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Funding a trust is critical when you have a trust-based estate plan. A trust is a receptacle, like a box. Before you fund the trust, it’s like the box is empty.

You fund a trust by retitling assets into the name of the trust. Let’s say you have several items that you want in the trust. Let’s say you have items A, B, C, and D that you want to go to the trust. Let’s say you fund assets A, B, and C to the trust, but forget about item D. Maybe it’s an asset you don’t see frequently and it completely slipped your mind. Assets A, B, and C are in the trust and will avoid probate. Item D isn’t in the trust and will need to go through the probate process (assuming no non-probate transfer process applies to it, such as a beneficiary designation).

In some states, probate can be a costly and time-consuming undertaking, depending upon the nature and extent of the assets subject to probate. Typically, if it’s not real estate, a small amount of assets (which varies by state but typically is less than $100,000) can pass through probate using the express lane of “summary” proceedings where the formalities are loosened. In some states probate even above these levels isn’t as costly or time-consuming. It just depends upon your area.

But, if your trust is fully funded, the assets don’t need to go through the probate process. The Assignment and Nominee agreement is one way used by attorneys to fund the assets into the trust. Here’s how it works.

An Assignment and Nominee agreement has two parties, the “Trustee” and the “Trustor” (also known as the “Grantor” or “Settlor”). The Trustee is the person in charge of the trust assets. The Trustor is the person who sets up the trust. Sometimes they are the same person. In fact, most commonly they are the same person.

Let’s say Mike sets up a trust, so he’s the Trustor. He also names himself as the Trustee to manage the trust. So, he’s wearing both hats. With an Assignment and Nominee agreement, Mike as the Trustor assigns assets to the trust, thus transferring them to it. Then Mike, as the Trustee who manages the Trust, sends them back to Mike, in his individual capacity, (i.e. as Trustor), to hold the assets for the trust for safekeeping. So, even though the asset is back in Mike’s hands, it is owned by the trust and for the trust.

Typically, you’re going to transfer most items by some other method, such as changing titles on each asset directly. But when you’ve forgotten about an asset, the Assignment and Nominee agreement can be a belt and suspenders approach to move that forgotten asset into the trust.

The Assignment and Nominee agreement is not a panacea, rather it is a backup to traditional methods of transferring assets into the trust. Also, the agreement by its own terms doesn’t apply to some assets, such as retirement plan assets.

Funding a trust is essential. Otherwise, the trust is like an empty box. The Pour-Over Will might move the assets into the trust at death, but that would be through the probate process. Also, you would have lost any lifetime benefit of the trust, such as management of the assets during a period of incapacity.

An Assignment and Nominee agreement can act as a backstop on the important funding process.

This article examines the application of the “Transfer for Value” rule and how to navigate around that rule while keeping the life insurance out of the taxable estate.

In the first article in the series, we saw that life insurance is included in the taxable estate if owned by the insured, even if the beneficiary isn’t the insured or their estate. In that article, we also saw that gifting the insurance to an irrevocable trust could remove it from the taxable estate, but there would be a three-year waiting period for the removal.

So, what could Mary do if she wanted to remove the policy from her estate right away? She could sell the policy to the trust for its fair market value. Let’s say the fair market value of the policy is $50,000. If Mary contributes $50,000 to the trust and the trustee of the trust purchases the policy from Mary, Mary wouldn’t have to wait the three years to remove it from her taxable estate. However, while this will solve Mary’s estate tax issue, it may cause the death benefit to be income taxable.

Normally, the life insurance death benefit isn’t included in taxable income due to section 101(a) of the Internal Revenue Code. But if the insurance had been transferred for valuable consideration, then it is subject to income taxation, except to the extent of the consideration paid, unless an exception to the Transfer for Value rule applies.

Here’s what would happen in our example of Mary and her trust: Mary owned a policy on her life. It has a death benefit of $3 million. She sells it to an irrevocable trust (which is not a grantor trust as to Mary) for its fair market value of $50,000. Mary dies and the trust receives the death benefit of $3 million. The trust will face income tax on the amount it receives, $3 million, less what it paid, $50,000. The trust will likely pay more than $1 million in tax on the $2,950,000 in taxable income from the life insurance death benefit. But there’s a way to draft the trust to fall within a safe harbor of the Transfer for Value rule.

