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.

Trustee

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.

Planning Considerations

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.

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
• Alimony

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.

Established by

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:

1. 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.
2. 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).
3. 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.

4. 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.
5. Tax Considerations
   1. 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.
   2. Gift. Transfers to a Self-Settled Special Needs Trust are not completed gifts.
   3. Estate tax. Assets in a Self-Settled Special Needs Trust are included in the estate of the beneficiary.
6. Estate Recovery.  There is no Medicaid estate recovery against a Self-Settled Special Needs Trust, but a payback provision has the same effect.
7.  Elective Share.  Assets in a Self-Settled Special Needs Trust would be considered subject to the elective share.
   

   Irrevocability

   While the above-referenced statutes do not mention irrevocability, the POMS do require that a Self-Settled Special Needs Trust be irrevocable.

   Spendthrift Clause

   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).