Life Estates: A Valuable Tool in Your Estate Planning Toolbox
A life estate is a planning tool that can prove to be extremely useful from both an estate planning and an asset protection standpoint. So, what is a life estate?
A “life estate” is a type of ownership interest in an asset that allows the owner of the life estate (a.k.a. the “life tenant”) to retain an interest in the asset for the duration of his or her lifetime. Most commonly, we see this used in real estate ownership. For example, mom and dad transfer ownership of their house to their son but retain a life estate for themselves. This results in mom and dad retaining the right to continue to live in the house, as well as retaining the obligation to pay all the regular carrying costs associated with the house (ex. taxes, insurance, utilities, etc.) while the remaining ownership interest is transferred to son. The person who owns the remaining ownership interest (the son, in this example) is known as the “remainderman.”
The biggest benefit mom and dad achieve in this example is that their house will now not need to pass through probate when they die. In CT, only assets that are individually owned by the decedent will need to pass through probate. If mom and dad had continued to own the house jointly, the house would not need to pass through probate upon the first death since jointly-owned assets (usually) pass automatically to the surviving co-owner without the need for probate. However, it would need to go through probate upon the surviving spouse’s death as the surviving spouse would individually own the house at that point. So, while joint ownership achieved the desired probate avoidance upon the first death, it did not at the second death. By transferring the house to son and only retaining a life estate, though, the house would avoid probate at both the first and second death.
A secondary benefit is that the house is now potentially protected from any potential long term care costs mom and dad might have. In the event mom and dad need to go into a skilled nursing facility and are unable to pay for that level of care out of pocket, they would most likely apply to CT’s Medicaid program to cover these costs. Unfortunately, in order to be eligible for Medicaid, mom and dad would need to spend down almost all of their assets first. This means that if mom and dad are both no longer living in the house, it would need to be sold and the proceeds spent down before they could receive Medicaid benefits.
The good news is that so long as mom and/or dad don’t need to apply for Medicaid within 5 years from the date of the transfer of the house to son, the house is protected and will not need to be sold. Medicaid has what is known as a “5-year lookback.” That means that when someone applies for Medicaid, the State will review all the applicant’s financial records for the prior 5 years to confirm that their assets were spent down properly. More to the point, the State will make sure that the applicant didn’t simply give their assets away in order to become Medicaid eligible. If the State discovers a substantial gift was made within that 5-year window, the applicant will be denied Medicaid eligibility for a period of time. However, since the State can only look back 5 years, any transfers beyond that window have no impact on Medicaid eligibility.
Despite these benefits, life estates do carry some risk. Namely, mom and dad’s house is now potentially subject to son’s creditors. If son gets sued, divorced, runs up substantial credit card debt, etc., son’s creditors can come after son’s assets, which now includes mom and dad’s house.
Another potential risk is that a year after the transfer of the house to son, mom and dad decide they want to sell their house and move to Florida. If they sell with son being the remainderman, son would have to sign off on all closing documents and son (not mom and dad) would be the one legally entitled to the vast majority of the sale proceeds. This problem can be fixed if son gives the house back to mom and dad before they sell, but this only works if son is willing to voluntarily transfer the house back to them.
At the end of the day, life estates provide a lot of benefit for certain individuals. However, you should carefully weigh the pros and cons before implementing one.