Seven Questions on Irrevocable Trusts (Part 2 of 2)

On one of my more popular YouTube videos, a subscriber asked 7 questions that were quite common and deserved a little more thought than just responding quickly in the comments. Here are the second three of the seven questions. Check out the full YouTube videos through the links provided below. Click here to read part one of this two-part series.

5) Can I have multiple trusts set up?

Yes, absolutely. But each trust should have its own specific purpose. Using Medicaid Planning as an example, we have what we call the “Two Trust Solution.” It’s actually four trusts, each with their own function and purpose, but the two main ones in the toolbox are the Irrevocable Family Trust and the Irrevocable Property Trust. The Irrevocable Family Trust is for sheltering money, rental properties (usually in LLCs), and other liquid investments.

The Irrevocable Family Trust completely takes the liquid assets off the table for nursing home Medicaid purposes five years after you transfer the assets into the trust, and you retain no right to the assets or income. The current trustee before you pass on is also the current beneficiary, so they can take out money, put it into their own bank account, and then turn around and pay for the things you need. All of the assets and income technically and legally are not yours, so it doesn’t count for Medicaid or inclusion as part of your taxable estate.

The Irrevocable Property Trust is for sheltering non-income producing real estate such as a primary residence and vacation homes. The Irrevocable Property Trust is actually an intentionally defective grantor trust, and you keep the right to the income, the right to live in the property, and certain other powers, and you also retain the responsibility for taxes and upkeep. Because you are retaining these certain powers and benefits, the real estate is included in your taxable estate which in turn means you get a “stepped up cost basis” upon death so that when the next generation sells the real estate, the capital gains taxes are computed based on the fair market value on your date of death and not what you paid for the real estate. However, these powers are not enough for the real estate to be considered your property for Medicaid planning purposes, and Medicaid can’t force you to “spend down” this real estate.

We also have a Special Needs Miller Trust and an Irrevocable Funeral Trust, each with their own specific purposes. The Special Needs Miller trust is in place in case you are in a state that has an income cap, and now the trust can be used to essentially convert income into an asset that needs to be spent down each month. This grew out of a lawsuit that reached this court-approved solution. For example, if a state had a monthly income limit on nursing home type Medicaid of $3000 a month, but nursing homes are costing about $10,000 per month, then that doesn’t make sense financially. If instead, the money went into the Special Needs Miller Trust, then the income would just need to go out to the nursing home each month if you were in one of those states. The Irrevocable Funeral Trust is put in place to put up to $10,000 into this type of trust to pay for funeral and other expenses if you have filtered, converted, and otherwise spent down just about everything else to qualify for Medicaid but there is still a few thousand dollars more. The money must be spent on funeral and related arrangements, but anything left over ends up going back to reimburse Medicaid.

These are just four trusts used in Medicaid planning concurrently, and they are described to illustrate the point that you can have multiple trusts set up, but each should have its own purpose and function. When it comes to estate planning, it is also not uncommon now for some of my clients to create an Asset Management Trust and an IRA Trust for each child as a way to protect their children from losing their inheritance to divorce, creditors, bankruptcy, or loss of public/disability benefits should the need arise.

6) How do I make my trust continue to generate dividends even after I pass on?

It is up to your trustee to invest money the right way, but this question often leads to clients wanting to impose their current specific investment philosophy that works for their benefit on to successive generations that may have a different economic climate and different needs as beneficiaries. That’s why I generally recommend that my clients NOT draft their specific philosophies into lasting legal documents. What you put into the trust language is mandatory, and must happen. If someone living in 1890 drafted a multi-generational trust that mandated that the trust forever maintain a stable of eight horses for the use of family transportation as well as a specific room with functioning butter churns, clothing looms, and a grain mill along with a minimum of five full time employees to keep these items functioning, then that would seem ridiculous to us in 2023. However, we have no idea how the financial and living situations will look even thirty years down the road will be.

Instead, the usual recommendation I give to clients is instead to give the trustee broad investment option powers, but then have a discussion or possibly leave an unsigned list of recommendations for the trustees to review. This way, they can assess your goals and find the best changing path to reach those goals without being tied down to any particular mandatory trust terms.

7) Can I include a clause of a percentage any of my kids can pull out of my trust annually after I pass on?

Yes, absolutely. When it comes to how assets in trust are invested, I recommend you leave that up to the trustee. As for how the money is distributed to the heirs, there should be some flexibility but also a firm end date but with some safeguards. Most of my clients look at the age of forty as a firm end distribution age. Up until age forty, the trustee has the discretion to distribute money, pay for expenses, and otherwise financially care for the beneficiary in a way that is best for them. This also includes potentially distributing the entire share to the beneficiary early if the trustee thinks it is warranted.

Why forty? Basically, most of my clients universally agree that if you haven't gotten your act together by the time you're forty, you're not going, so you might as well distribute the money at that point because holding it back isn’t going to force any more maturity. (You do have the option to distribute earlier, later, or maintain it for the life of the beneficiary and then distribute the remainder to other beneficiaries when that beneficiary passes on). The trustee also can simply say, “You’re twenty-eight years old, everything looks good with your life, and I don’t see a reason to hold this money back for another twelve years, so I’ll distribute it now.”

As for mandatorily distributing a percentage each year, there are two points to make. First, distributing the income generated on their share to the beneficiary each year make the trust’s taxes simpler. Second, it is a simple way to provide something to the beneficiary without potentially depleting the bulk of the inheritance too soon. So providing the income annually may not be as flexible as leaving distributions completely up to the trustee before age forty, but it also isn’t as potentially devastating as having a higher percentage of the assets be distributed each year to the point a bad economy for a few years in a row would wipe out the purpose of the inheritance in later years.

Full video: https://youtu.be/Ne0GVxBeeik