Asset Protection Planning: Five-Year Trust

To qualify for the Maine Medicaid (MaineCare) long-term care benefit, an applicant must have less than $10,000. Certain assets, like the primary residence, do not count towards this asset limit, but those assets are not protected from estate recovery. Estate recovery is when the State of Maine seeks reimbursement from the MaineCare recipient’s estate after death.

Asset protection strategies often involve gifting assets away to qualify for MaineCare and avoid estate recovery. However, if a MaineCare applicant has made gifts within five years, and if no exceptions apply, there will be a period of ineligibility. This is known as the “five-year lookback.”

A solution that works for many families is a Five-Year Trust (also called an asset protection trust). A Five-Year Trust is specifically designed to plan for the possibility of long-term care. When this type of trust is created and funded five years before long-term care is needed, trust assets are protected under the MaineCare rules. We recommend transferring assets to a Five-Year Trust instead of making outright gifts for these reasons:

• A Five-Year Trust protects trust assets from any creditors or liabilities a child might face during the parent’s lifetime.
• There are significant tax benefits to heirs in using a Five-Year Trust, including the step-up in basis upon death and the primary residence exclusion from capital gains tax.
• A Five-Year Trust preserves the individual’s estate planning goals regarding distribution of the assets upon death and retains some protections for the individual even though he or she is giving up control and ownership of the assets.
• A Five-Year Trust can also be beneficial in promoting transparency and family harmony.

The Key Players

1. Settlor: The settlor (also called the grantor or trustmaker) creates and funds the trust. The settlor may not be a trustee or beneficiary.
2. Trustee: The trustee legally owns the trust assets and manages them for the benefit of the beneficiaries. We suggest naming a trusted individual to serve as trustee and another to serve as successor trustee. You could also name co-trustees to serve together.
3. Lifetime Beneficiaries: During the settlor’s lifetime, the trustee may only distribute trust assets to the lifetime beneficiaries. Assets distributed to a lifetime beneficiary belong to that person. The lifetime beneficiary can choose to gift those assets to the settlor. This “trapdoor” to get assets back to the settlor is at the sole discretion of the trustee and the lifetime beneficiary receiving the distribution. This should only be used in emergencies. The goal is for the assets to remain in the trust during the settlor’s lifetime.
   
   The trustee has no obligation to distribute to any lifetime beneficiaries and can distribute in equal or unequal amounts. For that reason, it is helpful to name several loyal, trusted, and responsible lifetime beneficiaries so that the trustee has options if a distribution is needed. If real estate is transferred to the trust and there are lifetime beneficiaries other than children and grandchildren (such as in-laws, nieces, nephews, siblings, or friends), real estate transfer taxes will be due.
   
   
4. Remaindermen: The remaindermen are the final beneficiaries who receive the remaining trust assets after the settlor’s death. In that way, a Five-Year Trust is a “Will substitute.” In most cases, a Five-Year Trust mirrors the settlor’s Will.
5. Trust Protector: The trust protector can make certain changes to the trust if legally necessary. Trust protector provisions provide for maximum flexibility in the administration of the trust and can help resolve disputes among beneficiaries. The trust protector could be identified in the trust agreement, but more often the trust states that a trust protector could be appointed in the future if needed.

The Nuts and Bolts

• Irrevocability: The trust must be irrevocable. This means that after signing the trust agreement, the settlor cannot amend the trust, revoke the trust, or change their mind about the assets transferred into the trust. The settlor does retain the limited power to change the remaindermen. This is called a power of appointment.
• Distributions: The settlor no longer controls assets transferred to the trust. That means the settlor will not have access to the equity in any trust real estate, income generated on trust assets (rent, dividends, etc.), or proceeds if trust assets are sold. The trustee may not distribute trust income or principal to the settlor.
• Transfer Penalty: If an application for MaineCare long-term care benefits is filed, any transfer of assets within the preceding five years must be disclosed and a transfer penalty may be imposed. This includes any transfers to a Five-Year Trust.
• Tax Benefits: The trust includes a provision to preserve the personal residence exclusion from capital gains tax. This is relevant if the settlor transfers the home to the trust and the trustee sells it during the settlor’s lifetime. The trust also ensures that trust assets receive a step-up in tax basis at the settlor’s death. This is a benefit to heirs if assets have increased in value over the settlor’s lifetime.

The Most Common Questions

After establishing the trust, the settlor funds the trust with assets they wish to protect for the next generation. The settlor chooses what assets to transfer – funding the trust is not an “all or nothing” choice. These are some commonly asked questions regarding trust funding:

Will I have to pay tax when funding the trust?

It is extremely unlikely that any gift tax would ever be owed. The federal gift tax and estate tax combined lifetime exclusion amount for an individual is $13.61 million in 2024. The Maine estate tax threshold is $6.8 million for an individual. Estate tax applies to very few people.

The annual federal gift tax exclusion amount is $18,000 in 2024. (Maine does not collect a state gift tax.) If an individual gives more than $18,000 away in a calendar year, then the amount in excess of $18,000 counts against the giver’s lifetime exclusion amount. When funding the trust, it is prudent to file a gift tax return regardless of the fact that no tax will be owed.

Will I lose the homestead exemption?

The homestead exemption reduces the value of a home for property tax purposes up to $25,000. If the home is transferred to a Five-Year Trust, the settlor will lose the homestead exemption because the property will no longer be owner-occupied. This also means the settlor will not qualify for the Property Tax Stabilization Program which freezes property taxes for individuals over 65.

Can I transfer real estate subject to a mortgage?

Most lending contracts include a “due-on-sale clause” that authorizes the lender, at its option, to declare the loan due and payable if all or part of the property securing the loan is sold or transferred without the lender’s prior written consent. Typically, we suggest paying off any mortgages prior to funding a Five-Year Trust.

Can I transfer my retirement accounts to a Five-Year Trust?

Generally, we do not recommend funding a Five-Year Trust with retirement assets (IRA, 401(k), etc.) or any other liquid assets where the transfer or liquidation would have significant tax consequences.

Can I transfer my rental property to a Five-Year Trust?

Yes, income-producing property can be transferred to a Five-Year Trust. However, there are important considerations regarding the distribution, reporting, and taxation of income. Before funding, an attorney will discuss the pros and cons of transferring rental property to the trust.

The Main Idea

A Five-Year Trust is a secure and effective method for protecting assets for future generations. Whether this type of trust is the best asset protection strategy depends on the settlor’s goals and priorities, health circumstances, family dynamics, the type of assets to be protected, and any tax implications.

6/10/24