By Todd J. Preti

 

            A Special Needs Trust (SNT) is a form of discretionary, spendthrift trust designed to preserve government benefits for a disabled or aged beneficiary.  Distributions from the trust are intended to supplement public benefits, not supplant them.  The benefits at issue are principally those having limitations on the amount of resources and income the recipient may own.  Such means-tested public benefits consist primarily of Supplemental Security Income (SSI), Medicaid and VA Aid and Attendance.

 

The SNT is an extremely useful planning tool for parents with a disabled child and the elderly who do not have the resources necessary to cover their cost of care.  A properly drafted SNT will enable the beneficiary to qualify or remain eligible for public benefits while enjoying the resources of the SNT. Failure to draft the SNT correctly will cause the beneficiary to be unable to qualify for or lose their public benefits.  I have seen SNTs that were not drafted correctly, thereby causing the beneficiary additional hardship – the exact opposite of what the SNT was setup for in the first place.  Therefore, make sure the attorney who drafts the SNT is qualified and understands the drafting requirements in order to ensure the SNT works as designed and intended.

 

There are two primary types of SNTs:  the “Third party SNT” and the “First party SNT”.  A Third party SNT is a SNT established and funded by a person other than the beneficiary.  A First party SNT, also known as a “self-settled” trust, is a SNT established and funded by the beneficiary or the beneficiary’s agent.  Although it would seem obvious, it is critically important at the outset to determine whether the trust is a Third party SNT or First party SNT.  The distinction will control the drafting of the trust, the funding of the trust and the validity of claims by state and federal agencies against trust assets on the termination of the trust.

 

Third Party SNT

 

The Third Party SNT originated in estate planning for parents with a developmentally disabled child.  It is a form of discretionary, spendthrift trust in which the trustee is directed to take into account the existence of public benefits in making distributions from the trust. It is designed to supplement public benefits without supplanting them.

 

The two main public benefits that a disabled individual receives are SSI and Medicaid.  In determining whether an individual qualifies for SSI or Medicaid the individual’s resources and income are reviewed to ensure that they fall within the eligibility range.  The Medicaid resource rules are substantially the same as the SSI rules.  With respect to assets held in trust, the determining factor is the beneficiary’s power over trust corpus.  If an individual does not have the legal authority to revoke the trust or direct the use of the trust assets for his/her own support and maintenance, the trust principal is not the individual’s resource for SSI purposes.  If a trust is irrevocable by its terms under state law and cannot be used by an individual for support and maintenance, it is not a resource.

 

Like the resource rules, the Medicaid income rules are substantially the same as the SSI income rules.  In making distributions from a Third party SNT (and a First party SNT), trustees should note the following:

 

  • distributions of cash to the beneficiary will be income in the month received.  Such distributions will result in a dollar for dollar reduction of SSI in excess of the unearned income limit;

  • reimbursements to the beneficiary for purchases the beneficiary has made, even if the purchases are for exempt assets, will be counted as unearned income;

  • unearned income is not limited to cash distributions.  Distributions to the beneficiary of any item that the beneficiary may convert to cash may be unearned income;

  • payments to a third party for goods or services for the beneficiary unrelated to food, clothing or shelter are not considered income. Consequently, the trustee may purchase a plane ticket for the beneficiary without any impact on SSI or they may purchase other exempt items for the beneficiary, such as Household Goods (furniture, appliances, TV, carpet, cooking and eating utensils, dishes and cell phone) and Personal Items (clothing, jewelry, personal care items, educational or recreational items like books, musical instruments and hobby material);

  • if the trustee provides goods or services related to food, clothing or shelter directly to the beneficiary, or purchases them from a third-party source, such goods, services or payments may cause a reduction of the SSI benefit, but not dollar for dollar as with unearned income. The amount of the reduction is limited to certain maximums determined under applicable rules and regulation.

     

    A Third party SNT may be created by either an inter vivos or testamentary instrument.  An inter vivos trust is commonly used to receive gifts from several donors.  For example, parents may establish an inter vivos SNT for a disabled child and then notify the grandparents of its existence.  If the grandparents wish to leave assets to the disabled person, the inter vivos SNT may be used to consolidate asset management in a single entity, preserve public benefits and alleviate the need for the grandparents to establish a testamentary SNT in their own wills.  As long as the trust is not revocable by the trust beneficiary, the trust assets should not constitute countable resources for SSI and Medicaid eligibility purposes.  A revocable inter vivos Third party SNT gives the grantor the flexibility to modify the trust if the law changes or there are changes in other circumstances.  This flexibility allows the grantor to test the trust with public agencies by funding it, reporting it and defending it.  If the trust is found to be improper, it can be amended or revoked.  However, the power to revoke the trust will cause the trust assets to be includable in the grantor’s estate if the grantor predeceases the beneficiary.

