SPECIAL NEEDS – SPECIAL TRUSTS – WHAT YOU DON’T KNOW CAN HURT YOUR CLIENTS AND YOU!

Part. 2: Drafting Considerations & Trust Administration Considerations

By Bernard A. Krooks

Littman Krooks LLP New York, New York / www.littmankrooks.com

Part. 1 Overview & Taxation

III. Drafting Considerations

A. Trustee Selection

The selection of a trustee is one of the most, if not the most, important decisions in determining whether the special needs plan you have created will ultimately work for your client and his family. A trustee of an SNT should be knowledgeable in many areas, including trust law, tax law, public benefits law, investments, medical issues, education issues and advocacy issues, among others. Finding a suitable trustee is often a challenge due to a variety of factors. This is an area where the input of an experienced special needs trust practitioner can be extremely useful to the client.

The trustee may be a family member, professional colleague or a corporate fiduciary. It is not recommended that the beneficiary himself serve as trustee. The government would likely argue that this would give the beneficiary too much control over the trust property, and it could cause the trust assets to be considered an available resource for Medicaid and SSI purposes. It makes sense for many clients to consider appointing co- trustees: a family member and a professional trustee. The family member trustee can deal with the advocacy and care issues, while the professional trustee can take care of the investment and compliance issues. Regardless of who is appointed trustee, it is important to have a mechanism in the trust instrument for appointing a successor trustee. Failure to do so could result in unnecessary expense to the trust.

An SNT differs from a more traditional trust since the beneficiary may be on government benefits and there may be accounting or other requirements that cause the government to be an interested party. In addition, for a first party SNT, the government is entitled to the payback on the death of the beneficiary or early termination of the trust. Thus, there may not be the same desire to maximize total overall return since there will be immediate needs of the beneficiary that must be met. In any event, the trustee must keep accurate records and make sure that distributions do not inadvertently violate the Medicaid or SSI rules.

1.) Professional/Corporate Trustee

In many cases, the client will be well-served by having a professional serve as trustee of an SNT. Of course, this will likely mean increased expense compared to a family member; however, in most cases this will be well worthwhile. Most family members have never served as trustee of any kind of trust, much less an SNT. There could be a tendency to treat the trust money as their own or co-mingle the funds with their own. This is especially troublesome when the beneficiary with disabilities is not capable of monitoring the trustee’s actions.  It is important to have a trustee who will take the time to get to know the beneficiary and who will investigate and understand his needs. The trustee must have the backbone to refuse to make inappropriate distributions and also be flexible enough to make distributions that will enhance the quality of life of the beneficiary. Be careful, as not all  professional trustees will take the time to do the job properly. Increasingly, courts are becoming less tolerant of SNT trustees who  simply invest the money, take their fees and do not take other actions which benefit the beneficiary. [1] Courts are holding trustees of an SNT to a higher standard, often requiring them to apply for public benefits on behalf of the trustee or make distributions that improve the quality of life of the beneficiary. [2] For this reason, among others, many banks and trust companies will not serve as trustee of an SNT. It is important to work with a trust company that seeks out this type of business and will do a good job.

When utilizing a corporate trustee, make sure you incorporate their fee schedule into the trust document. Most banks and trust companies have a minimum annual fee or may have a minimum corpus requirement. In some cases, this will be an impediment to appointing a corporate trustee. It is important for the special needs planning practitioner to establish relationships with professional trustees who are flexible when it comes to minimum corpus requirements.

B. Trust Protector

In certain cases, it may be appropriate to appoint someone or an entity as trust protector to have the authority or duty to oversee the trustee in an SNT since the beneficiary often cannot serve this role. For example, a beneficiary with cognitive impairment would not be able to review the accountings of the trustee. A trust protector can have a number of roles, depending on state law and the trust instrument itself. There are several states which have trust protector statutes and these must be reviewed if your trust is governed by the laws of one of those states. [3] If the trust protector has the power to remove the trustee, the document should be clear whether this can be done for any reason or just for good cause. The trust instrument should also be clear on whether the trust protector has an affirmative duty to investigate actions of the trustee or simply respond to items which he becomes aware of. It is important to carefully think through which powers you give to a trust protector, as these can vary widely. They can be merely administrative in nature or can be substantive. You must decide whether the trustee has to follow the direction of the trust protector or whether the trust protector is merely acting in an advisory capacity. Depending on the powers given to the trust protector, fiduciary responsibility may attach thereto. [4]