There are 5 safe harbors from the Transfer for Value rule:

1. A transfer where the transferee derives their basis from the transferor. This would be in the case of a gift, typically. However, this rule has a couple of carve-outs such as if the policy had already been tainted by the Rule, a transfer by gift isn’t going to cleanse it. It just won’t create a taint itself.
2. A transfer to the insured. So, a sale of a policy to the insured will not be subject to the Rule because of this safe harbor. Importantly, a trust which is drafted as a grantor trust falls under this safe harbor.
3. A transfer to a partner of the insured.
4. A transfer to a partnership in which the insured is a partner.
5. A transfer to a corporation in which the insured is an officer or shareholder.

If the trust to which Mary sells the life insurance had been drafted as a “grantor trust” as to Mary, the sale of the policy to the trust would not trigger the Transfer for Value rule since the sale would have been considered the same as a sale to the insured herself, Mary, for income tax purposes. In that case, the trust would receive the $3 million death benefit and it would not be included in taxable income for the trust.

The Transfer for Value rule is just an example of the complexity which can be involved when considering the removal of life insurance from the taxable estate. It’s best to consult with an attorney who focuses their practice in estate planning so you and your loved ones can avoid the many traps out there.

First, why is life insurance in the taxable estate? Section 2042 causes inclusion in your estate if the life insurance on your life is either i) paid to your estate, or ii) if you had any significant control over the policy. Even if your estate wasn’t the beneficiary of the policy, if you could change the beneficiary of the policy or pledge the policy, among other things, it would be included in your taxable estate.

For example, Mary had a policy on her life that would pay the beneficiary, John, $5 million at her death. Assuming Mary has “incidents of ownership,” such as the ability to change the beneficiary, the policy on Mary’s life would be included in Mary’s taxable estate even though neither she nor her estate is the beneficiary.

Mary could remove the policy from her taxable estate by transferring it to an irrevocable trust, often called an “Irrevocable Life Insurance Trust” or “ILIT.” Mary should not be the trustee of the ILIT nor retain control over who is the trustee of the ILIT. Further, Mary cannot be the beneficiary nor change the beneficiaries of the ILIT without causing inclusion in her estate. But, at the outset, Mary can choose whomever she wants (other than herself) as the beneficiaries of the ILIT, like her three children.

If Mary makes a gratuitous transfer to the ILIT, then she would be making a gift of the current value of the policy, which would likely be far less than the death benefit. This may not be a concern if the value is low. However, if the policy is gifted, the policy’s death benefit would still be included in Mary’s taxable estate for three years after the transfer due to the application of another code Section, Section 2035, which only comes into play in certain narrow situations, including this.

So, what could Mary do if she wanted to remove the policy from her estate right away? She could sell the policy to the trust for its fair market value. Let’s say the fair market value of the policy is $50,000. If Mary contributes $50,000 to the trust and the trustee of the trust purchases the policy from Mary, Mary wouldn’t have to wait the three years to remove it from her taxable estate. However, while this will solve Mary’s estate tax issue, it may cause the death benefit to be income taxable.

A Power of Attorney is a document by which you appoint someone as your “Agent” to act on your behalf. If that Agent is unwilling or unable to act, the document can appoint one or more successor Agents. While a Financial Power of Attorney appoints an Agent to make financial decisions for you (as outlined in the first article in the series), a Healthcare Power of Attorney appoints the Agent to make Healthcare decisions for you. With a Healthcare Power of Attorney, when you are unable to make Healthcare decisions for yourself, your Agent is empowered to make them for you.

