildren. Maybe you have a farm and want to make sure it stays a farm for generations to come. A trust is the easiest and most efficient way to accomplish these goals.
The Irrevocable Trust
An irrevocable trust does everything a revocable trust does. The primary difference is who holds the power. In a revocable trust, the Trustee, the person who manages and administers the trust, is typically the Grantor, the person who made the trust. The result is that the Grantor’s ownership interest and power over the assets does not change once assets are deposited into the trust. For example, if you transfer your home into a revocable trust, where you are also the trustee, it is still your home and you have all the power to occupy, manage, sell, etc. that you had before. The asset transferred to the trust is still “in your name”.
Irrevocable means that the Grantor does not hold power over the trust and cannot retain power in the assets held by the trust. Since the Trustee is the person who manages the trust and therefore has power over the trust assets, the Grantor and Trustee cannot be the same person. Although, the trustee can be anyone other than yourself or your spouse, they can even be a child or sibling.
When a Grantor transfers an asset to the irrevocable trust, that transfer is a gift to the trust. The trust becomes the owner and the Grantor’s ownership interest in the asset is extinguished. The asset is no longer in the name of the Grantor once transferred; however, that does not mean that the Grantor cannot still benefit from the asset. For example, assets in an irrevocable trust can generate income and that income can be enjoyed by the Grantor. Likewise, the Grantor can occupy real property held by the trust.
Irrevocable Vs. Revocable
So why would anyone create and fund an irrevocable trust? The simple answer is protection of assets. A revocable trust is an amazing tool, but it does not always provide a comprehensive level of protection that may an individual may need based on the risks their assets face. Thus, when evaluating whether you may need a revocable versus irrevocable trust, it is first necessary to understand what risks your assets may face.
Probate is the process by which a Decedent’s assets pass to his or her heirs. This process is court mandated if the Decedent’s assets are not otherwise designated to pass directly to the Decedent’s heirs e.g. a trust or beneficiary designation.
The risk of probate is twofold: time and money. Let’s start with time. On average, a probate case can range anywhere from six months to two years. If any of the heirs sue or challenge the will, it can drag out the process considerably.
With regard to money, probate can be expensive. Probate can be demanding, and any executor will want to pay an attorney to take the burden off his or her shoulders. Further, probate is open season for creditors to come in and take a piece of the inheritance. Many people pay their bills as they come due, so they tend to not worry about creditors. However, most people’s probate creditors are from those debts incurred right before their death e.g. medical bills and nursing home bills. Both revocable and irrevocable trusts avoid the probate process.
- Long-term Care
Let me throw some numbers at you. Currently, 70% of individuals over the age of 65 will need some type of long-term care in their lives. This number is steadily rising because of the ageing of our population and the advancement of medical technology. With that being said, long-term care can range anywhere from $5,000.00 to $10,000.00 per month. Most individuals cannot afford that kind of bill and, even if they can, they will likely not leave anything behind for their loved ones.
A good option for many people, who do not have comprehensive long-term care insurance, is to utilize Medicaid to pay for long-term care. However, you first have to qualify for Medicaid and Medicaid can pose a risk to assets after you pass away. Not only does Medicaid set an asset threshold or ceiling for qualification i.e. a maximum amount of assets you may own and still qualify, they also want compensation for the money they pay out. The manner by which they receive this compensation is to take the Medicaid recipient’s remining assets when they die (we call this the Medicaid Death Penalty). In North Carolina, Medicaid is limited to only taking those assets passing through the probate process above. However, it is important to note that, among trusts, only an irrevocable trust can avoid the Medicaid Death Penalty.
Considering that there are some major benefits to having assets transferred out of a possible Medicaid recipient’s name and likewise avoiding probate, an irrevocable trust can be an amazing tool for asset protection.
Protection Vs. Control
The main consideration you must make in crafting your estate plan is: what’s more important for you, protection or control? The, perhaps, most valued aspect of a revocable trust is the amount of control the Grantor retains in the assets transferred to the trust (100%). Although, retention of all that control comes at a price, your assets still exposed to most risks.
Exposure to risk is not a good reason to brush the revocable trust off as a useless tool. In fact, depending on your particular situation, the revocable trust may be a better fit for you. For example, a young professional with a child, some assets, and fledgling retirement fund is a perfect candidate for a revocable trust. This person does not face the same risk for long-term care that someone retirement age would. They would need to ensure that they have their affairs in order if something were to happen to them i.e. distribution of assets and avoidance of probate. But they would not necessarily need to begin to transfer assets out their name to avoid the risks posed by nursing home bills.
Compare that example to someone retirement age who, over a lifetime, has built a retirement and acquired a significant amount of assets. This individual has more to lose and more opportunity for loss.
Let Them Have Cake and Eat it Too
The main goal in estate planning for any attorney is to get the best of both worlds for your client (also known as the “Hannah Montana approach” to estate planning). The thing is, you may currently benefit more from a revocable trust but you may also want the ability to benefit from the protection of the irrevocable trust in the future. In comes the Convertible Trust.
A convertible trust is one that converts from revocable to irrevocable upon a triggering event. With a convertible trust, you can have both control and protection. This type of trust allows you to start out revocable, so you can maintain all control and flexibility while your risk exposure is low. And, when your risk exposure is high—because of your age, health, or legal position—the trust converts, and you benefit from the protection of the irrevocable trust.
The conversion must be triggered by something that indicates you have a higher risk exposure than before. The trigger is built into the terms of the trust, so that the trust can automatically covert upon the triggering event. Some possible triggers that could be built into a convertible trust are: admission to a nursing facility; diagnosis of a debilitating physical ailment, such as Parkinson’s, or Multiple Sclerosis; or diagnosis of a cognitive illness, such as Alzheimer’s or severe Dementia. Note: you would not want to build in triggers that could be considered a fraudulent evasion of payment for debts or liability on litigation. For example, filing of bankruptcy or having someone obtain a civil judgement against you should not be triggers built into the trust.
No matter where you are in life, you should have a plan that works for you now and in the future. That plan could include a convertible trust or any of the other important estate planning tools that are available to you. To learn more about convertible trust and other estate planning tools, give us a call at (704) 259-7040 or look us up on the web at Mcelderlaw.com.
Brenton S. Begley
Elder Law Attorney
McIntyre Elder Law
“We help seniors maintain their lifestyle and preserve their legacies.”
PO Box 165
Shelby, NC 28151-0165