SPECIAL NEEDS – SPECIAL TRUSTS – WHAT YOU DON’T KNOW CAN HURT YOUR CLIENTS AND YOU!
Part. 3: Common Errors
Littman Krooks LLP New York, New York / www.littmankrooks.com
Set forth below are some common errors practitioners make when representing clients in connection with special needs planning and SNTs. These are by no means exhaustive, but merely a sampling of some of the things that can go wrong if careful attention is not paid to detail and all scenarios are not analyzed properly.
Not being flexible in drafting.
The needs of the trust beneficiary and circumstances of each particular matter must be considered when drafting an SNT. The trust should not be “cookie cutter,” but rather an instrument that will provide flexibility to meet the beneficiary’s needs for years to come. The goal of most clients is to improve the quality of life of the individual with disabilities. They are relying on the trust draftsperson to draft a document and put in place a plan that will adapt to the changing needs of the trust beneficiary and the ever-changing status of the law.
Not creating a third party SNT for someone over 65.
There is no law prohibiting the creation and funding of a third party SNT for individuals with disabilities who are age 65 or older. This limitation applies only to first party SNTs. Third party SNTs also are a very effective planning too for married seniors when a spouse wants to provide for a surviving spouse without jeopardizing the surviving spouse’s receipt of government benefits. In order to be effective, these types of third party SNTs must be created in a will as opposed to an inter-vivos trust.
Create a first party SNT for someone age 65 for over.
Federal law expressly prohibits the creation of first party SNTs for individuals age 65 or older. If this type of trust was created, the beneficiary would be subject to transfer penalties and potential disqualification of public benefits. Moreover, since the trust must be irrevocable, it may be extremely difficult to undo this mistake and engage in proper planning.
Requiring mandatory distributions of income or principal.
SNTs must be purely discretionary trusts. If the draftsperson puts in a standard pursuant to which the beneficiary can demand distributions from the trust then that could frustrate the entire purpose of the trust. Ideally, the trust should be designed to supplement, not supplant, government benefits. By requiring the trustee to make distributions, the beneficiary’s right to certain government benefits could be compromised.
Spending third party SNT assets prior to first party SNT assets.
Often, individuals with disabilities are beneficiaries of both a first party SNT and a third party SNT. For example, they might have received a lawsuit settlement which was placed into a first party SNT and the parents might have funded a third party SNT. Since the third party SNT does not have a Medicaid payback provision, it is essential that assets of the first party SNT be spent first prior to expending any third party SNT assets.
Gifts to first party SNT made by third parties.
While this may seem obvious; unfortunately, it does happen. Since the first party SNT must have a payback provision, it is imperative that any planning done by third parties include a third party SNT and that contributions by third parties go into the third party SNT and not the first party SNT.
Failure to coordinate with other relatives’ planning.
It is important to discuss with your client whether other family members are intending to leave assets to a child with a disability. Also, what if a parent of a child who is disabled predeceases his parents – would the grandparents unintentionally now be leaving assets outright to the child? After a client completes his estate planning, he should inform other family members of the third party SNT that has been put into place and how they can contribute to it if they so desire. This is one of the benefits of utilizing an inter-vivos third party SNT.
Failure to review and coordinate all beneficiary designations.
In any estate plan, but especially in a special needs situation, it is important to review and coordinate beneficiary designations. The intent and purposes of a third party SNT will be frustrated if the beneficiary designations of life insurance, retirement accounts, etc. leave assets outright to a person with disabilities.
Not preparing a letter of intent.
While not a legally binding document, a letter of intent is a critical component of a special needs plan. It provides a roadmap for future caregivers so that they can do the best job possible. In many cases, this document can be referred to by the trustee to help determine whether a distribution is appropriate.
Failure to select the proper trustee.
Too often, not enough time is spent discussing this very important decision. In many cases, the proper trustee is the key to the successful implementation of the plan and administration of the trust. Clients often wish to appoint a family member. However, family members often have a conflict of interest and have no experience serving as trustee. Serving as trustee of an SNT is even more complicated than serving as a trustee of a more traditional trust since the trustee must also be familiar with public benefit rules. In fact, many banks and trust companies refuse to serve as trustee of an SNT. It often makes sense to have co-trustees. In this scenario, the individual trustee can address the beneficiary’s personal needs and the corporate trustee can handle the investment and compliance issues.
Failure to consider a trust protector.
While a relatively new concept in the United States, the appointment of trust protectors is gaining traction, especially in SNTs. In an SNT, the beneficiary is often not able to monitor the actions of the trustee due to cognitive issues. Thus, a trust protector can serve a very useful oversight role in these cases. The trust protector can have a number of powers, including the power to make certain changes to the trust, the power to approve distributions, the power to change the trustee, among others. One issue you will want to address is whether the trust protector will be considered a fiduciary.
