By Thomas D. Begley, Jr., CELA
A Third Party Special Needs Trust is usually used in a Medicaid context not for the benefit of the grantor of the trust, but for the beneficiary.
The grantor of the trust is typically a parent, but could be grandparent, sibling, other relative or friend. The grantor uses the grantor’s assets to fund the trust. The assets of the beneficiary cannot be used to fund a Third Party Special Needs Trust. In order for the trust to be a Special Needs Trust, the beneficiary must be disabled. Disability is usually determined ,y the fact that the beneficiary has received a Determination of Disability from the Social Security Administration and is receiving either Supplemental Security Income (“SSI”) or Social Security Disability Income (“SSDI”). The trust is designed so that the assets are not counted for Medicaid eligibility purposes. The beneficiary is then able to take advantage of the continuation of public benefits including usually SSI and Medicaid, as well as use the assets in the trust to enrich the beneficiary’s life. The trustee is given complete discretion with respect to distributions, and special needs language is used in designing the trust. Provisions made for distributions to the beneficiary during the beneficiary’s lifetime and distribution of any remaining principal and accrued income upon the death of the beneficiary.
It is always good practice to select a professional trustee. The professional trustee has expertise with respect to public benefits law, tax Jaw, investment management, and usually has the ability to assist in navigating the disability system. Often the grantor of the trust is uncomfortable with a professional trustee, but this problem can usually be solved by appointing a family member as trust protector. The trust protector monitors the performance of the trustee and is given the authority to remove and replace the trustee. The trust protector’s power to remove and replace the trustee can be conditioned on cause, which would be defined in the trust document, or can be without cause. It is generally required that the replacement trustee be a professional with a certain amount of assets under management. In order for disability organization to qualify, the asset management limit might be as low as $50,000,000. On occasion, the grantor of the trust has worked with a financial advisor who would like to continue to be the financial advisor after the trust is established. Many professional trustees, such as Comerica Bank, have arrangements with money managers, such as Morgan Stanley or UBS, where Comerica will retain the outside money manager to invest the funds. This should be spelled out clearly in the trust document. The investment manager has an additional cost for managing the funds. The combined cost of the investment manager and the trustee usually exceeds the cost of having a professional trustee manage the funds in-house. This should be clearly understood by the client.
Alternatives to a Special Needs Trust
There a number of alternatives to Special Needs Trusts. These include the following:
- Disinherit a Child. The problem with this strategy is that one cannot be certain that public benefits, as we know them today, will continue forever. Many public benefits have been cut back in recent years and there is no guarantee that current benefits will not be reduced as well.
- Leave Money to the Child. The problem with this approach is that unless the funds being left to the child are very significant, they may not last long if the child’s needs, particularly medical needs, are great. It is usually better to maintain public benefits and establish a trust for needs or wants that will not be covered by public benefits.
- Leave Funds to Sibling. This is the common strategy that frequently backfires. The idea is to leave the share of the person with disabilities to a brother or sister with the understanding that the brother or sister will use that money to care for the child with disabilities. The problems occur when the child to whom the funds are left is sued by a creditor, is divorced, or simply says, “I want to use this money for myself. The Will says that I have to use it for my sibling with disability, but I am not going to use it for that purpose.” Sometimes it is the sibling that makes this decision, but frequently it is the spouse of the sibling who pushes for that result.
- Pooled Trust. A Pooled Trust is a good solution for relatively small amounts of money. If the trust is less than $100,000, Pooled Trust makes sense. If it is between $100,000 and $200,000, a Pooled Trust should be compared to a Third Party Special Needs Trust. If the amount involved is in excess of $200,000, a Third Party Special Needs Trust is almost always the best solution.
- ABLEAccount. New Jersey has adopted legislation authorizing ABLE accounts. These accounts are expected to come into existence sometime in the next few months. ABLE accounts are already in existence in several states, and some states, such as Ohio, permit out-of-state residents to open an ABLE account in that state. A problem is that not more than the gift tax annual exclusion amount can be contributed to an account in any one year and no beneficiary can have more than one account. The annual exclusion gift tax exemption for 2017 is $14,000. So, if the inheritance is $14,000 or less, an ABLE account might make sense.
Let’s examine the seven planning considerations in the context of a Third Party Special Needs Trust.
- Availability. Assets in a Third Party Special Needs Trust are not available for SSI or Medicaid purposes, because the Special Needs Trust gives the trustee sole discretion with respect to distributions and prohibits the beneficiary from revoking the trust. If the assets in the trust are not available, they are not counted for SSI or Medicaid eligibility purposes.
- Transfer of Asset Penalty. There is a transfer of asset penalty to the grantor for transfers to a Third Party Special Needs Trust. This is why a Third Party Special Needs Trust is seldom utilized in Medicaid planning for the grantor.
- Payback. A Third Party Special Needs Trust is not required to have a provision calling for payback to Medicaid for medical assistance paid on behalf of the trust beneficiary.
- Funding. Virtually all assets could be used to fund a Third Party Special Needs Trust. If retirement assets are being used, typically the trust is simply made the beneficiary of the retirement account upon the grantor’s death. Accumulation Trust language should be included. Beneficiary designations of life insurance, annuities or retirement accounts must be addressed. If part of the funds are going to healthy children, and part are going to the Special Needs Trust, consideration should be given to leaving the retirement accounts to the healthy children, rather than to the trust. Administration of a trust with a retirement account is somewhat complex, even for professional trustees.
- Tax Considerations
- Income tax. A Third Party Special Needs Trust can be designed as a grantor trust or a non-grantor trust.
- Gift tax. A Third Party Special Needs Trust can be designed as an IDGT or a non-IDGT.
- Estate tax. A Third Party Special Needs Trust can be designed so that the assets in the trust remain in the estate of the grantor or are excluded from the estate of the grantor.
- Estate Recovery. There is no estate recovery against the estate of the grantor of a Third Party Special Needs Trust or the beneficiary, so long as the grantor retains no interest in the trust.
- Elective Share. Assets in a Third Party Special Needs Trust would be subject to the elective share stature.