Here in Massachusetts, smart estate planning requires the guidance of a Massachusetts estate & trust administration attorney to help you create the documents you’ll need. Keep reading to learn the basics about Trusts, how they work, and why you likely should create a Trust as part of your estate plan.
If you have loved ones who rely on you, now is not too early to start planning your estate. Put simply, estate planning is about making wise choices and putting those choices in binding legal documents to ensure that your instructions are adhered to faithfully at the time of your death.
Wills and Trusts are key estate planning documents that perform many of the same functions, but if you have assets or real estate holdings (that are worth roughly $100,000 to $200,000), a well-drafted and adequately funded Trust ensures that your assets and properties will be handled and distributed according to your wishes.
Eventually, all Trusts become irrevocable. A Trust is irrevocable when the Donor (the person who creates the Trust) is no longer able to amend it. Some Trusts are set up as irrevocable from the start. Others start out as revocable (meaning the Donor may alter, amend, or even cancel the Trust), but become irrevocable at the death of the Donor.
Whichever path you choose for your Trust, it is imperative that your Trust be flexible – able to adapt to changes in the law, changes in family circumstances, or changes in the way the Trust should be managed.
What is Modification by Consent?
It is possible for an Irrevocable Trust to be amended – just not by the Donor. Over the past decade or so, multiple methods for amending Irrevocable Trusts have become popular. In Massachusetts, there is statutory authority for amending Irrevocable Trusts (Massachusetts General Law Chapter 203E § 411).
If the Donor and all the beneficiaries agree, they may petition the Probate Court for permission to amend an Irrevocable Trust. If the amendment will not frustrate the original purpose of the Trust, the Court will typically allow the amendment.
What is Amendment by Agreement?
Some Trust documents will permit amendment by other means. Irrevocable Trusts may be amended without Court approval, but only if the terms of the Trust agreement are governed by the laws of a state that allows such action or if the Trust agreement permits amendment by agreement within its own terms.
What is Amendment by a Trust Protector?
Alternatively, some Irrevocable Trusts use the role of a Trust Protector. A Trust Protector is usually an independent party, not related to the Donor or the beneficiaries, who is given special powers that a Trustee is not given.
Often, a Trust Protector will be permitted limited authority to amend an Irrevocable Trust. This authority might include the ability to change the Trust due to changes in tax law, or to remove a Trustee, or to take other actions that are intended to protect the Trust assets from negative outside influences.
What is “Decanting” an Irrevocable Trust?
Finally, an Irrevocable Trust may be amended by “decanting”. In Massachusetts, Trust decanting is permitted if the Trust instrument authorizes the Trustee to remove the assets from one Irrevocable Trust and place them in a new Irrevocable Trust with the same beneficiaries.
Some states have statutes that authorize Trust decanting, but Massachusetts does not. Instead, estate planning attorneys in Massachusetts rely on case law (the case, Kraft v. Morse, 466 Mass 92 (2013), involved the Kraft family – the owners of the New England Patriots).
Under the Kraft decision, Trustees who have authority under an Irrevocable Trust to make discretionary distributions may distribute the Trust assets to a new, Irrevocable Trust with the same beneficiaries and with terms and conditions that better fit the needs of the beneficiaries. While not exactly amending a Trust, decanting an Irrevocable Trust has the same effect.
How Does a Revocable Trust Work?
A good estate planning lawyer can help you decide if your estate plan should be based on a will, a Revocable Trust (also known as a Living Trust), or an Irrevocable Trust. With a Revocable or Living Trust, you can move assets into the Trust’s ownership while you retain control of those assets.
In order to understand how a Revocable Trust can help you and your family, you should understand what a Revocable Trust is. Essentially, a Revocable Trust is a contractual agreement among three parties: (1) a Donor – the person who creates the Trust and gives some property/asset to the Trust; (2) a Trustee – the person who will manage and control the assets of the Trust; and (3) a beneficiary – the person (or persons) who will get the use and enjoyment of the assets in the Trust.
Initially, most people set up their Trust and take on all three roles. But in order to have a valid Trust there must be at least one other person involved in the Trust. An easy way to add another person is to add a future interest beneficiary – someone to be the beneficiary after you pass away.
This is typically a spouse, if you are married, followed by the children (or whomever you wish to receive your wealth at the time of your death). This achieves your testamentary disposition needs.
What is the Role of a Successor Trustee?
Additionally, a Trust will provide for a Successor Trustee, someone to be the Trustee if you are no longer able to act in that capacity. If you are ill or unable to act as your own Trustee, your Successor Trustee may step in to manage the Trust assets on your behalf.
Eventually the Successor Trustee will manage the assets of the Trust after you pass away, making sure the inheritance is quickly and efficiently available for your heirs, the future interest beneficiaries.
You may modify or cancel a Revocable Trust as you wish, and the assets that are owned by your Revocable Trust at the time of your death will transfer to or for the beneficiaries without being subjected to the often costly and lengthy probate process.
