By Thomas D. Begley, Jr., CELA
Trusts for disabled individuals who have not reached age 65 and are funded with assets of the disabled person are authorized under OBRA-93.(1) The trust is for the benefit of disabled persons. The person much be under 65 at the inception of the trust. While the trust must be established and funded prior to the beneficiary attaining the age of 65, it may continue after 65. If the trust is funded with a structured settlement prior to the beneficiary attaining the age of 65, the trust remains viable even though payments from the annuity are received after age 65.
The trusts must be established by a parent, grandparent, legal guardian, or court. Curiously, they cannot be established by the disabled individual. However, there is legislation in Congress that would permit the individual beneficiary to establish his or her own trust.
By statute, transfers to the trust are not subject to the transfer of assets rules. The trust should be drafted so that the resources are unavailable. The trust should be administered in such a way that the income is not counted as income to the beneficiary.
The trust must provide that on death the funds remaining in the trust go first to reimburse Medicaid and then for the benefit of other beneficiaries.
The assets used to fund the trust must be the assets of the beneficiary, not the assets of a third party, except that a token amount is permitted to be contributed by a third party to seed the trust, i.e., S10 or S20. If a trust is funded with assets of a third party, it is considered a Third-Party Special Needs Trust and the rules are very different. Generally a Self-Settled Special Needs Trust, or First-Party Special Needs Trust is used in connection with:
- A personal injury settlement
- An inheritance
- Child support
When drafting a Self-Settled Special Needs Trust, it is always good practice to use a professional trustee. Family members are always well intentioned, but do not have the necessary expertise with respect to public benefits law, tax law and investments and do not know how to navigate the disability system. Family members frequently have a conflict of interest with the beneficiary. Family members are often uncomfortable in naming a professional trustee. A way to make everyone happy is to appoint family member as trust protector. The trust protector is given the authority to monitor the trustee and to remove and replace the trustee, if the trust protector is dissatisfied with the trustee’s performance. The trust protector’s power to remove and replace could be limited to cause, which would be spelled out in the trust document, or the power could be exercised without cause. If a family member serves as trust protector, it is inappropriate to provide for compensation for the family member. The document should provide that if the trust protector removes and replaces the professional trustee, the new trustee must also be a professional trustee. The professional trustee could be a corporate trustee or a disability organization. It is good practice to set a limit on the dollar amount under management by the new trustee. Fifty million dollars might be appropriate, so that disability organizations can qualify.
A Self-Settled Special Needs Trust must be established by a parent, grandparent, guardian or court. The Social Security Administration (SSA) is now taking the position that if a parent establishes a trust, they must fund the trust with 510 of the parent’s money. This position is based on a court case, Draper v. Colvi11.(2) The rationale seems to be that the person who “first funds” the trust is the establishor. If the parent signs the trust, but funds it with the personal injury settlement, inheritance, child support or alimony, then that money belongs to the beneficiary of the trust, so the court
and Social Security are taking the position that the first funding comes from the beneficiary and the beneficiary is not permitted to establish a Self- Settled Special Needs Trust.
The same rationale would apply to a trust established by a grandparent. Self-Settled Special Needs Trusts are seldom established by a guardian, because court action is required to authorize the guardian to establish the trust. As a practical matter, it is easier to simply have the court establish the trust. The judge will not want to sign the trust, so the trust document must state that the trust is approved, required and established and the judge directs another individual to sign the trust. Typically, the individual signing the trust is the parent, but the first funding doctrine does not apply, because the trust is actually being established by the court. It is not good practice to simply incorporate the trust in the court order by reference. It is important that the judge direct someone to sign the trust. If a parent or grandparent is not available, it could be any other family member or even an attorney.
In establishing any trust to be used in a Medicaid context, there are seven planning considerations:
- Availability. Because the trust language gives the trustee total discretion as to distributions, the assets in the Self-Settled Special Needs Trust are not considered available for Supplemental Security Income (“SSI”) and Medicaid eligibility purposes. It is important to carefully draft the trust with appropriate special needs language.
- Transfer of Asset Penalty. There is no transfer of asset penalty for SSI and Medicaid, because there is a statutory exemption under 42 U.S.C. § 1392b and 42 U.S. C. § 1396p(d)(4)(A).
- Payback. A payback to Medicaid is required by law. The payback is for all medical assistance received by the beneficiary since birth. It is not sufficient to pay back Medicaid benefits received from the date of the establishment of the trust to date. In the case of a personal injury settlement, the Medicaid payback is not limited to medical assistance related to the personal injury.
- Funding. Self-Settled Special Needs Trusts are generally funded by personal injury recoveries, inheritances, equitable distribution, alimony or child support. However, any asset can be used to fund a Self-Settled Special Needs Trust.
- Tax Considerations
- Income. A Self- Settled Special Needs Trust is considered a granter trust. Therefore, the income earned by the trust is taxed to the beneficiary at the beneficiary’s tax rates.
- Gift. Transfers to a Self-Settled Special Needs Trust are not completed gifts.
- Estate tax. Assets in a Self-Settled Special Needs Trust are included in the estate of the beneficiary.
- Estate Recovery. There is no Medicaid estate recovery against a Self-Settled Special Needs Trust, but a payback provision has the same effect.
- Elective Share. Assets in a Self-Settled Special Needs Trust would be considered subject to the elective share.
While the above-referenced statutes do not mention irrevocability, the POMS do require that a Self-Settled Special Needs Trust be irrevocable.
The Social Security Administration requires that a Self Settled Special Needs Trust have a spendthrift clause. The purpose of this clause is to prevent the beneficiary of the trust from assigning trust assets. If the beneficiary had the right to assign the corpus of the trust the assets would be available and the trust would not qualify as a Special Needs Trust. Even though the trust contains a spendthrift provision, it is not immune from claims of the beneficiary’s creditors, unless it is established in a state that has a Domestic Asset Protection Trust statute. A First-Party Special Needs Trust is a Self-Settled Trust and, therefore, subject to claims of creditors. New Jersey does not have a Domestic Asset Protection Trust statute.
1 42 u.s.c. § 13 96p( d ) (4)( A).
2 Draper v. Colvin, DSD Civ. 12-4091-KES Ouly 10, 2013); U.S. Cou rt or Appeals 5th Cir. No. 13-2757 (Mar. 3, 2015).