Introduction to Special Needs Planning and Special Needs Trusts
Planning for individuals with disabilities or special needs, is complex and requires great care. It is an area of the law that is fraught with dangerous misunderstandings. This article will provide an overview of planning for those with special needs.
One source of misunderstanding is that many assume that the only element of special needs planning is the use of a special needs trust ("SNT"). While an essential component to special needs planning, a special needs trust is only one factor of the planning.
SNTs are trusts created for people with disabilities who are under age 65. If you are disabled, federal law permits you to transfer your own funds into a specific type of trust that will not jeopardize eligibility for government benefits. The assets in the trust are not countable resources for government benefits such as Medicaid or SSI, which are means tested benefits. If you apply for means tested benefits, you must meet both financial and medical qualifications. The financial requirements are problematic if you have assets, e.g. a tort recovery or other legal settlement. The SSI limit on countable resources is $2,000. The Medicaid limit on countable resources varies by program but in many cases it is also $2,000. These limits do not include certain excluded assets, such as a home or irrevocably prepaid funeral benefits. While many litigation settlements might sound "rich," when the cost of medical care for a seriously injured person over a lifetime is considered, not to mention living expenses, even a substantial settlement might not last an entire lifetime. If Medicaid or other government benefits can cover some portion of these costs then the funds might, in fact, last as a lifetime supplement.
Special needs planning is important for the family of a person with disabilities. In the past, prior to the law permitting funding a special needs trust, disinheritance was an approach commonly used by family members. Many parents and other potential benefactors still opt to disinherit the child with special needs because that child receives public benefits. This is often the wrong choice and is sometimes based on the misconception of what government benefits provide. Remember public benefits only provide food and shelter at poverty level. This is not a generous or desirable standard. There is also no assurance these benefits will continue so the protection of proper planning could be vital. Other parents and benefactors have opted for leaving assets to their well children. While this might work, this approach is fraught with risks and issues. How do you know disabled child won't outlive other children? Assets bequeathed to the well child are subject to the well child's divorce and creditor risks. What if the well child receiving the money opts for the new Maserati instead of helping their special needs sibling? The well sibling that was supposed to be reliable often proves not to be. The bottom line is that these simplistic simple limited planning approaches often do not accomplish the objective of protecting the person with disabilities. Planning for people with disabilities is feasible and should be pursued.
Even the Wealthy Should Consider SNT Planning
Sometimes the wealthy mistakenly believe that SNT planning is not necessary for them; however, even wealthy clients need to address this planning. For example, a person with a multi-million dollar estate has a high functioning child with developmental disabilities. First, the cost of medical and other care over a long time period can be tremendous, and easily underestimated. Secondly, and very importantly, parents (or other benefactors) cannot buy the special child's admission into government programs that may list Medicaid eligibility as a requirement for enrollment. Medicaid eligibility is the key, or gate, to access a host of vital benefits and programs. Thus, this planning is important for many with a child with special needs or beneficiary regardless of financial ability.
Two basic types of SNTs
There are two general categories of special needs trusts, determined by the source of the funds to be protected by the trust. Understanding these two paradigms, and differentiating when to use each, is key to special needs planning.
- First party or self-settled SNT is funded with property the beneficiary already owns or to which he is already legally entitled. A common example is that you were severely injured in an automobile accident and received a large personal injury settlement. Other examples of assets that often compromise government benefits eligibility include an outright gift or inheritance, divorce settlement or alimony.
- Third party SNT - funded with someone else's assets, e.g., a third party's assets.
This is the key issue - the rules governing first party versus third party SNT are very different.
First Party SNT
If you receive a settlement, then you can only create a first party SNT with your funds. These trusts are often called "(d)(4)(A)" trust, after the provision of the federal law that refers to and permits these first party trusts, OBRA Section 1396p(d)(4)(A). A key component or requirement of a first party (d)(4)(A) trust is that on your death (i.e., the person receiving government benefits) Medicaid must be reimbursed up to the amount of Medicaid benefits paid for your benefit.
To qualify to establish a (d)(4)(A) trust there are a host of requirements, including:
- You, as the beneficiary, must be disabled within the meaning of the Social Security Act, i.e. you cannot be able to engage in any substantial, gainful activity by reason of a physical or mental impairment which can be expected to result in death or to last for at least 12 months.
- The trust must be irrevocable.
- You, as the trust beneficiary, must be under age 65 when the trust is funded.
- The trust must be for your sole benefit of you (i.e., the specific disabled beneficiary).
