Reverse mortgages and irrevocable trusts

A reverse mortgage allows you to access a portion of your home equity while still staying at home. If you put this house in an irrevocable trust, you may be able to avoid real estate taxes when you die and qualify for Medicaid benefits if you ever need to go to a nursing home. Let’s take a look at how reverse mortgages and irrevocable loans work and what happens when the two are combined.

Basically Takeaways

  • Reverse mortgages allow people aged 62 and over to use part of their home equity without selling the home.
  • Irrevocable trusts are a way of protecting assets — including a home — from real estate taxes. They can also make it easier for you to qualify for Medicaid benefits.
  • Both reverse mortgages and irrevocable loans can be costly and have other disadvantages.
  • A home with a reverse mortgage can hold on to an irrevocable trust, though this is unlikely to be beneficial to most people.

How a reverse mortgage works

A reverse mortgage allows a homeowner to withdraw equity from their home in a variety of ways, including a lump sum, monthly income, or credit capital to raise as needed. The loan must be repaid after the borrower dies, moves or sells the house.

The most common type of reverse mortgage is the home equity conversion mortgage (HECM), for which the borrower and any co-borrower must be at least 62 years old. The loan is secured by the Federal Housing Administration (FHA) to protect the lender. Younger spouses can be listed on the loan as eligible non-borrowing spouses, which entitles them to stay home after the death or relocation of their spouse (such as in a nursing home) if they meet certain other conditions.

HECMs are issued only by creditors approved by the FHA. The maximum loan amount is $ 970,800. Some lenders also offer privately owned reverse mortgages, which are not state-secured, but may have higher lending limits.

How an irrevocable trust works

Trusts can be either revocable or irrevocable. With the first, you can change the terms at any time. With the latter, the terms are much more difficult to change.

Both types of trust can give you more control than a last will and testament to how your assets are handled after your death (or sometimes during your lifetime). Both can also allow assets, such as your home, to bypass the often slow and costly validation process. In general, trusts are more difficult for frustrated heirs to challenge successfully.

Irrevocable trust, as the name implies, is key to the decisions you make when you first create it, so, for example, changing beneficiaries can be very difficult. The assets you invest in it become the property of the trust and are beyond your means. This means that they are not calculated to determine the tax liability of your property or your eligibility for Medicaid (if you follow other rules, as described below) and are protected by creditors.

Irrevocable trusts are generally more expensive to set up and maintain than revocable ones. They can take a variety of forms depending on what the concessionaire (the person building the trust) wants to achieve.

Use of irrevocable trust to avoid real estate taxes

Because they remove assets from the assignor’s property, irrevocable trusts can be used to avoid (or reduce) real estate taxes. However, this will only benefit people with quite a fortune. In 2022, The first assets of $ 12,060,000 are exempt from federal property taxes.

Seventeen states plus the District of Columbia also impose real estate taxes and also exempt assets up to a certain level, with all exempting at least $ 2-5 million. According to the Center for Budget and Policy Priorities, less than 3% of estates on average owe government real estate taxes.

2-5 million dollars

The value of the assets that 17 states plus the District of Columbia exempt from their state property taxes.

Use an irrevocable trust to qualify for Medicaid

Medicaid is a joint state and federal program which provides health insurance coverage to many low-income Americans, as well as the elderly, the blind, or the disabled. Program rules may vary from state to state.

People who may never have met the criteria for Medicaid coverage when they were younger often turn to it to pay for home care or other long-term care services later in life. Medicare, the federal health insurance program for Americans 65 and older, provides such coverage only in very limited cases.

To be eligible for Medicaid coverage, a person must qualify based on medical needs and also meet certain income and asset requirements. One of these assets is their equity, although they are exempt to a certain extent. With the exception of California, the limit in most states today for individuals applying for Medicaid is either $ 636,000 or $ 955,000, according to the U.S. Council on Aging. California does not set a limit.

If the Medicaid applicant is married, there is no equity limit on the home as long as the other spouse lives in the home. In addition to any equity capital exceeding the exemption threshold, measurable assets may include bank accounts, investments, retirement accounts, and second homes.

Expenditure and retrospective period

People whose assets exceed the limits often use a tactic called “repayment”, in which they spend assets to fall below the limits. Cost reductions are subject to a review period (five years in most states) during which the Medicaid applicant may not simply have given away assets or sold them for less than fair value — such as selling a discounted home to another family member.

The list of large ticket items allowed during the review period is relatively limited and includes things like home modifications, car repairs and medical devices not covered by insurance. The applicant can also pay for the nursing home out of pocket until they have spent enough to be eligible for Medicaid.

Another way to reduce measurable assets is to place them in an irrevocable trust. However, the trust must be established before the start of the review period to qualify.

There are also several exceptions that allow a Medicaid applicant to transfer his or her home to a relative during the review period. They include the child-caregiver exception, which allows the transfer of the home to a child who has served as the applicant’s primary caregiver for at least two years and has also lived in the home. Another exception is siblings, for siblings who are some homeowners and have lived there for at least a year.

When homes with reverse mortgages are held in irrevocable trusts

Irrevocable trusts and reverse mortgages serve different needs and usually target different types of people. The former are very useful to individuals with significant assets who wish to retain and pass on to their heirs. The latter tend to benefit people who may have no assets to speak of other than their home, which may not be of immense value. The average loan amount for an HECM in 2018 was about $ 134,000.

Given the relatively large exemptions for Medicaid from housing equity, along with the equally large exemptions for federal and state property taxes, few reversible mortgage borrowers are likely to find that an irrevocable trust will have great confidence. Instead of a trust, an over-the-counter homeowner could reasonably use a reverse mortgage to reduce that equity, but should consider the cost of the reverse mortgage as well as the impact of adding revenue from the mortgage on the other assets.

However, it is possible to put a house with a reverse mortgage in an irrevocable trust and some holders of irrevocable trusts will eventually find themselves inheriting one. In such a case, the beneficiary will again have to repay the reverse mortgage, either by selling the house or buying it himself. If they are lucky, trust will give them the funds to do so.

How much does an irrevocable trust cost?

The cost of setting up an irrevocable trust will vary depending on the type, the complexity of the property, the US state in which it was created and other factors. In most cases, it will be at least $ 3,000. A New York law firm set the average price at $ 6,000. In addition, there will be ongoing administrative costs that may amount to hundreds or thousands of dollars per year.

What if you want to change an irrevocable trust?

Irrevocable trusts are difficult – but not impossible – to change. A technique that has become more common in recent years is known as “decanting”. In states where this is permitted, the administrator “pours” assets from the existing irrevocable trust into a new one on different terms.

Are Reverse Mortgage Payments Considered Taxable Income?

No. The Internal Revenue Service (IRS) considers that the money a homeowner receives from a reverse mortgage is loan income, not loan income, and loan income is not taxable.

The bottom line

Reverse mortgages and irrevocable trusts can be useful tools for financial planning and real estate planning in some cases. However, they are both complex and potentially expensive and not suitable for everyone.

If you are interested in either an irrevocable trust or a reverse mortgage, you will want to consult an experienced expert, such as a real estate planning attorney, accountant or financial planner, before proceeding. In the case of HECM reverse mortgages, the government also requires that you meet with an approved housing consultant.

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