Let’s look at an example:

Mike is 19 and in college. Mike’s parents are divorced. Mike has named his father, Harry, as his Healthcare Agent. Mike fell ill due to COVID-19. He passed out and was brought to the hospital. The doctors needed to make decisions regarding his care and which of two routes to take in his treatment. Mike’s mother wants the doctors to take the first course of action and see what happens. Mike’s father wants the doctors to take the more aggressive course of action and put him on a ventilator until he improves. Because Mike named Harry as his Healthcare Agent, the doctors take the second course of action and put Mike on a ventilator and he recovers completely.

Sometimes a Healthcare Power of Attorney also includes a portion that is sometimes called an “Advance Directive” and sometimes called a “Living Will.” Often this portion could be in a completely separate document. It just depends upon the jurisdiction.

The U.S. Supreme Court, through sad cases such as Cruzan and Schiavo, has said the intent to be removed from life support when there’s no hope of recovery may be carried out if that intent is expressed clearly.

The Advance Directive or Living Will expresses your intent regarding what should happen to you if there is no reasonable hope of recovery. In other words, it expresses your intent regarding end-of-life decisions. Do you want to be kept on life support as long as possible, even if there is no hope of recovery? Or, if there is no reasonable chance of recovery, do you want to be kept out of pain to the extent possible, even if it might hasten your death? The decision is yours. Nobody wants to think about the possibility of being in a situation like that. But, if you express your end-of-life decisions now, your wishes can be carried out and your family can know they did what you wanted. Your expression will also help to circumvent a protracted battle among family members regarding what should happen, like the years-long battle in the Schiavo case. A Healthcare Power of Attorney ensures your healthcare decisions are made by the people of your choosing. An Advance Directive expresses your choice regarding end-of-life decisions. Both of these documents help avoid conflict among your family members regarding your treatment.

I wrote earlier that a Power of Attorney is a document by which you appoint someone as your “Agent” to act on your behalf. If that Agent is unwilling or unable to act, the document can appoint one or more successor Agents.

But what is a “HIPAA” Power? First, “HIPAA” is the Health Insurance Portability and Authorization Act of 1996. That Act brought about many things, including enhanced privacy in your health records. While HIPAA protections are a great addition to the law, they can thwart people who have a legitimate need to access your records, unless you give them the appropriate authorization. A “HIPAA” Power, otherwise known as a “HIPAA” Authorization, allows designated people to access your protected health information.

Why do you need to give others access? Without access, others may not even know that you were brought to the hospital, are in the intensive care unit, or your condition and needs.

Who would you authorize to access your protected health information? Typically, you’d grant access to your Agents under your Healthcare Power of Attorney and your Financial Power of Attorney. This allows those Agents access to information about your condition. For example, the Agent under the Healthcare Power of Attorney would require this information to make prudent decisions for your benefit. Similarly, the Trustee or Successor Trustee under your Trust should also have access for similar reasons.

Let’s look at an example: Mary was 75 years old. Mary was at lunch with a friend and they were in an accident on the way home. They were taken to the hospital. Mary’s friend suffered only minor injuries, but Mary was in a coma from her injuries. Mary’s friend alerted Mary’s family. Mary’s family encountered problems when they tried to find information about Mary’s condition. With a HIPAA Power, Mary’s family would be able to discuss Mary’s condition and prognosis with her healthcare providers and see her records.

Without the HIPAA Power, Mary’s family may not be able to learn of her condition. Her Successor Trustee under her Trust wouldn’t know that she was incapacitated and that the Successor Trustee was called upon to step up to serve. Similarly, the Agent under her Financial Power of Attorney wouldn’t know that Mary was incapacitated and that the Agent was called upon to serve.

With the HIPAA Power granting authorization to her Agent under the Healthcare Power of Attorney, her Agent under the Financial Power of Attorney, her Successor Trustee of her Trust, and designated family members, she can rest assured that those upon whom she relies can have the information they need to make decisions for her in her time of need.

Make sure you have laid the foundation for even the most basic estate plan: A Financial Power of Attorney, a Healthcare Power of Attorney (and Advance Directive), and a HIPPA Power (or Authorization).