- If property is left in the trust when you die, then Medicaid must be reimbursed pursuant to a "Payback Requirement," hence these trusts are sometimes referred to by the name "Payback Trust." Some states require that Medicaid must be reimbursed for all Medicaid benefits paid prior to the establishment of the trust, other states do not. The trust must include an express payback requirement.
- The trust must be established by a permissible settlor (the grantor or trustor who establishes the trust). The only four permissible settlors for a first party SNT are: (1) a legal guardian, (2) a parent, (3) a grandparent, or (4) a court. Social Security requires a person establishing the trust to have legal authority, such as a power of attorney or court order, with respect to assets of disabled beneficiary. If they do not have such authority the trust may be invalid or the trust assets countable to the beneficiary.
Congress also authorized "pooled SNTs" or "(d)(4)(C) trusts." These pooled trusts are "common" trusts, akin to special mutual funds which pool all assets for those beneficiaries with special needs who participate for investments purposes. A pooled SNT must be established and managed by a non-profit organization which maintains a separate account solely for the beneficiary of each trust account, but for purposes of investment and management of funds, the trust pools these accounts. Unlike a (d)(4)(A) trust, a pooled trust may be established by the disabled beneficiary, or by the parent, grandparent, legal guardian, or a court. On the death of the beneficiary, the non-profit organization may retain some of the trust account funds and the state is repaid an amount equal to the total amount of medical assistance paid on behalf of the beneficiary from the remaining balance of the account. A pooled trust may be enable you to obtain similar results as with your own SNT (d)(4)(A) trust, but for much less cost and with a lower threshold of assets.
Third Party SNT
In contrast to a first party or (d)(4)(A) trust, if a trust will be funded with the assets of a third party most of the requirements listed above are not necessary. For example, if a parent or grandparent establishes a trust for a child or grandchild with special needs, there is no requirement to provide for reimbursement to Medicaid. Unfortunately, sometimes standard forms are erroneously used that unnecessarily provide for a payback of Medicaid benefits. Obviously this can undermine the intended estate plan by eliminating the intended remainder beneficiaries. If this occurs you can endeavor to reform the incorrect provision but that can be costly and difficult to achieve. "Reformation" is the process of asking a court to change the trust to meet the wishes of the grantor, the person who set up the trust. To accomplish this requires a demonstration that the Medicaid payback provision was contrary to the grantor's intent when establishing the trust.
Caution: Any non-qualifying bequest, e.g. typical bypass trust or outright gift from a well intentioned grandmother, can undermine all the planning and destroy the means tested benefits. Well intentioned generosity can wreak havoc. Therefore, as part of a special needs plan, the family should advise any potential benefactors of the need to exercise caution in making bequests and to only do so to special needs trusts established for the intended beneficiary.
Caution: You need to review all assets and beneficiary designations to determine the impact on the child with special needs. If accidental payments or transfers are made to a child with special needs who is receiving government benefits or participating in government programs, the payments could result in disqualification. Again, advance planning can avoid the time and expense of petitioning a court to obtain an order to have any such funds paid into a special needs trust. The better approach is to try to identify these assets and beneficiary designations to avoid the problem before it occurs.
Distribution Standards for SNTs
The terminology used in the SNT document is critical. If a trust is designed to serve as primary support for beneficiary, the distribution standard may be for the health, education, maintenance and support of the beneficiary. If the "S" word = "support" appears in the trust, then trust assets will be countable resources of the beneficiary for purposes of means tested government benefits (i.e., they will be considered an available resource). Most people establishing trusts opt against using a support trust because of this negative impact.
In contrast to a trust providing for the support of a beneficiary with special needs is a trust that is intended only to provide supplemental care. These types of trust are designed to supplement, and not supplant or replace, government benefits for which the beneficiary with special needs may be eligible. Language is critical. Caution: The "boiler-plate" language in many standard trust documents can undermine the entire plan. This is why you need a specifically crafted SNT document, not a trust cobbled together from standard forms.
Essential to success is that the beneficiary with special needs cannot access the trust for health, support or maintenance nor can the trustee be obligated to provide for the health, support or maintenance for the beneficiary. This approach should prevent the special needs trust from being characterized as an available resource for the means tested programs and should protect trust assets.
Government programs may provide basic necessities but are not adequate to provide quality care for a person with special needs. A properly drafted SNT will greatly improve the quality of life of a beneficiary with special needs, allowing the beneficiary to qualify for benefits while providing a source of funds to supplement government benefits programs.
