[This article was originally printed in the Straight Word, a publication of the Burlington County Bar Association.]
by Thomas D. Begley, Jr., CELA
There are a number of mistakes that scriveners make in drafting special needs trusts. This article will discuss those that frequently occur.
- Including a Payback Provision in a Third-Party Special Needs Trust. Payback provisions are a creature of Omnibus Budget Reconciliation Act of 1993 (OBRA-93).[1] This statute relates solely to first-party special needs trusts. There is no federal statute governing third party special needs trusts. These trusts are governed by the Program Operating Manual System of the Social Security Administration (POMS). There is no requirement in the POMS for a payback provision in a third-party special needs trust. Inclusion of such a provision would require the trustee to make such a payback and subject the scrivener to a potentially serious malpractice action.
- Creating a Self-Settled Special Needs Trust for an Individual Over Age 65. Frequently, there is a personal injury settlement for a beneficiary over age 65. Often, these beneficiaries reside in assisted living facilities or nursing homes. They are receiving Medicaid and, in many instances, SSI. The personal injury attorney is anxious to protect the settlement and preserve public benefits. The trust attorney then drafts a self-settled special needs trust without inquiring as to the age of the beneficiary. Once the beneficiary attains age 65, he or she is no longer eligible for a special needs trust.[2]
- Requiring Mandatory Distributions of Income. If a trust distributes income to a beneficiary, it is considered unearned income by SSI and Medicaid. If the income distribution is less than the amount of the SSI payment, the SSI payment is reduced dollar-for-dollar so nothing is gained. If the distribution exceeds the SSI payment, then SSI is lost and if the Medicaid is linked to SSI, then Medicaid is lost as well. The key to a special needs trust is that the trustee must have full discretion over distributions. A mandatory distribution provision would mean that the trustee does not have discretion over these distributions.
- Inclusion of Crummey Powers. Often, an irrevocable life insurance trust (ILIT) is wrapped in a special needs trust. The trust is funded by a life insurance policy. If the special needs trust contains a Crummey Power giving the disabled beneficiary a right of withdrawal, then that right is income to the beneficiary in the month during which the right of withdrawal may be exercised and may disqualify the disabled beneficiary from SSI and Medicaid linked to SSI. The solution is to use a Cristofani Power giving someone other than the beneficiary with disabilities the right to withdraw.
- HEMS Standard in a Special Needs Trust. Most trusts include a direction to the trustee to make distributions to the beneficiary for the beneficiary’s health, education, maintenance, and support. This is commonly known as a “HEMS” standard. Such a trust is generally done for an individual who is not receiving public benefits. This is called a support trust. However, if a special needs trust contains a HEMS standard it is not a special needs trust, because the essence of the special needs trust is the discretion in the trustee in making distributions.
- Failing to Make the Trust Irrevocable. In the case of a self-settled special needs trust, the document must provide that the trust is irrevocable. If the trust is revocable, it is an available asset to the beneficiary and public benefits will be lost. In a third-party special needs trust, the document may provide that the third-party grantor may revoke the trust. Typically, the language will give the grantor the right to revoke the trust until the death of the grantor or until the trust is funded by someone other than the grantor.
- Failing to Adequately Fund a Special Needs Trust. This is perhaps the most common problem with third-party special needs trusts. Parents want to establish a trust for their child with disabilities. They have three children, two of whom are healthy and one whom has a disability. They want the trust assets divided equally among the three children upon death. Good practice dictates that a Life Care Plan be obtained outlining the level of funding that will be required to maintain the child with disabilities in the lifestyle that the parents want for that child. The healthy children can work, so one solution would be to leave them no money or a smaller percentage. The other solution is to fund the third-party special needs trust with a second-to-die life insurance policy on the parents. These two strategies can be used in combination.
- Selection of a Non-Professional Trustee. This is a very common and serious mistake. A professional trustee knows public benefits law, has investment expertise or hires such expertise, knows tax law, and is familiar with navigating the disability system. The professional trustee has no conflicts of interest and is in a position to say “no” to inappropriate distributions. The reason many individuals want a family member is cost. By the time the family member pays the bonding premium, if they can get a bond, hire someone to manage the money, and hire someone to prepare the tax return, they’ve usually spent far more money than they would in hiring a professional trustee. Family members often have conflicts of interest in that they will be receiving any money not distributed for the benefit of the beneficiary. Family members are often inclined to make a distribution that would be inappropriate. There is often conflict between the family member trustee and the beneficiary that destroys a family relationship.
- Failure to Appoint a Trust Protector. When a professional trustee is selected, for the most part, the result are satisfactory to all concerned. However, there are occasions when a beneficiary is legitimately dissatisfied with the performance of the trustee. A trust protector is a good check and balance on the professional trustee. The Trust Protector can removed and replace trustee.
- Failing to Give a Minor with Capacity a Power of Appointment over Trust Assets on Death. In New Jersey, a trustee cannot do estate planning for a minor. The typical self-settled special needs trust states that on death after the Medicaid payback, remaining trust assets go by intestacy. By giving the minor beneficiary a limited power of appointment upon attaining majority, the remainder of the trust assets can be distributed in a more appropriate manner.
[1] 42 U.S.C. §1396p(d)(4)(A).
[2] 42 U.S.C. §1396p(d)(4)(A).