By now, most IRA owners have heard the bad news. The SECURE Act eliminates the stretch IRA for the majority of beneficiaries who inherit in 2020 or later. Instead, for most, a 10-year payout rule will apply. Here is how this new rule works and how, for some beneficiaries, there may be new planning opportunities available.

How It Works
This new 10-year rule works like the old 5-year rule worked. There are no annual RMDs. Instead, the entire account must be emptied by the 10th year after the year of death. In the 10th year following the year of death, any funds remaining in the inherited IRA would then become the required minimum distribution (RMD). If the funds are not taken by the deadline, a 50% penalty would be owed.

The Opportunities
While many IRA owners will miss the stretch IRA, for some, the 10-year rule may be beneficial. Even when the stretch IRA was available, not all beneficiaries used it. Not every beneficiary was interested in keeping an inherited IRA open for years and years. Some beneficiaries want the money faster. For them, the 10-year rule is a good fit.

Those beneficiaries that did take advantage of the stretch were locked into a rigid annual RMD schedule. The annual RMD had to be taken regardless of the beneficiary’s tax situation or there would be a 50% penalty. There were no other options.

What the new 10-year rule offers is flexibility. During the 10-year period, the beneficiary may choose to take nothing during a particular year or large distributions in others, as long as the account balance is emptied by the end of the 10-year term. This provides a tax planning opportunity. Distributions can be structured in such a way as to minimize the tax hit. There are no restrictions as long as the account is emptied by the end of the tenth year following the year of death.

The 10-year rule also provides a big opportunity for Roth IRA beneficiaries. Distributions from inherited Roth IRAs are almost always tax-free. A beneficiary could take no distribution until the tenth year, leaving all the earnings in the inherited Roth IRA to grow tax-free. The account could then be emptied in the tenth year after years of tax-free growth with no tax bill for the beneficiary.

Good Advice is Essential
Maybe you inherited an IRA in 2020 and are concerned about the 10-year rule. Or, maybe you are considering your estate plan and are thinking about how your beneficiaries will fare under the new rules. Now is a good time to consult with a knowledgeable tax or financial advisor. While the stretch IRA will be missed, the SECURE Act 10-year rule allows for new planning opportunities for those willing to think outside the box.

First, what’s a Power of Attorney? It’s a document by which you appoint someone as your “Agent” to act on your behalf. If that Agent is unwilling or unable to act, the document can appoint one or more successor Agents. In other words, you give someone else (the Agent) powers you inherently already have yourself. With a Financial Power of Attorney, otherwise known as a General Durable Power of Attorney, you appoint your Agent to make financial decisions for you. The Power could be drafted to be “immediate.” In other words, the Agent would have the power to make decisions regarding your financial assets right away and without regard to your ability to make those decisions for yourself. In most states, you could make the Power “springing,” in other words it would only become effective upon your not being able to act for yourself because of incapacity. A Power of Attorney is “durable” if it continues notwithstanding you having incapacity. A Power of Attorney which is not durable would not allow your Agent to act during your incapacity.

The most useful and most common Financial Power of Attorney is one that is “general.” In other words, it is effective as to all your property. You could have a Power of Attorney that is “specific,” in other words it only applies to a particular property or for a particular purpose.

Let’s look at an example:

Mary is going to Europe for a semester abroad. She has a car which she wants her father, Harry, to sell for her. She signs a Financial Power of Attorney in which she appoints Harry as her Agent. The Power would need to be immediately effective as Mary is not expecting to have a period of incapacity. She could have the Power prepared so that it is specific to the sale of her car. Or, Mary could have the Power prepared as a general power.

Let’s look at another example:

Harry has a Power of Attorney prepared and wants his wife, Betty, to act for him in the event he becomes incapacitated. He has a Power of Attorney prepared to appoint his wife, Betty, as his Agent. His daughter, Mary, is his successor Agent. If Harry’s Power of Attorney is springing, Mary could act only upon Harry’s incapacity. Harry’s incapacity is defined in the Power, such as a certification of incapacity by two physicians. Harry has a Power of Attorney which is a “hybrid” in which it is immediately effective when his spouse is acting as his Agent, yet it is “springing” when anyone else (such as Mary) is acting as his Agent.