The Flexible or Standby SNT
What if you have a grandchild who faces several medical concerns, but it cannot yet be ascertained whether or not she will in fact qualify or even need government programs or assistance? Even more significant, what if you are establishing a perpetual trust? Future unknown heirs might in fact have special needs. Can you address this now? While it is not necessarily routine to do so, the safest approach might be to incorporate special needs provisions into trust and estate planning documents. Planning Tip: Consider using standby special needs trust provisions in all trusts. Give the trustee the power to appoint the future special needs beneficiary's share to a new SNT (i.e., expressly authorize the trustee to "decant" these assets into a new SNT). Consider including a broad payment clause that expressly permits a pour-over into a special needs trust. This is complex and difficult to achieve.
Administration of a SNT
Creating a special needs plan, and drafting a special needs trust, are only a part of the process. Administration of a SNT is complex, even tricky. It is advisable to have a trustee that understands the programs for which the beneficiary is eligible. The trustee must administer the special needs trust in accordance with the terms of the trust agreement, and applicable laws. If there is a child with special needs, unless the trust authorizes specific distributions, the trustee may breach his or her trustee fiduciary duty if an inappropriate distribution is made. Good intent, or more specifically, acting in good faith, may not be sufficient to avoid a lawsuit.
It is important to assure that the beneficiary is appropriately provided for, but also to understand the nature of distributions which are permissible to make from the SNT. If distributions are not made correctly they could disqualify the beneficiary from vital government benefits.
Example: The trustee of a special needs trust purchases a house in which both the trustee and the beneficiary with special needs reside. Can the trustee do this? The trustee must be careful. It can be done but if others live in the house with the beneficiary, they must pay rent to the trust that owns the house. If the house is owned in part by the trust and another family member, that other family member must pay his or her pro rata share of carrying costs otherwise SSI or Medicaid will deem that the trust is making a gift to the family member who is not the trust beneficiary and disqualify the beneficiary for benefits.
Trustees should consider obtaining a "life care plan" for the beneficiary with special needs. A life care plan is a practical "soup to nuts" road map of all of the needs of an individual with disabilities, both present and future, as well as the costs of those needs prepared by a specialized life care planner. This can provide a guide for the trustee to know what lies ahead. It is a great starting point to estimate how much the disabled child will need for care. How to invest? How to distribute and when?
Example: Trust assets are used to purchase a wheelchair accessible van. You must make sure that the beneficiary is the primary beneficiary/user of the van. If not, Medicaid or Social Security could argue the trust is in effect making the other users beneficiaries of the trust, which is impermissible. While you can permit someone to drive the van for the disabled beneficiary, caution is in order. You should even consider keeping a log to show who is using the van, when and for what purpose. Anyone else using the van must bear his or her share of the van costs to avoid this issue.
"Grantor" is the person establishing a trust. They are also referred to as the "trustor" or "settlor." There is a distinction as to whom the grantor is for legal purposes (i.e., listed in the trust) and the person treated as the "grantor" for income tax purposes.
There is a separate concept for income tax purposes. In certain situations, a person (not necessarily the person listed in the trust document as the "grantor") can be treated as the "grantor" for income tax purposes. This means that the trust income is taxable to that person. If an SNT is a grantor trust for tax purposes the grantor who is taxed on trust income for tax purposes will be the child with special needs. This beneficiary is the defacto grantor for tax purposes even if someone else is required by law (e.g., parent, court) to be the nominal "grantor" for legal purposes of establishing the trust.
You need to obtain a taxpayer identification number (EIN) for SNTs so that the trust has its own number. If the SNT uses the Social Security number of the beneficiary it can be more difficult to demonstrate to the IRS that the trust income is not that of the beneficiary. Social Security sometimes seeks to disqualify the beneficiary for SSI benefits for having too much income based upon the distributions from the SNT. The trustee will need to clarify to Social Security what was countable income and what not countable income.
You must choose trustees carefully. SNTs, as previously discussed, are difficult, complex, and legally technical to administer. You can have an institution serve, but typically an institution will not do so unless there are sufficient assets because of the complexity of administering these trusts properly. For most trusts, a person working with the bank as co-trustee, such as a trusted family or friend, is an optimal approach, if the assets are sufficient for an institutional co-trustee. Many banks and trust companies will not handle a special needs trust at all, others may not accept such a trust unless it has a $1 million minimum of assets.
When choosing an individual trustee, whether to act as a co-trustee or alone, choose someone that has as many of the following attributes as feasible:
Families often suggest siblings of the child with special needs and assert that their well children would always provide for their special child. This is not always optimal and consideration should be given to whether they really are up to the task. You may also consider the use of a trust protector to change the "line-up" of trustees for the special needs trust.
- Understands the personal, emotional and financial needs of the special needs beneficiary.
- Understands the disabilities of the beneficiary with special needs.