For example, an IRA Inheritance Trust ™ is a Revocable Trust that becomes the beneficiary of your IRA (individual retirement account) after your death. It provides your beneficiaries with protection from creditors, divorce, bankruptcy and estate taxes, all while allowing for distributions over a beneficiary’s lifetime.
How Does an Irrevocable Trust Work?
Irrevocable Trusts are often created for very specific, sometimes limited purposes, such as asset protection, estate tax reduction, income tax reduction, gifting, or eligibility for certain government benefits. Often, when you create an Irrevocable Trust, you give up the ownership and control of whatever assets are placed in the Trust.
A properly designed Irrevocable Trust will consider a number of variables, such as:
1. Whether the assets of the Trust should be included in the estate of the Donor for important income tax benefits, or whether the assets should be \excluded from the estate of the Donor for estate tax savings;
2. Whether the transfer to the Trust should be a completed gift (often requiring the filing of a gift tax return – Form 709) or should be an incomplete gift – meaning the Donor may change who will ultimately receive the gift;
3. When the income of the Trust is received by a beneficiary, whether the income tax liability will stay with the beneficiary or be shifted to the Donor. When the tax is paid by the Donor, it is done so without a gift tax consequence, which can significantly increase the perceived value of the assets given to the Trust;
4. After the death of the Donor, whether the income taxes should be paid by the Trust or by the beneficiary (often Trust tax rates are quite high, so having the beneficiary bare the tax burden – even if the income is retained by the Trust – is a money-saving choice);
5. Where the Irrevocable Trust should be established – in Massachusetts or in a state with more favorable Trust laws;
6. The choice of Trustee – the beneficiary or a professional Trustee; and
7. What distributions should the Trust authorize? Generally the best asset protection can be achieved if the Trust is purely discretionary – so that the Trustee may decide what, if any, distributions will be made and when they will be made.
Each decision will impact how the Trust will work and the degree of benefit it can convey. But if you create an Irrevocable Trust, you must remember that it is not reversible. Generally, the assets you gift to an Irrevocable Trust cannot be given back to you.
However, in some Irrevocable Trusts, the Donor may be given the power to “swap” assets with the Trust. But possessing such a power does have income tax consequences, and it is not advisable to include a swapping power in an Irrevocable Medicaid Planning Trust.
What Are Some Specific Examples of Irrevocable Trusts?
Irrevocable Trusts can hold and then distribute assets to a beneficiary weeks, months, or even years after your death. Examples of Irrevocable Trusts include:
#1: A Capital Gains Avoidance Trust
A Capital Gains Avoidance Trust is an Irrevocable Trust to which you give highly appreciated assets. The Trust then sells the highly appreciated asset. Normally, the sale would trigger a capital gains recognition, resulting in income taxes.
But because of the way this Trust is designed, after the sale, the entire proceeds from the sale of the highly appreciated asset may be reinvested without payment of capital gains taxes. Instead, an income stream is paid to the beneficiary (who is usually the Donor), and as the income is received, capital gains taxes are paid on a portion of the income payment.
When the beneficiaries die, whatever remains in the Trust, if anything, is paid to a charity of the Donor’s choice. This Trust lets you avoid the capital gains tax when you sell appreciated real estate, stocks, or other capital assets. This type of Trust can be structured so that the capital gain is spread out over many years, thereby reducing the total tax paid. This Trust is also sometimes called a Charitable Remainder Trust.
#2: An Irrevocable Life Insurance Trust
An Irrevocable Life Insurance Trust is a Trust designed to own a life insurance policy. It controls and owns your life insurance policy while you are alive, and it manages and distributes the proceeds from the policy after your death.
Many people know that life insurance death benefits are generally not subject to income tax, but when life insurance is owned by the insured, it is a part of the owner’s taxable estate and therefore subject to estate taxes.
By having your life insurance owned by an Irrevocable Life Insurance Trust, not only will the death benefit pass free of income tax, it will also pass free of estate tax.
#3: A Domestic Asset Protection Trust (DAPT)
A Domestic Asset Protection Trust is a self-settled Irrevocable Trust that is intended to protect your assets from potential future creditors. Currently nineteen states recognize some form of a self-settled Asset Protection Trust, but Massachusetts is not one of those states.
Even though Massachusetts does not yet recognize these Trusts, the use of DAPTs can have an important role in your estate plan. These Trusts can be used to reduce the Massachusetts estate tax in addition to providing asset protection.
#4: A Spousal Limited Access Trust (SLAT)
A Spousal Limited Access Trust is another tool that may provide asset protection and estate tax reduction benefits in Massachusetts. This type of Irrevocable Trust is similar to a By-Pass or Credit Shelter Trust that is established as a lifetime gift instead of a gift to the spouse at the time of the Donor’s death. Trust assets are available for the needs of a spouse but are not owned by the spouse.
Because Massachusetts does not have a state level gift tax, and because the federal lifetime exemption is so high, using SLAT can have significant Massachusetts estate tax reduction benefits by exempting Trust assets from the estates of both the Donor and the Donor’s spouse.
