Editor’s Note: This post is the second post in a multi-part series in which attorney Jason Krautkramer discusses the value of a Medicaid Asset Protection Trust in estate planning for farmers.
If you’re like most people, when you hear “asset protection planning” you think of someone like Bill Gates or the Kennedys. A very common misconception is that only wealthy families and people in high-risk professions need asset protection planning. In reality, anyone can be sued and lose all of his or her assets. A car accident, foreclosure, job loss, medical crisis, business failure, or an injured tenant or guest can result in a huge monetary judgment, decimating your finances. Farmers face the additional risks of product liability for contaminated commodities and custom hire services. The goal of asset protection planning is to take property currently vulnerable to seizure by creditors, predators, and lawsuits and positioning it in a way to discourage lawsuits, provide a valuable bargaining chip if a lawsuit arises, and minimize loss.
It may surprise you to know that you are likely taking advantage of basic asset protection strategies without knowing it. For example, the first line of defense against liability is insurance, including homeowners, renters, automobile, business, professional, malpractice, long-term care, and umbrella policies. Another type of basic asset protection planning is investing in 401(k) or IRA accounts. Under federal law, 401(k)s and IRAs (excluding inherited IRAs) are protected from creditors in bankruptcy (with certain limitations). Maximizing contributions to your 401(k) or IRA if you still are farming will not only increase your retirement savings, but will also keep the investments away from creditors, predators and lawsuits. If you want to take advantage of intermediate asset protection, a Medicaid Asset Protection Trust (MAPT) might be for you.
A MAPT provides asset protection from future creditors because you forfeit the right to receive principal from the MAPT and because the MAPT is a discretionary trust for other trust beneficiaries. You create the MAPT while you are alive by gifting your assets into the trust for the benefit of your beneficiaries. Although you can retain the right to receive the income from the MAPT, you have to give up the right to receive the principal from the MAPT in order to make the assets unavailable for Medicaid qualification. By giving up the right to receive the principal from the MAPT, you also prevent your future creditors from reaching the MAPT principal—if you can’t access the principal, neither can your future creditors. This arrangement is ideal for farmers who want to protect their land, equipment, or other assets from future creditors but don’t want to forfeit tax advantages of continuing to own the assets.
For the other beneficiaries of the MAPT (commonly your children), the MAPT essentially creates a “box” around the assets in the MAPT, showing the world that the assets are not the beneficiary’s property to do with as they please. Instead, only the trustee can reach inside the box and, based on your specific instructions, such as education, health care, a wedding, buying a home, or starting a business, pull funds out for the benefit of the beneficiary. Creditors, predators, and divorcing spouses are generally blocked from reaching inside the box and taking property out. When the beneficiary dies, what is left inside their box will pass to the heirs you choose. You could decide, for example, to have the assets pass to your grandchildren inside their own separate boxes and on down the line, thereby creating a cascading series of discretionary lifetime trusts that will protect the inherited property and keep it in your family for decades to come, which is often the ultimate goal for the family farm.
If you want to maximize creditor protection, you need to ensure the MAPT is drafted with the proper terms because not all protection MAPTS are designed to maximize creditor protection. One of a MAPT’s greatest strengths is that its terms are flexible. If you want you can design a MAPT to leave an inheritance outright to your child or grandchild without any strings attached or have the inheritance distributed in portions upon reaching certain ages. However, that is risky in this day and age of high divorce rates, lawsuits, and bankruptcies. There is also the very real risk that an outright inheritance left to your spouse will end up in the hands of a new spouse instead of in the hands of your children or grandchildren. If you want to ensure maximum creditor protection, you need to keep the inheritance in trust instead of leaving it outright or allowing the beneficiary to receive it upon reaching certain ages.
To protect your assets, you must plan ahead. Asset protection planning cannot be done as a quick fix for existing legal problems. Your plan must be in place before a lawsuit arises—or in terms that a farmer might use—you must plan when the skies are clear. For Medicaid qualification, this means the planning must be done at least five years before the need for Medicaid arises. In other situations, a significant period of time must pass before the asset protection plan is effective (up to 10 years in some cases).
A MAPT is a great estate planning tool for farmers because it can protect farm assets from creditors and lawsuits and also ensure that the family farm remains in the family. Stay tuned for part three of this series where I discuss the tax advantages of a MAPT. Please call our office if you have any questions about this type of planning and to arrange for a consultation.
Read the First Post in this Series: Estate Planning for Farmers: Medicaid Eligibility Planning