- Understands that it might be necessary to spend a lot of trust up front for accessible house or handicapped vehicle, etc. This is often difficult for some individual trustees to do as they fear that the trust will run out of money, when in fact the large up front expenditure could be a huge benefit for the beneficiary with special needs.
- Understands government benefit programs of the beneficiary with special needs, and the potential impact of distributions on those programs.
- Has integrity; is honest and reliable.
- Possesses financial acumen. This is less important if there will always be an institutional co-trustee and of greater importance if there is no institutional trustee. The trustee will have to comply with the prudent investor act which governs how trust assets should be invested. They need the ability to understand and implement these requirements.
- Has no conflict of interest. You may not want remainder beneficiary being the trustee. It would be inadvisable for even a trusted person to be placed in the position that the less he or she distributes to the beneficiary, the more they stand to inherit.
Practice Tip: A parent or other close family member who establishes the trust should prepare a letter of intent explaining programs, needs and desires/preferences of the beneficiary with special needs to assist the trustee in administering the SNT.
Caution: Be aware in selecting trustees that the financial institution that handles the SNT now may not handle them in five years.
Life Insurance and Special Needs Planning
Life insurance can be a tremendous tool in a special needs estate plan. Stability is vital in planning for a child with special needs, and life insurance can be a great equalizer. A young couple with little money can buy a survivorship policy and name the SNT as beneficiary.
Consider establishing a stand alone SNT rather than including it in your will or other trust so that your life insurance policy can be paid directly to that trust.
Caution: Beware of the "Crummey" power. This is an annual demand right that is almost routinely included in life insurance trusts ("ILIT") so that gifts to life insurance trusts will qualify for the gift tax annual exclusion. However, these "powers" might be wholly inappropriate in a special needs trust. In a SNT-ILIT someone other than the child with special needs should be the powerholder. For example, another child who is a remainder beneficiary could be the Crummey powerholder. You need to make sure that this other child/beneficiary's interests are real to be respected for Crummey power purposes. Tricky. If the child with special needs is the powerholder, that right of withdrawal will be a countable resource towards the means tested limit. Another approach is to have a toggle switch on the Crummey power to turn it on or off. If so, include a provision permitting amendment of trust to qualify for government benefits. If no Crummey powers are provided, or if they are inadequate to cover the cash gifts to the ILIT to pay for premiums, you might need to file gift tax return each year and report the gifts made to the ILIT.
A common planning technique for some special needs plans is for you to purchase a life insurance policy to fund a SNT for your beneficiary with special needs, with the remainder of the proceeds paid to charity after the death of the beneficiary with special needs. One downside to this planning is if there are other assets that are also going to be paid or distributed into this trust, e.g., retirement assets, the charity will taint the designated beneficiary status. Caution: Consider including a provision in the trust stating that any distributions to the remainder charitable beneficiaries are secondary to the distributions to the current beneficiary with special needs. This may help overcome what would otherwise be a fiduciary obligation of the trustee to both your special needs child, who is the current beneficiary, and the charity as remainder beneficiary
Don't Forget Tailoring Durable Powers of Attorney
For parents with a special needs child your powers of attorney should grant specific authority for your agent to:
- Create a third party special needs trust for your special needs child.
- Have sole discretion to make gifts. Gifts should never be obligated (e.g., if the agent is mandated to make annual exclusion gifts, $13,000 in 2009, that would disqualify the child with special needs from means tested government programs).
- The special needs child has no right to demand distributions. While the power of attorney would not grant this, you might wish to include a specific prohibition to avoid any doubt.
If the parent is named as legal guardian of an adult incapacitated child, a successor guardian should be named in the power of attorney.
Draft a Letter of Intent and Instruction
Prepare letter of intent. This is of particular importance for a special needs beneficiary. Consider adding a provision to a special needs trust that you may provide a personal letter of intent and that trustee should consider it in the administration of the trust. You might wish to add that the trustee is not obligated to consider the letter of intent in order to avoid creating unintended legal obligations.
What should be included in the letter?
Consider "Dear Family" letter explaining to family why good intentions in the form of a bequest to the special needs child could be very detrimental, and that instead they should opt for bequests to the third party special needs trust you establish. This is separate from the letter to the trustee or others above.
- What personal preferences does your special needs child have? Food? Entertainment? Other?
- What does your special needs child prefer by way of activities? Not prefer?
- What government and private programs does he or she participate in?
- What suggestions do you have as to how the trustee should apply limited resources.
- List names, addresses, phone numbers and other pertinent information about key medical, personal and other contacts.
- If you have specific knowledge about specific limitation on distributions or requirements of specific programs, provide details.