C. Trustee Discretion 

Many attorneys draft third party SNTs as wholly discretionary trusts instead of using “supplemental” needs trust language. In order to ensure that a third party SNT is not considered an available resource by the government agencies, it is important not to include a support standard or a right of the beneficiary to revoke the trust. Any trust provision that could be interpreted to give the beneficiary the right to compel a distribution or revoke the trust could present a potential problem with respect the beneficiary’s right to qualify for government benefits. If the  settlor intends for the trust to be an SNT, then it is important for his intent to be evidenced in the trust document. The trust instrument should specifically state that the beneficiary does not have the authority to revoke the trust, or to direct the trustee to make distributions from the trust for any purpose. As a precautionary measure, practitioners should consider using a “poison pill” provision in third party SNTs to terminate the trust if the governmental agencies take the position that the trust assets are countable as an available resource for SSI or Medicaid purposes. This provision would permit the trustee to terminate the trust and distribute the trust corpus to the remainder beneficiaries if the trust estate would otherwise become liable for services that would be provided through public benefits programs.

The third party SNT should not provide for mandatory disbursements to the beneficiary since this can cause eligibility problems with respect to Medicaid and SSI. Moreover, the trust document should prohibit the beneficiary from anticipating, assigning or selling the right to future payments. The current value of these payments may be considered a resource to the beneficiary since he could potentially sell the right to future payments for a lump-sum settlement.

Another drafting issue with respect to trustee discretion that deserves some thought is whether the trustee should be permitted to make a distribution even if it reduces or eliminates the beneficiary’s entitlement to government benefits. If this type of distribution would improve  the quality of life of the beneficiary, then perhaps it makes sense to make the distribution even if it would reduce or eliminate the beneficiary’s right to receive government benefits. To avoid confusion during the administration of the trust, the trust document must be clear on this point.

SNT practitioners frequently debate whether an SNT should include very specific distribution standards or standards which are broad in nature. The theory behind specific standards is the hope that it will provide clear guidance to trustees (and beneficiaries and family members) as to what is intended with respect to permissible distributions. The thought is that this will reduce any potential litigation risk or the need to seek court approval for distributions. However, by being specific, you may run into problems getting the trust approved by SSA since they change their policies and the POMs from time to time. One of the provisions may run afoul of a subsequent POMS provision which changes SSA policy on a particular issue. Additionally, there may be a concern that by listing an item, the trustee must make a particular distribution. Conversely, it is thought that broad standards allow the trustee to exercise its unfettered discretion to make a distribution to improve the quality of life of the beneficiary in accordance with the trust instrument. In fact, many corporate trustees actually prefer this to a specific standard. After all, it is very hard to anticipate at the time of drafting all the future possible needs of the beneficiary. One of the drawbacks of a broad standard is that the trustee often feels the need to seek court approval for certain distributions since they are not specifically stated in the trust. In this regard, it is sometimes helpful if the settlor of the trust has drafted a letter of intent which could be used by the trustee as guidance in determining if a distribution should be made. With respect to this issue, there is no “one size fits all” approach that can be applied to all trusts. Each case must be thought through and discussed with the relevant parties prior to drafting the trust.

If an individual has a first party SNT and a third party SNT set up for his benefit, language should be included in the third party SNT directing the trustee to use trust assets only to the extent that the first party SNT is not permitted to provide the same distribution. Since the assets of the first party SNT are subject to the Medicaid payback, those assets should be spent on behalf of the beneficiary prior to tapping into the third party SNT.

The SNT may be designated as the beneficiary of a retirement account. While a “conduit” trust will provide income tax benefits, it is generally not the preferred choice if the SNT beneficiary is receiving government benefits.  A conduit trust is a trust under which the trustee must distribute all retirement plan distributions to the beneficiary. These distributions could have a negative effect on the beneficiary’s eligibility for government benefits. The preferred approach is an “accumulation” trust which allows the trustee to accumulate retirement plan distributions and make distributions to the beneficiary in the trustee’s discretion. While this may not have the same beneficial income tax results as a conduit trust, it will generally serve the needs of the SNT beneficiary better by allowing the trustee to make (or not make) distributions as appropriate.

D. Trustee Powers

In an SNT it is important for the trustee to have the power to invest trust assets in non-income producing assets, such as a car or a house. Also, in an SNT, preservation of principal may not be paramount since the intent is to improve the quality of life of the beneficiary with disabilities and the interests of the remaindermen are secondary to those of the lifetime beneficiary with disabilities. In order to avoid unnecessary litigation and expense, the trust instrument should be clear on these points.

