For an older person who needs care in a nursing home, an assisted living facility, or his or her own home, the expense can be overwhelming. The average nursing home, for example, now runs more than $200 a day, according to a 2012 MetLife survey. In some metropolitan areas, you'll need to spend many times that to pay for a decent level of care.

Medicare, the federal health care program primarily for men and women 65 and over, covers such bills only when the person is in a nursing home for short-term rehabilitation. That leaves Medicaid, a joint federal and state program, as many people’s only option for long-term care. (See Medicaid Vs. Medicare and Will Medicare pay for long-term costs?)

The problem is that to be eligible for Medicaid, a person must have relatively modest “countable assets” – often totaling as little as $2,000 or $3,000, though the figure varies by state. Countable assets include items such as bank accounts, mutual funds, and stocks and bonds. As a result, people have often have had to exhaust their life savings before Medicaid would begin to pay their bills. That makes it difficult to leave an inheritance or to provide for a surviving spouse or other dependent, such as a grown child with special needs.

However, there is a way to qualify for Medicaid and also preserve at least a portion of a person’s wealth. That’s through the creation of a trust.

Types of Trusts

There are two basic kinds of trusts, revocable and irrevocable. Revocable trusts, as the name implies, can be revoked. Because of that, Medicaid counts the assets in a revocable trust as belonging to the person who established it, and if the amount exceeds the countable assets limit, he or she is won’t qualify for assistance.

An irrevocable trust, on the other hand, effectively transfers control of the money from the person to a trustee, making it possible to qualify for Medicaid, though not always immediately.

The reason is that Medicaid currently has a five-year “look back” period. Any money transferred into a trust or simply given away in the five years before a person applies for Medicaid can result in a delay in qualifying for benefits. The length of the delay (called the “penalty period”) is determined by dividing the amount or value of the transfer by Medicaid’s “regional rate” for nursing home care in that geographic area. For example, in an area where the regional rate is $10,000 a month, someone who transfers $100,000 into a trust before entering a nursing home would be ineligible for a total of 10 months unless the transfer had been made more than five years earlier.

In that situation, someone (typically a family member) would have to pay the nursing home out of pocket before Medicaid started picking up the bills, effectively wiping out any advantage of putting $100,000 into the trust. In fact, in many cases, the monthly rate of the nursing home is higher than Medicaid’s regional rate, which means that the actual cost of care during the penalty period will be greater than the amount of the transfer, according to David A. Cutner, an elder law attorney with Lamson & Cutner, P.C., in New York City.

But by combining the creation of an irrevocable trust with a promissory note or the purchase of a private annuity, many people can still preserve 40% to 50% of their assets, Cutner says. How that works is explained in Top 5 Strategies To Pay For Elder Care.

Other Advantages of a Trust

Whether a person puts money into a trust or gives it to relatives, it will be subject to the same five-year look back period. However, a trust has certain other advantages.

For one, a trust is a separate legal entity, so the money is generally safer than it would be with a family member. Even a relative with the best of intentions could face a lawsuit, divorce or other misfortune, putting that money at risk.

For another, assets in a trust benefit from a step-up in basis, which can mean a substantial tax savings for the heirs who eventually inherit from the trust. By contrast, assets that are simply given away during the owner’s lifetime typically carry his or her original cost basis.

Here's how the calculation works: Shares of stock that cost $5,000 when originally purchased, and that are worth $10,000 when the beneficiary of a trust inherits them, would have a basis of $10,000. Had the same beneficiary received them as a gift when the original owner was still alive, their basis would be $5,000. Later, if the shares were sold for $12,000, the person who inherited them from a trust would owe tax on a $2,000 gain, while someone who was given the shares would owe tax on a gain of $7,000. (Note that the step-up in basis applies to inherited assets in general, not just those that involve a trust.)

Choose the Right Trustee

A properly drawn trust will not only preserve some of the older person’s assets but also allow the trustee the discretion to distribute money to beneficiaries who can spend it for the older person’s benefit.

That’s one reason to choose a trustee who can be counted on. “You want someone who is stable and sensible and financially responsible,” attorney Cutner says. If the older person has any reservations, he adds, an alternative is to name a bank as either the trustee or a co-trustee.

The Bottom Line

People who need financial assistance from Medicaid don’t have to exhaust their life savings in order to qualify. A properly drawn irrevocable trust can protect at least a portion of their assets, both for their own benefit and for that of their eventual heirs.

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