Having remainder beneficiaries whose interests are adverse to the beneficiary with disabilities.
Too often, families lose sight of the fact that the SNT was set up primarily for the benefit of the person with disabilities. Practitioners need to be mindful of potential conflicting and hostile family relationships which may impact the administration of the SNT. For example, if a sibling is a trustee and also a remainder beneficiary, the sibling may be hesitant to spend necessary money on the beneficiary for fear that his remainder interest will be diminished. In these situations, it might make sense to have a third party such as a trust protector involved in the decision-making process of whether to make a particular distribution.
Failure to consider a contingent SNT in a Will.
Many practitioners will not include an SNT in an estate plan because the family is not sure that the individual with disabilities will ever need government benefits. In these situations, a contingent SNT works very well. The practitioner can draft the will leaving the assets either outright or in a trust which is not an SNT. If, at the time that the beneficiary becomes entitled to receive the assets, it is possible that government benefits may be in his future, then the SNT provisions can be triggered. This approach allows the decision on whether to utilize an SNT to be deferred, thereby giving all parties more time and information to make the proper decision. When including a contingent SNT in a will, it is important to review state trust law with respect to Medicaid eligibility.
Prohibiting disqualifying distributions.
The goal of special needs planning is to improve the quality of life of the individual with disabilities. In certain circumstances, the beneficiary may be better off if services or items are paid for by the SNT even if this will have the effect of reducing or eliminating government benefits. It is important that the trust allow for the trustee to exercise its discretion in this regard.
No provision to terminate third party SNT if it is treated as available asset.
Medicaid agencies are becoming increasingly aggressive in their treatment of trusts, including third party SNTs. For that reason, it is important that the trustee (or someone else such as a trust protector) have the power to terminate the trust if Medicaid takes the position that the trust is an available resource. In that case, it may be important to remove the assets from the trust so that other planning may be implemented.
Include a Medicaid payback clause in a third party SNT.
This is one surefire way to have an unhappy client and a malpractice case on your hands. Many practitioners don’t understand the difference between a third party SNT and a first party SNT and they think that all SNTs must have a Medicaid payback. That is simply not the case.
Give SNT beneficiary with disabilities Crummey powers.
For tax planning purposes, it is often desirable for trust beneficiaries to have a Crummey right of withdrawal so that contributions to the trust qualify for the annual gift tax exclusion. If the trust beneficiary is receiving government benefits, however, it is possible that SSA or Medicaid could take the position that a disabled beneficiary’s Crummey right of withdrawal could cause the assets of the trust to be available to that beneficiary. Further, the lapse of the power could be considered a gift for eligibility purposes. If estate and gift tax planning is important to the client, perhaps there are others, including contingent remaindermen, who you could give the Crummey power to.
Make first party SNT revocable.
First party SNTs must be irrevocable trusts. If the beneficiary has the power to revoke the trust, then the trust assets will be considered available for Medicaid and SSI purposes.
Include sprinkling provisions in first party SNT.
A first party SNT must be for the sole benefit of the beneficiary with disabilities. Thus, first party SNTS may not contain a provision which gives the trustee the power to distribute or sprinkle trust assets to other individuals. With respect to third party SNTs, sprinkling provisions are permitted although many practitioners prefer to set up separate trusts.
Not reviewing public benefits.
Clients frequently do not know the exact benefits they are receiving. Always review written documentation of benefits eligibility. For example, if a beneficiary is receiving only SSDI and Medicare and it is not anticipated that he will be receiving any means-tested benefits, perhaps an SNT is not necessary.
If retirement benefits are being funded into an SNT, the practitioner should consider whether it makes sense to use an accumulation trust as opposed to a conduit trust. While this might accelerate the payment of income taxes, it may preserve more of the trust corpus for the beneficiary, when needed.
In many cases, practitioners assume that an SNT is the best option, when in fact, that might not always be the case. In a third party SNT situation this can be addressed by using a contingent SNT. This allows for the creation of an SNT in the future, if necessary. In a first party SNT situation, the amount of funds might be so substantial that it might not make sense to apply for means-tested government benefits. In addition, there may be a Medicaid lien which must be satisfied prior to funding the SNT. This lien is in addition to the Medicaid payback required on the beneficiary’s death. In some cases, Medicaid may actually be able to recover more monies from the beneficiary if an SNT is funded than if an SNT is not created and funded. Thus, the beneficiary may be better off not being on Medicaid or SSI. Of course, each case must be evaluated on its own circumstances.
© 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.