When designing a trust to protect assets against nursing home spend-down, lawsuits, scam artists, undue influence from family or acquaintances, or other hazards, we use certain features over and over again.
These features make the trust more user-friendly, allowing the person establishing the trust (called the “grantor”) to receive income, change beneficiaries, and enjoy certain tax benefits. Other frequently used features make the trust work better, especially if the trust lasts a long time and circumstances change.
Keep in mind that trusts have different purposes, and the features discussed today are not right for every trust.
But for a typical, middle-class trust to protect assets during retirement years, these are some of my most frequently used features to make our clients’ trusts as effective as possible.
1. Distributions During Lifetime
A trust can allow the trustee to make distributions to beneficiaries during the lifetime of the grantor.
This feature allows the grantor’s family to have access to the trust principal, in case funds are needed to pay for care, cover unexpected emergencies, or simply to allow the grantor to lead a better quality of life.
As you may know from reading our other blog posts, an asset protection trust is irrevocable. The grantor has no access to those funds. But it is quite common for a trustee to make a distribution to a beneficiary, who will then pay for some need of the grantor.
For example, the grantor may require nursing home care four years after setting up the trust. The trustee may use distributions from the trust to pay for one year of nursing care. Then, if the grantor applies for Medicaid, the transfer of funds used to establish the trust will have been made more than five years before the Medicaid application, and will not be subject to any type of penalty.
Paying for that one year of care will protect the rest of the trust, but would not be possible if the trust didn’t have that provision allowing distributions during lifetime.
2. Put Checks and Balances on Distributions
Number 2 goes hand-in-hand with Number 1.
When giving power to the trustee to distribute money out of the trust, we want to make sure that power is not abused.
The answer is to place a safeguard on the trustee’s power. We usually add a clause to the trust that says the trustee may not act alone when making distributions during the grantor’s lifetime. The trustee must get written permission in advance, from a successor trustee (who was often another beneficiary) or from a person or entity that has been named as a “trust protector.”
We will usually specify that this requirement does not apply if the grantor is serving as trustee. The grantor then preserves the ability to make distributions of his or her choosing, while making sure that anyone else serving as trustee cannot act alone to distribute assets from the trust.
Unwise distributions could defeat the purpose of the trust, or even threaten the security of the grantor. So it’s wise to take steps to avoid that temptation.
3. Right to Receive Income
Someone who wants to set up a trust to protect assets may be relying on the dividends, interest, or other income generated by the investment of those assets.
Wouldn’t it be great if that person could protect those assets, while still receiving the income?
That is exactly how we often set up an asset protection trust. A trust can be irrevocable, which provides the asset protection, but still provide income to the grantor.
A so-called “grantor-type trust” has certain tax advantages too. The grantor can report income on his regular Form 1040, without having to file a separate Form 1041 for federal taxes. Income reportable to an individual is usually taxed at a lower rate than income reported by a trust. Assets in a grantor-type trust also enjoy something called “step-up in basis” upon the grantor’s death, which can reduce capital gains taxes. Those are just a couple of the tax advantages.
4. Right to Change Beneficiaries
Clients are often pleasantly surprised to learn that they can make a trust irrevocable but still preserve the ability to change beneficiaries later on.
When a trust is irrevocable, it can often seem so final. But if you have the ability to decide who gets the trust assets, and in what proportions, after you’re gone, it feels a lot like you still only assets.
Accomplishing that result is simply a matter of adding a “power of appointment,” in which the grantor reserves the right to change the beneficiaries through an amendment to his or her last will and testament.
Enjoying asset protection, while having a measure of control over those assets, is the best of both worlds.
5. Provide for Successor Trustees
A trust may last many years, even decades. You want to make sure that there is always someone reliable in charge of it.
Therefore, a good trust should provide a well thought out list of successors, who will take over the position of trustee if the initially named trustee can no longer serve. I recommend naming at least two successor trustees.
Another good strategy is to make the final successor trustee a corporate entity, such as a bank or trust company. If you’re concerned that the successors you name may not be around years from now, but the trust could be, the position of trustee can fall to a corporate entity that will likely have much more longevity than any person you know.
Finally, I like to give the grantor the ability to remove and replace any trustee, and to name additional successor trustees. That gives the grantor greater control over the trust, as well as the ability to make changes if circumstances are different in the future.
Final Thoughts About Asset Protection Trusts
Again, not all of these provisions are right for every trust. But they are so useful in adding value to the appropriate trust, we use them time and again.
If you would like to discuss what’s right in your situation, give us a call.