With these Powers of Attorney in place, Mary can travel to Europe and rest easy that Harry will be able to sell her car for her while she’s hiking in the Alps. Meanwhile, Harry can rest assured that his Power of Attorney will enable Betty and Mary to act for him if needed.

Powers of Attorney add great flexibility to an estate plan. However, sometimes an Agent under a Financial Power of Attorney could encounter resistance to its use from financial institutions which have been defrauded through the use of Powers of Attorney. For this reason, trusts may offer better incapacity protection than Financial Powers of Attorney, though Financial Powers of Attorney are a good idea even with a trust-based estate plan.

Medicaid is a partnership between the state and federal governments to provide medical benefit assistance to people, including those over age 65, who have financial need.

In order to be considered to have financial need, when you go into a nursing home and go on Medicaid, you cannot have more than $2,000 (in most states) in “available” resources. Some resources don’t count, such as the car used for your medical transportation. Also, assets that cannot be used for your benefit, such as in an irrevocable trust, typically don’t count either.

A prior post set forth the reasons giving assets to an irrevocable trust is a better strategy than giving outright. But, it’s important to keep in mind that uncompensated transfers, whether outright or to an irrevocable trust, can generate a penalty period. This article will examine when there’s a penalty and how it works.

If you give away assets during the “lookback period” there’s a penalty period. The lookback period typically is five years (60 months) from the date on which you apply for Medicaid and are “otherwise eligible.” Otherwise eligible means that you have a medical need and are financially eligible. So, let’s look at an example: Mary is medically in need of going into a nursing home. She only has $2,000 in available resources, such as her checking account. In other words, she’s “otherwise eligible” and is applying for Medicaid. When Mary applies for Medicaid, they’re going to ask her about any uncompensated transfers she made within the “lookback period,” which in almost every state is 5 years. If Mary didn’t have any uncompensated transfers to report, she’d be good to go.

But, what if Mary had made an uncompensated transfer during the lookback period? In that case, Medicaid wouldn’t kick in until the penalty period passes. The penalty period is the amount of the uncompensated transfers in the lookback period, divided by the Average Private Pay Rate (“APPR”) for her area (typically the state but sometimes the county or local area). Mary had made $150,000 in uncompensated transfers in the lookback period. The APPR in her area is $10,000. So, she has a 15-month penalty period.

So, once Mary is otherwise eligible and applies for Medicaid, she’ll have a 15-month period during which Medicaid won’t pay for her care. She’d have to pay for her own care during that period. But how can she do that if she only has $2,000 in available resources? Typically, she’d use exempt resources such as her home equity or she’d have her family pay for her care during that time. If she didn’t have family willing to pay or any exempt resources, she could find herself in a real bind.

That is the reason it’s important to do gifting early so that you maximize the chances of having it done outside of the lookback period. None of us know when we might need medical assistance. Therefore, it’s best to start your Medicaid planning as early as possible.

Gifting, including to a Medicaid trust, can be a great tool to allow you to protect some assets and still qualify for Medicaid. 

Medicaid is a partnership between the state and federal governments to provide medical benefit assistance to people, including those over age 65, who have financial need.

In order to be considered to have financial need, when you go into a nursing home and go on Medicaid, you cannot have more than $2,000 (in most states) in “available” resources. Some resources don’t count, such as the car used for your medical transportation. Also, assets that cannot be used for your benefit, such as in an irrevocable trust, don’t count either.

If you give assets away, this may generate a penalty period which I will explain in the next post, but is generally five (5) years. As long as these assets are no longer available for your use, they aren’t considered your resources. So, you could give your assets to your adult children. However, there may be many reasons not to do that. Your child could:

• Be a minor or otherwise lack capacity,
• Get divorced and lose the assets in the divorce settlement,
• Get sued due to a car accident or other event,
• Lose the assets through poor investments, gambling, etc.

