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Protecting Your Future: Irrevocable Trusts, Medicaid, and Long-Term Care in New Jersey
What if you could shield your hard-earned assets from the costly implications of long-term care? What if you no longer had to worry about the dreaded five-year look back window while applying for Medicaid? That's exactly what we're unpacking in episode number 463. We use the real-life example of Mrs. O'Malley, an 82-year-old woman striving to protect her home, to demonstrate the advantages of transferring assets into an irrevocable trust. We emphasize the might of legal advice in this process and highlight the boons of an irrevocable trust, such as the ability to downsize without resetting the infamous five-year countdown.
We also take a deep dive into the varied types of long-term care services in New Jersey, their respective costs, and the potential fallout of transferring assets prematurely before applying for Medicaid. Discover the value of written care contracts with family members, the role of annuities in Medicaid computations, and the exceptions for transferring assets to a spouse or disabled child. This episode is brimming with practical advice and vital information for anyone considering their long-term care options in New Jersey. Buckle up and get ready to arm yourself with the knowledge you need to approach your future with confidence.
Welcome back to the podcast. This is episode number 463. I am Tom Malouli and today we're going to talk about long-term care, medicaid, the five year look back window and some common mistakes and some examples that we've seen over the years. We want to address trusts and their role. We want to talk about the five year look back window and get into more detail about that and some of the things you need to know when it comes to Medicaid. So let's jump in.
Speaker 1:There's a lot of folks that say, well, you need to have a trust. Getting a trust or using a trust is such a generic term. You really need to be a little more specific. One of the things we like to decipher when we're speaking with folks are the differences between a revocable trust and an irrevocable trust. Revocable, if you just parse the name out revoke a ball. So a revocable trust is something that you control. Everything passes through to you. You can revoke the trust, can change things, you can add assets, you can take assets out. Really, the main benefit. There are some others, but the main benefit is the fact that when you pass away and your assets are in a revocable, revocable trust, those individual assets are shielded from the probate process. So your executor does not need to go down to probate to a surrogate's court and itemize all of your assets. This keeps nosy neighbors out of your business. All of the assets can be in a revocable trust and the executor can just present. The revocable trust has all of the assets in it. By comparison, an irrevocable trust meaning you cannot revoke this.
Speaker 1:Once you put assets, transfer assets into an irrevocable, an irrevocable trust, that's it. You lose control of the assets. So where revocable trust is a pass through, it's not really a shelter. An irrevocable trust is a separate entity. Your title as your role with the irrevocable trust is you are the grantor. There's three parties to this. There's the grantor, person who puts the assets into the trust, the trustee and the beneficiaries of the trust. The trustee and the beneficiary could be the same person. The main thing that you need to know with an irrevocable trust especially with what we're going to talk about with Medicaid and long term care you are the grantor. You're giving up ownership forever. You're getting the asset out of your name. This will become important later in the podcast. When you're transferring the asset into the irrevocable trust and it's going out of your name, that starts a very important five year clock.
Speaker 1:Here's a good example Mrs O'Malley. She's 82 years old. She owns her own home. It's worth $600,000. She's in good health. She plans to live there forever. She pays her own bills, she's pretty with it. She's got two adult kids.
Speaker 1:Mr O'Malley passed away years ago. Mrs O'Malley would like the kids to inherit her home. Adult children may not want that particular house, but they may want to do something with the proceeds from the sale of the house. So how can Mrs O'Malley protect the home if she goes into a nursing home or needs long term care? Well, she can use an irrevocable trust.
Speaker 1:An irrevocable trust can be set up so that it dictates that Mrs O'Malley could retain the right to live in the home for the rest of her life. Of course, with that comes some obligations. Mrs O'Malley would still have the obligation to pay the costs associated with the house. So she has to pay the property taxes, she has to pay the insurance on the house. She has to pay her utility bills every month. When she set up the irrevocable trust and transferred this home, this asset, into the trust, the transfer of the house starts the clock running on the Medicaid five year. But the title for the house. The owner of the house has now been transferred to an irrevocable trust. It's set up so that the adult children of Mrs O'Malley are the trustees and they also happen to be the beneficiaries of the trust. Most importantly, the transfer of the house starts the clock running on the Medicaid five-year look-back period.
Speaker 1:Right now Mrs O'Malley doesn't need any help. She doesn't need any assistance to someone coming into her house. She doesn't need that. She doesn't need long-term care. She takes care of her own business. Now is a very good time to make this transfer to the trust. By the time she might need long-term care. Hopefully five years will have gone by and if that's the case, then her home could be completely protected from long-term care costs.
