Trusts come in many different forms and are used for many different purposes. Generally, trusts are either revocable or irrevocable, grantor or non-grantor, inter vivos or testamentary, and simple or complex. Trusts are used to manage assets, distribute income, provide for college educations, pay for funerals, pay estate tax liabilities, and qualify for government entitlement benefits - Medicaid, SSI, and Veterans pension.

Annuities also come in many different forms and are used for many different purposes. Generally, annuities are either tax-deferred or immediate; fixed, indexed or variable; qualified or nonqualified; and Medicaid compliant or non-Medicaid compliant. Annuities are used to defer income taxes, manage taxable income, control investment risk, and qualify for government entitlement benefits - Medicaid, SSI, and Veterans pension.

When it comes to Medicaid planning the type of trust that is most commonly used is an irrevocable trust. The trust is a Medicaid pre-planning tool in that it must be established, funded, and has five years pass from the date of the last transfer in order to become an effective Medicaid tool. The trust may be established as a grantor trust, giving the grantor the right to its taxable income, but it is not required. If the trust passes all the aforementioned criteria and the grantor later enters a nursing home and needs Medicaid benefits, none of its assets will be taken into consideration - they are deemed not owned by the grantor.

If the irrevocable trust in the previous paragraph contains cash assets, rather than having the trust pay taxes (assuming the trust is not a grantor trust) at it's high tax rates the better approach is to have the trustee invest the cash into tax-deferred annuities. A tax-deferred annuity, even though it earns income each year, is not taxed until the trustee elects to take a withdrawal or annuitize the tax-deferred annuity contract. At that time the trust would be required to pay income taxes. If the tax-deferred annuity involves a withdrawal, the taxable portion of the withdrawal amount is to the extent of deferred income - "Last in First Out" treatment. Once all of the deferred income is withdrawn, the remaining portion is simply return of principal - which is always non-taxable. If the tax-deferred annuity is annuitized (converted to an immediate annuity), the deferred income is equally spread out over the period certain time frame. Thus, a portion of each immediate annuity payment is deferred income - taxable, and return of principal - nontaxable.