When You Need a Trust to Protect Elderly Relatives and Transfer Wealth

People who take advantage of the elderly are more common than you may think. Which is why it isn’t uncommon for us to discuss with clients using a trust to protect elderly relatives wealth. We read a story recently about a son who funded his mother’s bank account with $100,000 to help pay for her care. One of the home health aides had the woman sign a Power of Attorney document, which allowed the aide to slowly drain money from the account.

Fortunately, the caregiver only managed to take a few thousand dollars before she was caught, but not everyone is so lucky. The range of scams and strategies used to confuse and manipulate the elderly is endless. Everything from phone scams to internet scams to document fraud seems to be rampant these days. Whatever you can do to curb these abuses or prevent them from happening in the first place should be a top priority.

Why Use a Trust to Protect Elderly Relatives Wealth

Further, asset protection strategies are important not only to keep out lurking outsiders who may pose risks but also to protect the assets from the elderly themselves, who may be incapable of making sound financial decisions. In the example above, the use of a trust in which the son was the trustee could have avoided the situation altogether. Part of his error was funding an account in his mother’s name alone.

Using a Trust to Restrict Access

Using a trust to manage assets has several key advantages over an arrangement like a bank account registered in one person’s name. In the example above, the trust could have been structured to allow the woman to be her own trustee until the point at which her mental incapacity disqualified her. At that point, her son could have taken over as trustee and maintained sole discretion over how and when his mother received money from the trust.

In the above case, in which the son was funding an account for his mother’s healthcare, the purpose for the money was very clear. However, in some larger cases in which millions of dollars may be involved, the trustee plays a crucial role in controlling the access and distribution of those funds over a much longer period of time. For example, the funds may initially pay for Grandma’s care, but any amount remaining after her passing is to be invested by the trustee and distributed years later to the grandchildren for their higher education.

Managing Trust Assets

Beyond control over the distributions, the trustee also plays an important role when it comes to the management of the assets. If you simply fund a trust with cash and leave it there, it’s not going to grow. Perhaps some allocation to cash is appropriate if the trust is funding ongoing care for an elderly relative. However, if the trust has $5 million in it, and you don’t expect to use more than $300,000 for care expenses, the way in which you allocate the other $4.7 million is vital, particularly for those future generations who will receive the benefit from those good investment decisions.

Stocks and bonds often play a role in the liquid portion of the trusts. Stocks can provide growth, income, or a combination of both. Bonds can provide steady income with less risk when that is a priority. The trustee must consider the ongoing tax burden if these investments will provide dividends, interest, and capital gains. They also must consider alternatives that may present less risk and still meet the needs of current and future beneficiaries.

Funding a Trust With Insurance

Life insurance can be very useful as a wealth creation vehicle, particularly for those with a conservative mindset. It provides a market-risk free way to create a large amount of future funding through an upfront payment. Life insurance has the advantage of leverage, so a $1 million payment may provide $3 million or even $5 million of future tax-free cash, depending on the age and health of the insured at the time the policy is issued.

The table below outlines the pros and cons of funding a trust with life insurance.

Funding Trusts with Life Insurance
Pros Cons
  • Life insurance provides a reliable estate planning tool. You know exactly what the cost is and exactly what you’ll get in the future.
  • The operational structure of insurers and how they price policies allows $1 million today to buy $3 million in the future.
  • A tax-free payout is provided. This is possibly the largest potential advantage, and we’ll discuss it in more detail below.
  • Life insurance is often less liquid, with the understanding that the payout generally comes after the death of the insured. If the trust buys a policy on a 65-year-old, it may be 30 years or longer until those proceeds are received. There still may be the possibility of extracting cash value from the policy or borrowing against it, but generally, this is a less liquid vehicle, especially in the early years.  
  • The possibility of the insured living past life expectancy would reduce the total internal rate of return of this investment alternative.

Funding a Trust with Annuities

Beyond life insurance, there are also annuity products that can act as a hybrid between life insurance and more traditional investments in stocks and bonds. An annuity may be useful in the case of elder care because you can use the annuity to create a stream of predictable, ongoing payments. The table below outlines the pros and cons of funding a trust with annuities, including considerations for each type of annuity.

Funding Trusts with Annuities
Pros Cons
  • The purchase of an immediate annuity can take a lump sum and turn it into a lifetime income stream—exactly what older people need when they don’t have a pension and Social Security alone isn’t doing the trick.
  • Annuities are tax deferred and often come with death benefits, which on a case-by-case basis, can be advantageous to your estate plan.
  • Annuities are complex vehicles and each has their own specific advantages and drawbacks.
    • Fixed annuities can be fairly safe and reliable, but in a low interest-rate environment, the returns may be paltry.
    • Variable annuities allow your premiums to float around in stock and bond sub-accounts, but that has the potential to help or hurt you and the expenses tend to be high.
    • Fixed-index annuities try to do everything by guaranteeing your account value but also allowing for the possibility of credits if a linked market index performs.

The terms of each annuity contract are complex, so you’ll want to really comb through it with a trusted professional.

How Trusts Can Reduce Tax Burdens for Elderly Relatives

Most elderly people receive some form of Social Security payments as well as Medicare benefits. Any additional income they receive could impact those benefits. While the amount of Social Security you receive is based on earnings over your lifetime, those benefits are taxed based on your earnings now.

Social Security Benefits Taxable Amount by Bracket
Filing status Income bracket Taxable amount
Single $25,000 to $34,000 up to 50% of benefits
Single $34,001+ up to 85% of benefits
Married $32,000 to $44,000 up to 50% of benefits
Married $44,001+ up to 85% of benefits

As the chart demonstrates, any sort of significant income can cause your Social Security payments to become taxable. However, if done correctly, using a trust can avoid having the income pass through to you. This, in turn, prevents the Social Security payments from being taxed and can lower your overall marginal tax bracket.

Trusts can also be used to shelter assets and keep an elderly person eligible for Medicaid. If assets are held irrevocably in a trust, they should not be included in an accounting of assets because they are not owned by that person. It may sound unusual for a wealthy person to go through this process to qualify for government assistance, but when you consider the massive cost of assisted living facilities, nursing homes, and so on, it can make sense to preserve money for the next generation. This process, often known as “Medicaid planning,” is complex and should be done alongside a professional.

We mentioned above that one of the largest benefits of owning life insurance inside of a trust is the tax-free payout. The necessary ingredient to getting that tax-free payout is avoiding any incidents of ownership that may cause the payout to be included in your estate. To avoid this conflict and gain the tax benefits, you must:

  • Forfeit the ability to make any changes to the trust
  • Not be listed as a trustee or co-trustee
  • Not be married to a trustee
  • Not transfer any policies into the trust within three years of your death
  • Establish the trust as “irrevocable” so that you don’t reverse these terms after setting them

If you will be potentially subject to the estate tax, the importance of keeping the proceeds of that policy outside of your estate cannot be overstated. We are talking about a 40% tax rate that could chop millions of dollars out of the inheritance you leave to your heirs if your estate planning is not done correctly.

As we’ve demonstrated, the use of a trust has financial and security advantages that can benefit the elderly, who may be receiving income or principal from the trust now, and the future generations who will receive the assets managed inside of the trust.

When planning your estate, dealing with experienced professionals is essential. One small, avoidable misstep can cost your family a fortune or put the security of your accounts at risk. The experts at Howard Kaye have been down this road countless times and can help you design a rock solid estate plan. We can help make the process of caring for an elderly relative easier and safer by using trusts and management strategies that we’ve designed ourselves. Contact us today by calling 800-DIE-RICH to learn more.

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                        irrevocable life insurance trust