#5: A Medicaid Planning Trust (MPT)
A Medicaid Planning Trust, sometimes called an Irrevocable Income Only Trust (IIOT) is a special Trust with a very limited purpose. A Donor will establish this kind of Trust if s/he intends to preserve the estate from the cost of nursing home care.
COVID-19 has certainly done some damage to this type of Irrevocable Trust – a recent article in the Boston Globe revealed that nearly 62 percent of all COVID-19 related deaths in Massachusetts occurred in nursing homes and rest homes.
Since this type of Irrevocable Trust is set up to make the Donor eligible for state-paid nursing home care, it is now less attractive to use this kind of Trust, given the deadly mix of virus-susceptible nursing home residents and COVID-19.
Unfortunately, what most people who use this Trust don’t realize is that the principal placed into this type of Trust is NEVER available for the use of the Donor or the Donor’s spouse. The Trust assets may only be used to produce income for the Donor or the Donor’s spouse. Five years after the assets are given to the Trust, the assets are protected from the Medicaid look-back rules (the “five-year look-back”).
What is the Main Problem With an MPT?
However, the problem with this type of Trust is its lack of flexibility. An MPT can not include any provisions for amending the Trust. Furthermore, it should not include any ability for the Donor to “swap” assets with the Trust.
While assets in these Trusts are protected from nursing home expenses after the five year look-back period has passed, the assets can not be used for most assisted living arrangements (which most people need before they need nursing home care).
Additionally, most people desire in-home care, but the assets in an MPT are not available to be used that way, in most cases. However, these Trusts may make sense if you have a diagnosis that will definitely require you to reside in a nursing home.
Understanding the Limitations of an MPT is Imperative
But before setting up this kind of Trust, you must understand the limitations on you and your spouse. If you die first, your spouse will need to live with the restrictions of this Trust – and the assets will still be unavailable to your spouse.
Consider this: the average cost of nursing home care in Massachusetts is approximately $130,000 to $150,000 per year (as of 2020). The average stay is approximately two years. So, the total cost is approximately $300,000.
Certainly, that is a lot of money. But what is the total value of your estate? Add up the value of everything you own – real estate, retirement accounts, investments, bank accounts, life insurance, etc. Does it make sense to you to give away the total value of your estate, making it forever unavailable for the needs of you and your spouse, to save a rough average of $300,000?
If you answer “yes,” then this type of Trust may be appropriate. The bottom line is this: if an attorney is suggesting an MPT for you, be sure to ask a lot of questions. Make sure you understand the lifetime ramifications of this kind of Trust.
If you are told there is a back door, or that there can be a tacit understanding with the kids that the assets of the Trust may somehow be returned to you, then Massachusetts (MassHealth) will take the position that the assets ARE available to pay for your nursing home care. Yogi Berra said it best: “If you don’t know where you are going, you’ll end up someplace else.”
What Steps Are Required to Create an Irrevocable Trust?
To establish an Irrevocable Trust in Massachusetts:
- Identify the properties and assets that you want to move into the Trust.
- Determine your beneficiaries.
- Determine who is qualified to act as the Trustee.
- Have a qualified Massachusetts estate planning lawyer prepare the Irrevocable Trust.
- Transfer the appropriate assets to the newly formed Irrevocable Trust.
- Let the Trustee manage the Trust – don’t try to manage it for the Trustee.
Is It Really Irrevocable?
To create an Irrevocable Trust and to take advantage of the benefits it offers, the terms of an Irrevocable Trust must prevent you from revising or amending it. Can an Irrevocable Trust ever be changed or amended? The answer is no, not by the person who creates it.
In rare cases, however, beneficiaries or the Trustee may be able to make a change to an Irrevocable Trust when such a change is in the best interests of a beneficiary and is not in conflict with the intentions of the person who created the Trust (the “Grantor” or “Donor”).
For example, if you designate assets for a child’s or grandchild’s education, but after your death the child or grandchild develops a serious medical condition that requires costly treatment, your Trustee may seek a modification that will allow the Trust’s funds to pay for necessary treatment.
Upon a Grantor’s death, a Trustee becomes responsible for the administration of the Trust. By working with the right Cape Cod estate planning attorney, a Trustee in Massachusetts can obtain the sound legal advice needed for proper administration of the Trust at every stage of the process.
What’s Right for You?
Every estate plan is unique, so an Irrevocable Trust may or may not be right for you. But without the right estate plan, the Internal Revenue Service (IRS) or the Massachusetts Department of Revenue may be able to take a significant portion of your family’s assets after your death.
A good estate plan is a smart idea for everyone, regardless of age, health, or financial status. Although no one knows what tomorrow may bring, the proper estate plan will provide for your loved ones and put them in the best possible position to deal with whatever the future holds.
The right Massachusetts estate planning attorney will answer your estate planning questions, address your concerns, and provide the legal services and personal assurances you need to help you create the best possible estate plan for you and your family.