Irrevocable Trusts

Irrevocable Trusts — Pennsylvania FAQs

Why would I give up control of my assets?

Because control is what creditors, Medicaid, and the estate tax all key on. Assets you can reach are assets they can reach. Transferring the family home into a properly drafted irrevocable trust removes it from a nursing-home spend-down once the five-year lookback runs; moving a life insurance policy into an ILIT keeps the death benefit out of your federally taxable estate. We only recommend it when the protection is worth the tradeoff, and most designs preserve the income stream or the right to live in the home even though the principal is out of your hands.

What is the Medicaid five-year lookback?

When you apply for Medical Assistance long-term care coverage in Pennsylvania, the county assistance office reviews all asset transfers made in the 60 months before the application date. Uncompensated transfers — including funding an irrevocable trust — create a penalty period of ineligibility calculated by dividing the transferred value by the statewide average private-pay nursing home rate. The penalty does not start until you are otherwise eligible and in care, which is why crisis transfers backfire. Fund the trust more than five years before you need care and the assets are outside the lookback entirely.

Can an irrevocable trust ever be changed in Pennsylvania?

Yes, more often than the name suggests. Pennsylvania's Uniform Trust Act, 20 Pa.C.S. Chapter 77, allows modification or termination by consent of the settlor and all beneficiaries under § 7740.1, by court order for unanticipated circumstances under § 7740.2, and for uneconomically small trusts under § 7740.4. Pennsylvania also permits decanting — a trustee with discretionary distribution authority can distribute trust assets into a new trust with updated terms under § 7740.8. None of this is self-help; it requires counsel and usually notice to beneficiaries.

What are the tax implications of an irrevocable trust?

It depends on the design. Most Medicaid asset protection trusts are drafted as grantor trusts for income tax purposes, so income is reported on your personal return and the assets get a step-up in basis at death — important for a long-held home. Non-grantor trusts pay their own tax and hit the top bracket at a very low income threshold. For Pennsylvania inheritance tax, retaining a life interest or the power to revoke pulls the assets back into your taxable estate under 72 P.S. § 9107, and transfers made within one year of death are taxable regardless. The drafting details determine the outcome.

What kinds of irrevocable trusts do Pennsylvania families use most?

Four dominate: Medicaid Asset Protection Trusts to shield the home and savings from long-term-care costs; Irrevocable Life Insurance Trusts to keep death benefits out of the taxable estate and provide liquidity for taxes; special needs trusts to provide for a disabled beneficiary without disqualifying SSI or Medical Assistance; and spendthrift or dynasty trusts to protect an inheritance from a beneficiary's creditors or divorcing spouse.