E. Trust Amendment

Due to a rapidly changing regulatory and legal landscape, it is possible that an SNT will need to be amended after it is executed. For example, if the beneficiary moves to another state, the new state’s Medicaid agency may not agree with certain trust provisions and could require that they be removed or amended before Medicaid will be granted in that state. In addition, the POMS are constantly changing and may cause the exempt trust to no longer be exempt. This is a major reason why the draftsperson needs to incorporate flexibility into the trust so that it may be amended when necessary. Even though decanting or reformation may be available, it is almost always more cost-effective and practical to amend the trust if the power to do so is included in the trust document. This is one area where a trust protector can be extremely helpful. If the original trust is a first party SNT which was approved by a court, it is quite possible that the court will insist on approving any modifications to the trust.

F. Other Provisions

The trust should give the trustee the power to hire professionals, including lawyers, accountants, financial advisors, and care managers. Some corporate trustees will often insist on this provision prior to agreeing to serve. Be mindful that in first party SNTs, professional fees payable from the trust may be subject to court approval.

The trust should always contain a spendthrift clause which eliminates the ability of the beneficiary to encumber or alienate the trust estate, and protects the trust estate from the claims of the beneficiary’s creditors.  The trust should also contain a specific provision setting forth the beneficiary’s lack of control over the trust assets. While this may seem obvious to the draftsperson, it is important that this be made explicitly clear to public benefits caseworkers who might be called upon to review the trust upon submission of an application for, or review of, public benefits.

Always try to use people-first language. Use the term “individual with disabilities” instead of ‘disabled person.” While this may result in awkward drafting, it is important to many in the disability community.

IV. Trust Administration Considerations 

A. Family Member as Caregiver 

Frequently, parents of children with disabilities need to stay at home and care for their child and cannot be part of the regular workforce causing some parents to give up successful careers. Other times, parents cannot rely on the Medicaid system to provide appropriate aides for their child. It may be appropriate for the trust to pay for private aides or to compensate the parent as a caregiver. A third party SNT can provide for this type of compensation. However, when dealing with first party SNTs, even if the trust grants the authority, the trustee may still wish to notify Medicaid and seek court approval. A few years ago, the POMS actually had a provision (which was subsequently withdrawn) that would have prohibited  first party SNTs from paying family members as caregivers unless the family member was certified. Interestingly, the POMS did not define who was a family member or how one would become certified. The provision was purportedly put in place because SSA was concerned about alleged abuses of certain family members who were taking advantage of the trust beneficiary who had disabilities.

B. Travel Expenses

Another POMS provision which was also subsequently withdrawn would have treated a trust provision which allowed the first party SNT to pay for the travel expenses of someone else as a violation of the “sole benefit” rule resulting in trust assets being considered an available resource. This POMS provision has since been revised to permit payment by first party SNTs of travel expenses of non-beneficiaries in limited circumstances. The revised rule provides that payments to third parties do not violate the sole benefit rule if they are for goods and services received by the beneficiary or payments for travel expenses of third parties which are necessary for the trust beneficiary to obtain medical treatment or payments that allow a third party to visit a beneficiary who resides in an institution, nursing home, or other long-term care facility (i.e., group homes and assisted living facilities), or other supported living arrangement in which a non-family member or entity is being paid to provide or oversee the individual’s living arrangement. However, the travel must be for the purpose of ensuring the safety and/or medical well-being of the individual. [5] It is important to note that these provisions are limited solely to those beneficiaries receiving SSI and also do not apply to third party SNTs. Thus, payment from third party SNTs to reimburse travel expenses of family members is permissible so long as the trust provides for such reimbursement. This distinction is due to the fact that third party SNTs do not have to be for the sole-benefit of the beneficiary with disabilities.

C. Housing Options

The purchase of a home for someone with disabilities is something that can improve his quality of life for a long time. However, a home purchase often presents a number of complex issues at the time of purchase and during the time period that the beneficiary resides in the house. For this reason, many practitioners suggest that a beneficiary rent in instead of owning a home. If the decision is made to purchase a home, a threshold question is whether the purchaser of the home should be the trust, the beneficiary, or some other third party. If a first party SNT owns the home, then the value of the home will be subject to the Medicaid payback upon the death of the beneficiary. If the beneficiary owns the home, the Medicaid payback will not apply; however, Medicaid may, under certain circumstances, place a lien on the home, or, the value of the home may be subject to Medicaid estate recovery upon the death of the beneficiary. Pursuant to 42 U.S.C. Sec. 1396p(b)(1)(B), Medicaid may have the right to recover for certain long-term care benefits paid after the beneficiary attained the age of 55. With respect to third party SNTs, it often makes sense for the SNT to own the home since there is no Medicaid payback in those types of trusts.

