Much confusion abounds in the world of asset protection trusts, including the false belief by many elder law, estate planning, and asset protection attorneys that self-settled Offshore Asset Protection Trusts and/or Domestic Asset Protection Trusts are helpful in connection with Medicaid asset protection planning. In fact, these trusts are useless when it comes to the world of Medicaid asset protection planning.
“Self-Settled Trust” Defined
The term “self-settled asset protection trust” refers to a very specific type of “self-settled,” i.e., an irrevocable asset protection trust where the settlor is allowed to receive distributions of both income and principal. Such trusts have historically been prohibited in the United States.
This prohibition is seen in both the Restatement of Trusts, Second, and the Uniform Trust Code. Section 156 of the Restatement of Trusts, Second, states the traditional rule as follows: “(1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest. (2) Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit.” Section 505(a)(2) of the Uniform Trust Code states that “with respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.”
Offshore Asset Protection Trusts
The demand for self-settled asset protection trusts (i.e., irrevocable asset protection trusts where the settlor is allowed to receive distributions of both income and principal) and the refusal of anyU.S.jurisdiction to recognize them led to the development of a prosperous Offshore Asset Protection Trust industry by the mid-1980s. Offshore Asset Protection Trusts make it nearly impossible for general U.S.creditors to reach the underlying assets because the trusts are not subject to the jurisdiction of the States. Thus, in order to enforce the judgment, the creditor must theoretically file suit in the offshore jurisdiction and then try the case in the foreign jurisdiction. Foreign law will apply and the creditor and witnesses must travel across the globe to try the case.
Domestic Asset Protection Trusts
The Domestic Asset Protection Trust (DAPT) is a spin-off of the Offshore Asset Protection Trust. DAPTs were first introduced in theUnited Statesin 1997 as an effort to retain in theU.S.some of the wealth that had been steadily moving into Offshore Asset Protection Trusts. Alaska and Delaware were the first to offer DAPTs. Since then, eleven other states have enacted DAPT legislation: Colorado, Hawaii, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah and Wyoming.
Subject to certain exceptions that vary from one DAPT state to another, most creditors cannot reach property in a DAPT unless that property was fraudulently transferred to the trustee. Most important, for elder law attorneys, however, is the fact that the term “most creditors” does not include Medicaid.
On the contrary, the biggest limitation of both Offshore and Domestic Asset Protection Trusts, which makes them essentially useless for a client who desires complete asset protection, is that these trusts allow the settlor to have access to principal and are therefore absolutely ineffective for Medicaid asset protection purposes because, under federal Medicaid law and under the Medicaid laws of every state, if the Medicaid applicant or the spouse of the Medicaid applicant has access to principal, the assets in the trust will be deemed “countable” for Medicaid purposes.
The Asset Protection Trust that Works for Medicaid and General Asset Protection
Only an irrevocable trust that puts 100 percent of the principal beyond the reach of the settlor is effective for both Medicaid asset protection and general asset protection. This can be a trust designed so that the settlor has no direct access to income or principal or, if the settlor wishes to retain use of at least the income from the trust, it can be designed an Income-Only Trust (IOT), which allows the settlor to receive all ordinary income from the trust, but no direct access to principal. Based on the author’s research, IOTs work in all 50 states for general asset protection because of the general common law as seen in both the Restatement of Trusts, Second, and the Uniform Trust Code.
IOTs work for Medicaid asset protection because of OBRA ’93 and two ensuing clarification letters from HCFA (now CMS) – one dated 12-23-1993 (the Richardson letter), and one dated 2-25-1998 (the Streimer letter), which together made clear that: “[t]ransfers to an irrevocable trust with retained income only interests are considered available only to the extent of the income earned”; and “transfer of those assets to or for the benefit of someone other than the beneficiary does not incur a separate transfer penalty.” Based on the author’s research, the only two states where the IOT does not work for Medicaid asset protection are Connecticut and Minnesota, both of which have “trust buster” statutes that effectively nullify the Medicaid asset protection features of an IOT.
For more information about the benefits and flexibility of IOTs, and how to properly draft IOTs, visit the author’s Web site at https://www.LivingTrustPlus.com or order the ALI-ABA publication Planning and Defending Asset-Protection Trusts (2009) at https://www.ali-aba.org/bk64, in which the author’s chapter Asset Protection for the Middle Class: Income-Only Trusts & Medicaid Asset Protection provides a detailed treatise on the topic.
Evan Farr, CELA, is an ElderLawAnswers member attorney in Fairfax, Virginia.
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