In a prior blog post, we discussed whether a will or trust might be needed for an estate plan. Another common question is: what is an irrevocable trust and do I need one? Irrevocable trusts have their place in estate planning but not everyone needs one nor should everyone have one.
Most trusts are revocable trusts. These types of trusts can be amended or revoked by the grantor (creator) any time until the time of death. Additionally, assets can be transferred into and out of the trust at will by the grantor. In essence, a revocable trust is one and the same as the grantor until the grantor passes away.
An irrevocable trust is what its name implies – once established, it cannot be changed except for a few notable exceptions. There are different kinds of irrevocable trusts but the most common is used to protect assets from nursing home costs and/or creditors. For this article, we will focus on an irrevocable trust to protect assets from nursing home costs.
The idea of the irrevocable trust is to transfer the assets to be protected into the trust. After transferring the assets to the trust, the original owner has no further ownership or control of the asset. The owner has also given up all rights to receive the assets back from the trust. Because the original owner cannot have access to the protected assets, neither can a nursing home or creditor. Note: assets are not protected from a nursing home until five years after the date of the transfer.
When the trust is established by the original owner, they will name a trustee for the trust. The trustee has the legal duty to manage and oversee the trust and trust assets. The trustee must follow the terms of the trust but otherwise has no duty to the original owner. The trustee can be anyone other than the original owner. The trustee is often a child or children of the owner.
The trust can be set up with specific requirements. For example, the original owner may state that the trustee does not have authority to sell any farmland held by the trust. The trustee must follow the directives of the irrevocable trust. Also, the irrevocable trust will act just like a revocable trust at the original owner’s death. That is, the same distribution plan provisions that might be included in a revocable trust and can be included in an irrevocable trust.
Let’s look at an example to help explain how an irrevocable trust works:
Mom and Dad own 300 acres of farmland that has been in the family for many generations. They also own some retirement accounts and investments. They are concerned that if one or both go into a nursing home, they may run out of money and be forced to sell land to pay for their care.
Mom and Dad establish an irrevocable trust and transfer the 300 acres into the trust. They name Son and Daughter as co-trustees of the trust. The trust terms include a provision that the land cannot be sold while Mom and Dad are alive. At Mom and Dad’s death, the trust requires the Smith Farm to go to Son and the Jones Farm to go to Daughter with a right of first refusal to each other.
Ten years after they set up the irrevocable trust, Mom and Dad go into a nursing home. After being in the nursing home for a few months, they run out of money to pay for their nursing home care. The nursing home cannot foreclose on the land to be paid. Mom and Dad do not own the land and the 5-year penalty period has expired. Because Mom and Dad own no assets, they will likely be eligible for Medicaid assistance for their nursing home care.
Upon Mom and Dad’s death, the trust’s distribution plan will cause the Smith Farm to go to Son and the Jones Farm to go to daughter with the right of first refusal.
As the example shows, an irrevocable trust can protect assets against nursing home costs and creditors. It can also act as part of the estate plan by including distribution provisions for the heirs and beneficiaries upon death.
The biggest disadvantage of an irrevocable trust is that it cannot be undone. Upon the assets being transferred into the irrevocable trust, they will never be owned by the original owner again. Deciding upon an irrevocable trust requires the owners to give up full ownership and control of the assets. This can be a difficult decision for the owner, especially for farmers giving up ownership of their land.
The best candidates for irrevocable trusts are typically older, retired farmers who no longer need their land for collateral to buy other land or assets. For farmers who are still actively farming and may need their land for collateral, an irrevocable trust may hinder the growth of their farming operation. Before establishing an irrevocable trust, be sure to talk to an attorney about the advantages and disadvantages of an irrevocable trust to determine if it is the best strategy for you.