     

    A testamentary trust is the most commonly used form of Third party SNT.  Its principle advantage is its flexibility.  Because the trust is not effective immediately, its terms may be modified prior to the death of the testator (or grantor).  Unless an inter vivos Third party SNT is immediately necessary to receive gifts or inheritance from other family members, most parents prefer to establish the SNT on the death of the surviving parent.

     

    Like all trusts, the choice of who to name as trustee is extremely important.  Neither the beneficiary nor the beneficiary’s spouse should serve as trustee of either a Third party or First party SNT.  Except for this restriction, the choice of trustee is subject to the same considerations that apply to other discretionary, spendthrift trusts.  In addition to the traditional choices of a family member or corporate trustee, the grantor should consider a professional trustee at least as a co-trustee.  The concern is that the trustee, in making distributions, could greatly impact the availability of public benefits and, as such, should have substantial knowledge and experience with a SNT.

     

    In establishing a SNT, the following dispositive provisions should be included:

     

  • be fully discretionary as to income and principal;

  • evidence the grantor’s intent that distributions from the trust should supplement, and not supplant, the beneficiary’s financial eligibility for means tested public benefits, and give examples of types of distributions that the grantor might consider appropriate.  The grantor should also consider including a liberalizing provision that gives the trustee discretion to make distributions that may cause the loss or reduction of benefits if the trustee considers such distributions in the beneficiary’s best interest.

     

    As a last resort, the grantor should also include a backstop provision which attempts to address potential changes in the law relating to trusts that could cause the trust assets to be considered available resources once the trust becomes irrevocable.  The backstop provision would provide that if assets in the trust are determined to be an available resource to the beneficiary the trustee is granted the discretion to terminate all or part of the trust.  The terminated portion is distributed as if the beneficiary were then deceased.  Because of the risk of misappropriation, prior court approval for any termination under this provision is recommended.  Additionally, if the trustee also happens to be a remainder beneficiary, court approval reduces the risk that the power would be considered a general power of appointment for estate tax purposes.  Although the trust corpus is no longer for the benefit of the disabled beneficiary, the goal is to have the recipients of the trust distribution keep and conserve the trust corpus for the disabled person, however, there are no legal obligations for them to do so.  Finally, a Third party SNT should not have a payback provision requiring the trust to pay back the state an amount equal to the public benefits received by the disabled beneficiary at the disabled beneficiary’s death.  This is a major difference from the First party SNT.

     

    First Party SNT

     

    The First party SNT was designed for seniors seeking Medicaid benefits for the cost of skilled nursing care.  There are currently three types of First party SNTs that qualify for the safe-harbor trust rules:

     

  1. The Court Approved SNT – used to manage the proceeds of personal injury or other litigation for a disabled plaintiff.  This trust requires court approval.

     

  2. The Non-Court Approved SNT – used in non-court approved situations by mentally competent persons.  For example, a physically impaired but mentally competent SSI recipient might receive an inheritance and transfer it to the SNT.

     

  3. The (d)(4)(c) SNT – this is a SNT for pooled funds managed by a non-profit corporation.

     

    As previously stated, a First party SNT is established and funded by the beneficiary or the beneficiary’s agent.  This type of trust must include a payback provision requiring that on termination of the trust, the trustee shall reimburse the state Medicaid agency for benefits paid to the beneficiary during the existence of the trust.

     

    In the case of a revocable trust, the corpus of the trust is considered an available resource to the grantor, payments from the trust to or for the benefit of the Grantor are considered income and any other payments from the trust are treated as disposition of assets for less than fair market value subject to the transfer penalty provisions.  Therefore, a revocable First party SNT would not provide a benefit and should not be used if the grantor/beneficiary wants to be eligible for public assistance. Only an irrevocable First party SNT should be used to maintain public assistance benefits.

     

    The First party SNT is similar to the third party SNT in that they both allow for the discretionary distribution of principal and income to the beneficiary, however, unlike the Third party SNT, the assets remaining in the trust at the beneficiary’s death must be used to repay the state an amount equal to the total medical assistance paid on behalf of the individual for Medicaid and SSI.

     

    As this article indicates, a SNT is an extremely useful planning tool.  The Third party SNT is an excellent type of trust for parents with a disabled child while a First party SNT is designed for seniors or disabled adults trying to qualify for Medicaid. The use of a First party SNT is very complicated and one should consult a qualified attorney prior to establishing such a trust. 

     

    If you need assistance with drafting or administering a SNT please contact Midgett Preti Olansen PC at (757) 687-8888.