Reverse Mortgages and Irrevocable Trusts

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Reverse Mortgages and Irrevocable Trusts

With a reverse mortgage, you may access some of your home equity while you’re still a resident. You may be able to avoid estate taxes after you pass away and become more eligible for Medicaid benefits if you ever need to enter a nursing home if you place that house into an irrevocable trust.

Let’s examine the operation of irrevocable trusts and reverse mortgages as well as the results of combining the two.

Key Takeaways

  • People 62 years of age and older may use reverse mortgages to access some of their home equity without having to sell it.
  • A residence may be protected from estate taxes by using an irrevocable trust. Additionally, they may make it simpler to be eligible for Medicaid assistance.
  • Irrevocable trusts may be expensive and have other drawbacks, much like reverse mortgages.
  • Although most individuals are unlikely to benefit from this, a reverse mortgaged house may be kept in an irrevocable trust.

How a Reverse Mortgage Works

With a reverse mortgage, a homeowner may access the equity in their house in a number of ways, such as a flat amount, regular payments, or a line of credit that can be used as required. After the borrower passes away, vacates the property, or sells it, the debt must be repaid.

A home equity conversion mortgage (HECM), the most popular kind of reverse mortgage, requires that both the borrower and any co-borrowers be at least 62 years old. The Federal Housing Administration (FHA) insures the loan to safeguard the lender. If they satisfy certain additional qualifications, younger spouses may be named on the loan as an eligible non-borrowing spouse, giving them the ability to stay in the house when their spouse passes away or vacates (for example, into a nursing facility).

Only FHA-approved lenders may issue HECMs. $970,800 is the maximum loan amount. Additionally, some lenders provide proprietary reverse mortgages, which are not government-insured but may have larger lending ceilings.

How an Irrevocable Trust Works

Trusts come in revocable and irrevocable varieties. With the former, you are always free to modify the terms. The terms are far more difficult to adjust with the latter.

Both kinds of trusts may provide you greater influence over how your possessions are managed after your death than a final will and testament does (or sometimes during your life).Both may enable assets, like as your house, to avoid the sometimes drawn-out and expensive probate procedure. Trusts are often more difficult for disgruntled heirs to effectively dispute.

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As the name suggests, an irrevocable trust locks in the choices you make when you initially establish it. For instance, changing beneficiaries might be quite challenging. The assets you put in it become the trust’s property and are out of your control. This implies that they are protected from creditors and not taken into account for calculating your inheritance tax obligation or Medicaid eligibility (assuming you meet other criteria, as detailed below).

Revocable trusts are less costly to establish and keep up than irrevocable ones. Depending on what the grantor—the person who creates the trust—wants to achieve, they may take many different shapes.

Using an Irrevocable Trust to Avoid Estate Taxes

Irrevocable trusts may be used to avoid (or minimize) estate taxes since they take assets out of the grantor’s estate. Only those with quite sizable estates, however, will gain from this. Federal estate taxes are not applicable to the first $12,060,000 in assets in 2022.

Seventeen states and the District of Columbia have estate taxes as well, and all of them exclude assets worth at least $2 to $5 million. Less than 3% of estates, on average, incur state estate taxes, according to the Center for Budget and Policy Priorities.

$2–$5 million

the amount of assets free from state estate taxes in 17 states plus the District of Columbia.

Using an Irrevocable Trust to Qualify for Medicaid

Many low-income Americans, as well as individuals who are elderly, blind, or have impairments, may get health insurance via Medicaid, a combined state and federal program. States may have different regulations for the program.

Late in life, Medicaid is often used to pay for nursing home care or other long-term care services by people who may not have been eligible for it when they were younger. Only extremely restricted scenarios are covered by this kind of insurance under Medicare, the government-sponsored health insurance program for Americans 65 and older.

A person must meet specific income and asset restrictions as well as qualify for Medicaid based on medical necessity. Their home equity is one among such assets, however it is exempt up to a certain amount. According to the American Council on Aging, the current cap for single people applying for Medicaid in most states is either $636,000 or $955,000, with California being the exception. California has no restrictions.

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As long as the other spouse resides in the house, there is no home equity cap for married Medicaid applicants. Bank accounts, investments, retirement accounts, and second residences are examples of countable assets in addition to any home equity that exceeds the exemption threshold.

Spending down and the look-back period

A strategy known as a “spend down,” in which people spend assets to go under the limitations, is often used by people whose assets exceed the limits. The Medicaid applicant cannot have simply given away assets or sold them for less than fair market value during the look-back period, which is five years in most states. This includes selling a house to a relative at a significant discount.

There is a pretty small list of high-ticket goods that are permitted during the look-back period, which includes things like house improvements, auto repairs, and medical gadgets that aren’t covered by insurance. Until they have spent enough to qualify for Medicaid to take over, the applicant may also pay for nursing home care out of their own money.

Placing assets in an irrevocable trust is another option to limit countable assets. However, the trust must be created prior to the start of the look-back period in order to be eligible.

A Medicaid applicant may move their house to a relative during the look-back period under a number of circumstances. They include the caregiver-kid exemption, which permits the residence to be transferred to a child who has lived in the house and been the applicant’s main caretaker for at least two years. Another is the sibling exemption, which is applicable to siblings who have shared ownership of the property for at least a year.

When Homes with Reverse Mortgages Are Held in Irrevocable Trusts

Reverse mortgages and irrevocable trusts fulfill various purposes and often appeal to different types of individuals. People who have considerable assets they want to protect and pass on to their heirs might benefit the most from irrevocable trusts. People who may have no other assets outside their property, which may not be of great worth, tend to profit from reverse mortgages. In 2018, a HECM loan’s median amount was about $134,000.

Few reverse mortgage borrowers are likely to discover that an irrevocable trust will be of much use given the relatively substantial home equity exemptions for Medicaid as well as the equally significant exemptions for federal and state inheritance taxes. A homeowner with excess equity might theoretically utilize a reverse mortgage to lower that equity instead of a trust, but they would need to take into account the reverse mortgage’s costs and the impact of adding the mortgage proceeds to their other assets.

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However, a house with a reverse mortgage may be placed into an irrevocable trust, and some beneficiaries of irrevocable trusts may find themselves inheriting one in the future. The recipient will still be responsible for paying off the reverse mortgage in this scenario, either by selling the house or doing it themselves. The trust, if they’re lucky, will provide them the money to accomplish it.

How much does an irrevocable trust cost?

The price to form an irrevocable trust varies depending on the kind, the size and complexity of the estate, the state in which it is established in the United States, and other considerations. It will often cost at least $3,000. The typical cost, according to one New York legal practice, was $6,000. There will also be continuous administrative expenses, which are probably going to be in the hundreds or thousands of dollars each year.

What happens if you want to change an irrevocable trust?

Trusts that are irrevocable are difficult to modify, but not impossible. “Decanting” is a method that has grown in popularity in recent years. The trustee “pours” assets from the current irrevocable trust into a new one with differing provisions in those places where doing so is legal.

Are reverse mortgage payments considered taxable income?

No, the money a homeowner gets from a reverse mortgage is not considered income by the Internal Revenue Service (IRS), and loan proceeds are not subject to tax.

The Bottom Line

In certain situations, irrevocable trusts and reverse mortgages may be beneficial instruments for financial and estate planning. However, they may be costly and difficult, and they aren’t suitable for everyone.

You should first speak with a competent professional, such as an estate planning lawyer, an accountant, or a financial planner, if you’re interested in either an irrevocable trust or a reverse mortgage. The government further mandates that you consult with a certified housing consultant in the case of HECM reverse mortgages.

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