When purchasing a home, the question invariably arises as to whether the purchase should be financed. The proceeds of a mortgage will not be considered income for SSI or Medicaid purposes so long as they are used to purchase the home in the same month in which they are received. If the trust owns the home, it may be difficult for the trustee to qualify for a mortgage. Of course, this situation can be ameliorated if the trust company and the mortgage company are owned by the same entity. If the home purchase transaction is structured so that the beneficiary owns the home, it may be also difficult to obtain a mortgage since many beneficiaries do not work or have poor credit. For this reason, it is common for home purchases to be all cash transactions.

If a house is owned individually by a first party SNT beneficiary, it may not make sense for the ownership to be transferred to the SNT if the beneficiary is under age 55 since Medicaid does not have a right of recovery for benefits paid to an individual prior to age 55. If ownership of the house is transferred to the first party SNT and other family members are living in the house owned by the trust, the trustee should consider contributions from those family members. This is especially true in first party SNTs since you want to make sure that the trust does not violate the sole-benefit rule by allowing others to live in the house rent-free. In these situations, it is often necessary to charge the other family members rent. If the other family members provide care to the beneficiary that allows him to stay at home, that can be a mitigating factor.

D. Purchase of a Vehicle 

A trust can purchase a vehicle for the benefit of a beneficiary. It is important to consider who should be the owner of the vehicle. It often makes sense to title the vehicle in the name of the beneficiary or family member. This way, if a car accident occurs in which the beneficiary or family member was responsible, it will minimize the exposure of trust assets in any subsequent litigation. It is suggested that the trust hold a lien on the title of the car so the beneficiary or family member cannot sell the vehicle.

E. Payback Provision 

As previously noted, all first party SNTs must include a payback provision at the death of the beneficiary or early termination of the trust. It is important to remember that the payback is only for Medicaid expenditures and not SSI. Be mindful that beneficiaries sometimes move during lifetime and thus receive Medicaid benefits from more than one state. Upon death, the respective states will be entitled to a pro-rata allocation of whatever remains in the trust on death. Also, different states may have different rules regarding how far back the payback must go. In some states, the payback includes Medicaid expenditures incurred prior to the creation of the trust. In these types of cases, the viability of creating a first party SNT must be considered in light of the fact that the payback to Medicaid may be higher than if a first party SNT is not created.

Some, but not many, expenses receive priority over the Medicaid payback. For example, trust administration expenses and federal and state estate taxes may be paid prior to repaying Medicaid. Debts due third parties, funeral expenses and payments to residual beneficiaries cannot be paid until the state is reimbursed for Medicaid paid. For this reason, it is critically important that burial and funeral expenses be prepaid by using a Medicaid-exempt, irrevocable prepaid funeral contract prior to the beneficiary’s death. In fact, a first party SNT should include a provision authorizing the trustee to spend trust assets for this purpose. When determining the amount to be paid back to Medicaid, it is important to review a report provided by Medicaid which details each and every expenditure made by Medicaid on the beneficiary’s behalf. Frequently, there are errors, including care provided to other individuals and payment for special education and related services, which are not subject to payback.

Part 3. Common Errors

© 2016 University of Miami School of Law.  This outline was prepared for the 50th Annual  Heckerling Institute on Estate Planning sponsored by the University of Miami School of Law, and published by LexisNexis. It is reprinted with the permission of the Heckerling Institute and the University of Miami School of Law.

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[1] See In the Matter of the Accounting by JP Morgan Chase Bank, N.A. v. Marie H. (N.Y. Surr. Ct., No. 2005-1307, Dec. 31, 2012).

[2] See Liranzo v. LI Jewish Education/Research (N.Y. Sup. Ct., Kings Cty., No. 28863/1996, June 25, 2013).

[3]  Included in the states that have trust protector statutes are Alaska, Delaware, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Utah, Wyoming, Arizona, Idaho, and Michigan.

[4] Some commentators have argued that a trust protector is always a fiduciary and that neither a state statute nor a settlor can change that.

[5] POMS SI 01120.201 F.2.b.