Asset Protection Trusts
An Asset Protection Trust is where a grantor, (person establishing the trust) irrevocably transfers assets into the trust for protection from long term care costs. Here’s how it works:
The Four Pillars of an Irrevocable Income Only Trust (IIOT)
- Irrevocability: Once established, the trust cannot be revoked.
- Income Only: Trust income is paid to the Grantor, but there is no direct access to the principal by the Grantor or spouse.
- Asset Protection: Principal assets are protected from medical institutions and nursing homes.
- Beneficiary Access: Under specific circumstances, principal may be accessible by designated family members (though this may impact tax advantages like the step-up in basis).
IIOT vs. Outright Transfers to Children
Many people consider giving assets directly to children, but an APT offers significant advantages:
- Control: The Grantor maintains more control over assets since income is paid directly to them rather than through children.
- Risk Avoidance: Assets in an APT are shielded from a child’s creditors, divorces, or bad habits (gambling, spendthrift behavior).
Tax Benefits:
- Income Tax: Income is taxed at the parent’s typically lower rate.
- Step-Up in Basis: Children receive a step-up in tax basis to fair market value upon the Grantor’s death, avoiding significant capital gains taxes.
- Primary Residence: The capital gains exclusion for the sale of a principal residence is maintained.
- Financial Aid: Assets in a child’s name can disqualify their own children (the Grantor’s grandchildren) from college financial aid; an APT avoids this issue.
Comparison Summary
| Issue | APT (Trust) | Outright Transfer |
|---|---|---|
| Lookback Period | Five Years | Five Years |
| Control | Some | None |
| Risk Avoidance | Yes | No |
| Financial Aid Issue | No | Yes |
| Income Tax Rate | Parent (Lower) | Children (Higher) |
| Step-Up in Basis | Yes | No |
A properly drafted Asset Protection Trust is an exceptional planning technique. These trusts can be used to reduce risk for the parents and also achieve tax benefits in appropriate situations. Pitfalls include potential tax disadvantages in an improperly drafted trust, as well as potential estate recovery and elective share issues. By carefully analyzing the facts and properly drafting an income only trust, we can help you protect assets while preserving meaningful benefits for your family.
How long before I need Medicaid benefits do I need to set up an Asset Protection Trust (APT)?
In an ideal scenario, you should transfer your assets into an APT more than five years before applying for Medicaid benefits. This is because Medicaid has a five-year “lookback period,” during which it reviews any asset transfers you’ve made. If assets were moved into the trust within that five-year window, they could still be counted toward your Medicaid eligibility. Early planning is essential — the sooner you establish the trust, the better protected your assets will be.
If I transfer my assets into an APT, do I lose all control over them?
Not entirely. While the trust is irrevocable — meaning you cannot change its core terms or reclaim the assets — you do retain certain rights. You can continue to receive income generated by the trust assets, change the remainder beneficiaries (those who ultimately inherit), and remove and replace the trustee. You will also remain responsible for paying income taxes on any earnings the trust generates, since it qualifies as a “grantor trust” for tax purposes.
Why is an APT potentially better than simply transferring assets directly to my children?
Outright transfers to children carry several risks that an APT avoids. Your child’s creditors could make claims against transferred assets, a divorce could expose them to equitable distribution proceedings, and poor financial habits could result in the assets being lost entirely. Additionally, from a tax standpoint, direct transfers carry over your original cost basis — meaning your children could owe significant capital gains taxes when they sell. Assets held in an APT, by contrast, receive a step-up in cost basis to fair market value upon your death, often eliminating that tax burden entirely.
Ready to protect what you have built?
Schedule a consultation with our Pennsylvania estate planning and elder law attorneys today.