Special needs planning is vital to the personal and financial security of your special needs beneficiary. There are a host of financial, legal, tax and other complications that need to be evaluated in creating a plan and drafting the appropriate legal documents. A broad and comprehensive perspective is generally needed to achieve your goals.
1. (d)(4)(A) - This refers to the federal law that created a safe harbor for self-settled trusts known as special needs trusts in 1993. It sets forth the federal requirements for these trusts, include the payback provision, so that the assets in the trusts are not countable. Money transferred to these trusts is deemed to be gifts and are not subject to a penalty period of ineligibility. This is not referring to the annual gift exclusion of $13,000 per year.
2. (d)(4)(C) - This refers to the federal law establishing pooled trusts as safe harbor self-settled special needs trust that differ somewhat from (d)(4)(A) trusts. The trust funds are pooled for investment purposes but a separate account is maintained for each beneficiary by the non-profit fund. Some of the funds are retained by the non-profit organization on the death of the beneficiary.
3. Countable Resources - The assets or resources you must keep below the permissible limit to qualify for means tested benefits, e.g. $2,000 to qualify for SSI and typically $2,000 to qualify for Medicaid. Irrevocably prepaid funeral expenses are not countable. A home is not countable.
4. Grantor - A SNT is a grantor trust for tax purposes but the grantor for tax purposes is the beneficiary. The tax issues of a "grantor" trust should be distinguished from the important legal implications of who can be the grantor to establish a first party SNT.
5. Inter-vivos Trusts - A trust created during lifetime. An inter-vivos SNT enables any family member to have a bequest for the beneficiary with disabilities under a Last Will and Testament "pour over" into this trust. A "seed" trust might have $100 to make it valid.
6. Means tested benefits- Government benefits that have a financial requirement. You must prove you qualify to the government agency providing benefits. It is vital in SNT planning that the beneficiary not be disqualified. If a trust beneficiary can compel a distribution from the trust, the trust assets will be countable. For example, if you have a first party special needs trust or third party supplemental benefits trust pay rent for the beneficiary with disabilities, you may disqualify the beneficiary since SSI benefits are intended to pay for shelter. If money is used to pay a provider it is treated as in kind. If a trust is established under someone's Will that disqualifies the beneficiary, all is not lost. You can go to court and try to reform the trust by showing the probable intent of the testator not to disqualify the beneficiary from government benefits.
7. Medicaid - A means tested government medical program. The limit on countable resources varies from as low as $2,000, depending on the specific Medicaid program. Medicaid pays for long-term, custodial type care and includes physician, hospital and prescription coverage. Those with disabilities typically have very high medical bills and Medicaid is a very important resource. In many states, if an individual qualifies for SSI they automatically qualify for Medicaid. So for many individuals with disabilities one of the most important benefits of SSI is that it gets you Medicaid qualification.
8. Medicare - For those over age 65 and those under 65 who are disabled who contributed to Social Security system. If you never contributed to Social Security but were disabled prior to age 22 you can collect under a parent's Social Security. If you collect Social Security disability for two years you qualify for Medicare. It is not means tested (i.e., there are no income or countable resource limits). If the only government benefit you get is Medicare you will not need a SNT. Medicare does not cover long-term custodial care.
9. Payback Trusts - This is often used to refer to first party SNTs (also called (d)(4)(A) trusts) so that on the death of the beneficiary the remaining trust assets must first be used to repay Medicaid. The balance of the assets can then be distributed to the remainder beneficiaries.
10. Prudent Investor Act - Requires fiduciaries to invest trust assets based on the investments suitability for the beneficiaries.
11. Special Needs Trusts - SNTs are unique trusts (legal agreements). Typically the person setting up a trust is the grantor or settler; however, a SNT must be established by a court, legal guardian, parent, or grandparent. If the person does not have a parent or grandparent or guardian they must have the trust established by court. The language of the trust should say assets can be used to supplement and not supplant what is provided for by government benefits. First party trust is a special needs trust. A third party trust is often called a supplemental benefits trust.
12. Supplemental needs -Supplemental needs are those not covered by Medicaid or SSI. Medicaid pays medical bills. SSI pays for food and shelter. A SNT can pay for needs that are not medical, rent or food. It can pay for special wheelchairs, hair needs, personal grooming, vacations, etc. The language of the trust should provide that assets may be used to supplement and not supplant what is provided by government benefits.
13. Supplemental Security Income (SSI) - Means tested cash benefit for the aged, blind and disabled from Social Security. Your monthly income must be below the federal benefit rate ($674 in 2009) plus state supplement, if any ($31.25). You must have countable resources of less than $2,000 not counting the home or prepaid funeral benefits.