Life Estate vs. Irrevocable Trust: An Overview

Whether you’re preparing your estate to pass on to loved ones or helping guide a parent in that process, estate law can be tricky and unfamiliar ground. One of the most important aspects of estate preparations is figuring out what to do with one’s home and property.

Ensuring property is transferred to the right party when the time comes is a key aspect of estate planning. A Life estate and an irrevocable trust are two different methods to go about this, each with its own advantages and disadvantages.

Key Takeaways

  • Life estates and irrevocable trusts are used in estate planning.
  • Transferring large assets, such as a home, into a life estate or irrevocable trust can help an individual qualify for Medicaid.
  • Life estates split ownership between the giver and receiver.
  • An irrevocable trust allows an individual to give away part of an asset.

Life Estate

A life estate, when used to gift property, splits ownership between the giver and receiver. Many parents set up a life estate to reduce their assets in order to qualify for Medicaid. Even though the parent still retains some interest in the property, Medicaid does not count it as an asset. A life estate lasts for the lifetime of its creator. It prohibits the selling of the assets without the permission of its beneficiaries. For example, a parent cannot sell a home without permission from his children if his children are beneficiaries in the life estate. 

Irrevocable Trust

If you’re trying to get eligibility for Medicaid and are worried that your home will disqualify you, consider getting an irrevocable trust. For example, if a husband and wife both own a home, the husband can transfer his portion to his wife. His Medicaid eligibility will not include the home.

However, there needs to be a five-year gap between the creation of the trust and the application for Medicaid. Otherwise, those funds will be counted as part of existing assets when determining Medicaid eligibility. This means you cannot start an irrevocable trust shortly before applying for Medicaid if you want to receive those benefits. One of the downsides of an irrevocable trust is that the founder of the trust relinquishes any rights he has to the home. However, the beneficiary of the trust cannot sell the home unless they are also named as a trustee. Once an irrevocable trust has been created, the trustee cannot take back control of the trust. 

Key Differences

CFP Johanna Turner of Milestones Financial Planning LLC said it’s important to remember that a life estate and an irrevocable trust are not necessarily an either-or scenario. “You can put something into an irrevocable trust (like a residence) and retain a life estate,” she said. “You are ‘irrevocably’ transferring ownership of your house to the trust, but you still retain control. In this scenario, you could sell the house, remodel, rent out part of it, etc., but the house itself—or the sales proceeds from it—would stay in the trust.”

In this scenario, a parent would also not risk giving their children part of the tax liability that comes with owning a house. The parent would retain more personal control over the house and would not need their child’s permission to sell the home. This would be the best option. It would still allow the parents to apply for Medicaid and not have the property count in their assets, but they would remain the sole decision-makers for the house.

The Bottom Line

A home is typically the most valuable thing you can leave behind, so make sure to protect yourself and your beneficiaries by using an irrevocable trust or a life estate. Both have their advantages and disadvantages, but a mix of the two can often be the best solution.