But, there is a better way. You could give the assets to an irrevocable trust. The trust principal would not be for your benefit, otherwise, it would be an available resource. The trustee of this trust would invest those assets. You could retain a right to the income from the trust (in the vast majority of states). The trustee could distribute to someone else, like one of your children, in the trustee’s discretion. After your death, the assets would be divided as you had outlined in the trust.

Let’s look at an example: Mary had $400,000 over the asset limit in her state. She transferred it to an Irrevocable Medicaid Trust. John was her trustee. Mary retained the right to the income of the assets during her lifetime. John, as trustee, could make distributions to Mary’s daughter, Betty, during Mary’s life. At Mary’s death, the assets in the trust would be split between Mary’s daughter, Betty, and Mary’s son, Alex. If Mary needs some of the principal, John could make a distribution to Betty. Betty could use the money distributed to her for Mary’s benefit if Betty wanted to do so but would be under no obligation to do so.

If you wanted to provide the most protection, the trustee shouldn’t be Mary or Betty. If Mary were the trustee, some states would consider the trust assets to be “available” to her. Therefore, unless you’ve checked with your state’s Medicaid-administering agency and they have determined it’s ok for the Trustor to be the trustee of the Medicaid trust, it’s best not to do so. In Illinois, a beneficiary can be the trustee.  If Betty were the trustee and could distribute to herself, it would allow Betty to take all the assets out of the trust for her own benefit and thus, would allow her creditors to do the same thing.

A Medicaid trust can be a great tool to allow you to protect some assets and still qualify for Medicaid. But, each state is different, so call me to discuss.

Bob

The novel “coronavirus” (also called “SARS-CoV-2”) causes the disease “COVID-19.” It first appeared in late 2019 and was reported to the World Health Organization (WHO) on December 31, 2019.  COVID-19 has impacted the lives of millions of people and countless events around the world.

The coronavirus has caused an unprecedentedly steep increase in unemployment and has roiled stock markets around the world. The resulting low-interest rates open the door to unique estate planning opportunities.

The IRS sets the “Applicable Federal Rate” or “AFR,” which is the rate the Service determines is the going interest rate. As long as you charge at least that rate, you will not be deemed to have made a gift in charging the interest rate. The AFR is set in the middle of the month for the next month. The AFR for May 2020 is historically low. Those rates are .25% for a loan of up to 3 years, .58% for a loan term of 3 to 9 years, and 1.15% for a loan over 9 years duration. The rate for certain estate planning transactions, such as life estate and remainder interests, is .8%.

One common way to help loved ones without using any lifetime exclusion is by lending money at a very low-interest rate. If you charge no interest, then (with an exception for small loans between individuals), the Service will deem that the borrower paid interest to the lender and the lender gave it back to the borrower. This would cause taxable income to the lender and a taxable gift by the lender. (In a future article I’ll examine these so-called “gift loans” under Section 7872.) A loan at the AFR faces no such imputation of income or a gift.

Let’s look at an example: John lost his job due to the coronavirus pandemic. He had a good job at a major retailer that had to close due to stay-at-home restrictions. As a result, John is considering moving his family closer to his mother, Mary, as she’s getting older and needs more help as she ages. Mary has excess funds and decides she wants to benefit John. She wants him to have a good start and wants to make it easier for him and his family to move closer to her. She doesn’t want to use any of her gift tax exclusion as she has other uses for it. She lends John the money for his house, charging interest at the AFR, 1.15% for a 30-year loan (in the month she lends the money). She also lends John money to start a new business. This helps John immensely. He doesn’t have a job and will be moving to a new city. He would have had difficulty qualifying for a loan. Even if he could have gotten a loan, it would have been at a much higher interest rate.

Mary was able to provide a real benefit to John. This helped make it possible for John (and her grandchildren) to move closer to her. It allowed John to save money on his mortgage and business loan. It allowed Mary to help John without using any of her exclusion. It also allowed her to slow the increase in the size of her taxable estate.

This transaction worked to benefit both Mary and John. It allowed John and his family to move closer to Mary and for them to become even closer, both geographically and personally.

Bob