Speaker 1:Little wrinkle that some folks may not realize. Since Mrs O'Malley's adult children are the trustees of the trust, they can actually sell the house. Suppose Mrs O'Malley says, hey, this house is getting too big for me, I'd really like to downsize. The trustees of the irrevocable trust can sell the house and downsize, help out their mom, move into something smaller. So the trust can sell the house. All the money from the sale of the house would stay within the trust. Doesn't go to Mrs O'Malley. The trust would buy the new place Something very important. The sale of the home does not end. The purchase of a new home Does not start a new five-year clock ticking on that five-year look back. So she put the asset into the trust. Five, six, seven years go by. She decides she wants to downsize. She's good, she doesn't have to worry about a new five-year clock ticking.
Speaker 1:There are some additional benefits that come with some irrevocable trusts, and you really do need an attorney to do this. Don't try and do this on your own. A irrevocable trust can also be set up to protect the house from any possible lawsuit that one of the O'Malley children might be facing. Say, someone decides they're going to sue one of the adult children for something else. The creditor can't get to Mrs O'Malley's home. The trust could also protect the home if one of the children gets divorced or if one of the one of the adult children passes away before Mrs O'Malley. None of these issues are going to affect Mrs O'Malley's home.
Speaker 1:However, this is where good plans suddenly could go off the rails. So before you become completely sold on a irrevocable trust, you need to see this from a different perspective. While your attorney, your elder care specialist, will do a good job of protecting your assets from Medicaid, they might be exposing you to potentially higher taxes. So this is only a decision that you can make. You may be able to protect the assets, but you might be facing some potentially higher taxes Once the assets are taken out of someone's name and put into a trust. It's really irrelevant how the trust invests the assets. You could downsize, as we talked about a moment ago. The trust could also just sell the house and put the money into the stock market, into CDs, into bonds. Again, as we mentioned earlier, this has no impact on the five-year clock that's ticking for Medicaid.
Speaker 1:But you need to know there are some tax implications that come with irrevocable trusts. These types of trusts are considered pass-through vehicles. Income that comes into the trust flows into the trust and then out each year to the beneficiaries. The beneficiaries will pay income taxes on any income that they get from the trust. If the irrevocable trust is invested in bonds and CDs, there's going to be a distribution at the end of the year. There could be taxable income to the beneficiaries. Income is taxable to the beneficiaries.
Speaker 1:What about capital gains? Well, capital gains are not considered income to an irrevocable trust. Capital gains count as contributions to principal. They basically get added to the cost basis so that gain the capital gain is not distributed to the beneficiaries. The trust will be responsible for paying capital gains taxes. You should know when we're talking about taxes, it's important that the irrevocable trust passes through income to the beneficiaries. The beneficiaries will pay tax at their own rate, because the income tax rate for trusts is 37%. That's why it's important that it passes through. There's also going to be a 3.8% Medicare tax as well. When it comes to capital gains, trust is going to pay the capital gains taxes, depending on the level of income. That could be 15% or 20%, plus the 3.8% Medicare tax as well. There's important tax information that you may need to keep in mind.
Speaker 1:When we talk about Medicaid. It's a very simple mistake to make to use the term Medicare. You probably already heard me say that once in error at the beginning of this episode. Understand that Medicare is a healthcare program for seniors. Medicaid is the program that pays for long-term care, whether it's in home care or nursing homes, because Medicaid runs on a state level. It's a nationwide program authorized by the federal government, but it's run on the state level, unlike the IRS.
Speaker 1:The Medicaid department in your state is going to look at the application very closely. They're going to look at every single financial transaction going back 60 full months that's five years. So it's not like the IRS where you kind of have a reverse lottery. You have a small chance of getting audited by the IRS. You should expect that the Medicaid bureau is going to take a very close look at any assets that have been transferred out of your name or financial transactions that were made in the last 60 months, in the last five years. So what happens if you transfer assets out of your name and then within the next five years you have to go into some type of long-term care situation?
Speaker 1:You have to apply for Medicaid. There are a few exceptions and it will be considered a penalty, a delay penalty, a period of time until you're eligible to start receiving Medicaid benefits. The joke of it all is that you don't actually receive Medicaid. It just pays the bills for you. You need to essentially drain most of your assets to be in a situation where Medicaid is going to be picking up the cost of your long-term care. It's a drag, but let's go through some examples of penalties that people face as they're applying for Medicaid.
Speaker 1:Suppose you live in a state and the average monthly cost for long-term care is $10,000, $10,000 a month and you made a gift of $60,000 to family members over the last five years. Say you were helping a family member pay for college, but over the last five years you've given $60,000 in gifts. $10,000 a month is the cost of Medicaid long-term care. So the way that they calculate the penalty period is they take the $60,000, they divide it by $10,000 per month. You have what's called a penalty period of six months before Medicaid will pick up the costs. I just mentioned an example where the average monthly cost for long-term care is $10,000,. Let's talk specifically what things cost in New Jersey. These are recent numbers as of the last few months.
Speaker 1:There are four different types of long-term care services in New Jersey Home care, assisted living, nursing homes and adult daycare. Let's do each of these individually. So home care is where you have a home health aid or personal care assistance which helps you with your daily living activities meal prep, managing your pills, your medications in-home health care services. In New Jersey, the cost that they use to calculate that is 20 hours a week $2,500. The actual number is $2,534 per month. These are numbers that we sourced from AARP.
Speaker 1:The second type of long-term care service in New Jersey is assisted living. This is a residential facility where you get support. So assisted living, the cost associated with that in New Jersey $6,495 per month. $6,500 a month With nursing homes. This is where you would reside and have access to skilled nursing facilities that give you or provide around-the-clock medical care and supervision. Nursing home care in New Jersey with a semi-private room $11,253 a month. If you're getting nursing home care in New Jersey, get your own private room. It's $12,150 a month. That is $405 per day. The last type of long-term care service that's available in New Jersey is what they consider adult daycare. This is a non-residential program, so you don't live there, but it's a place that offers social and therapeutic services for seniors during the daytime hours. Adult daycare costs per month in New Jersey. According to AARP, the average cost is $2,700, $2,709 per month. Now, these are only average numbers across the state of New Jersey.
Speaker 1:Your situation may be higher or lower depending on what's happening nearby for you. Hey, one other thing that I wanted to mention before we get too much further along when it comes to calculating the penalty. We were talking about irrevocable trusts. Suppose you create an irrevocable trust but within five years of transferring assets into the irrevocable trust, within those 60 months, say that your situation changes and now you have to apply for Medicaid. The assets that were transferred to an irrevocable trust in that case are going to be considered a gift. You should expect that those assets are going to be included in calculating your ability to pay.
Speaker 1:Here's another example where people get hung up and wind up in a penalty. Suppose you're in the five-year window of time and someone sells their house to a family member, but they sell it to them at less than market value. During the Medicaid review, when they're reviewing your application, it's discovered that the fair market value of homes in the area were selling for $500,000. You sold it to a family member for a discount of, say, $350,000. Still a good price. It's not like you transferred the asset for a dollar. It's a $150,000 discount to the fair market value. In those cases it is up to each state Medicaid board to look at this. They may consider the $150,000 discount a gift and take that $10,000 average per month and give you a penalty of 15 months before Medicaid benefits kick in.
Speaker 1:Something else a lot of folks tend to overlook the IRS allows people to gift up to $17,000 to one person in 2023. You can make as many gifts as you want, but you can gift up to $17,000 to an individual without needing to file a gift tax return. But if you made a gift like that in the 60 months, the five years prior to your Medicaid application, it's going to count as a penalty. Even gifts for special occasions, like you gave someone a wedding gift those are also going to be included in the Medicaid calculations. I'll also mention that if you have transactions but you don't have documentation for certain transactions, it's going to be an issue. They're not just going to take your excuse or your explanation. For example, you hire someone to be your daily care person. They live in your house and you pay them cash. These assets are going to be included in your penalty period. Just know that it's not going to be exempt.
Speaker 1:You may want to consider, or you really ought to consider, having a care contract with family members, people who are helping you. It's estimated that almost 80% of primary caregivers today are family and friends, and it's mostly family. Please, if you're going to go this route, consider getting something and writing and get it up front. This can't be done retroactively. You can't apply for. Do the Medicaid application in 2023 and say my niece took care of me for the past three years in 2020, 2021, and 2022. Now I want to pay her for that. Here's an agreement that we sent. You can't go back retroactively and do this. Get something in writing. Get it up front.
Speaker 1:There's always questions about annuities. An immediate annuity is something that is paying you a monthly check. Now there is no asset. When you annuitize a contract or you have an immediate annuity, you've basically turned over the asset to the insurance company in return for a guaranteed stream of monthly checks for the rest of your life or for some period of time. This annuity will not count towards your assets. However, the income that's coming in, just like Social Security, could very well be included as monthly income to help defray the cost. If you have a deferred annuity, that is something where you like an investment. You put money in once and you're allowing it to compound. You're not receiving any income. This will be included in the math when you're calculating your ability to pay for long-term care.
Speaker 1:There are some exceptions. You can make a transfer to a spouse within limits. You can also transfer assets to a third party for the sole benefit of your spouse, like a trust. You can also make transfers to a disabled child. That's permitted. Again, there are limitations on these. You can also transfer assets to a third party or trust for the sole benefit of a disabled child. There's a lot of moving parts when it comes to Medicaid applications. Again, we're not attorneys, but we get asked these questions all the time during the planning process. That's going to wrap up episode 463. Hopefully you found it helpful.
Speaker 2:Thanks for listening and we'll talk to you again next week. Tom Malouli is an investment advisor representative with Malouli Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Malouli Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Malouli Asset Management may maintain positions and securities discussed in this podcast.