Rhode Island Special Needs Trusts
Understanding Special Needs Trusts
Special needs trusts are essential planning vehicles not only for disabled persons themselves, but also for family members and caretakers of disabled persons. This article will explain the basics of how and why special needs trusts are utilized, both for the practitioner and the client. In addition to reviewing the different types of special needs trusts and their unique functions, we will also look at some of the dangers of improper estate planning stemming from the lack of use of special needs trusts, as well as some of the pitfalls involved in the erroneous creation and use of special needs trusts.
Why Create a Special Needs Trust?
From a life planning standpoint, special needs trusts afford parents and other family members of disabled persons the opportunity to provide the desired level of control over financial assets or other property held for the benefit of the disabled person. The trustee of a special needs trust is given a limited amount of discretion as to how the trust assets are administered for the benefit of the disabled individual, in accordance with the wishes of the person creating the trust (generally a parent, grandparent or sibling of the disabled person). Instead of lifetime gifting or leaving property upon death to a disabled individual, the trust becomes the proper receptacle for all such transfers of property. Designating the trust as the owner of such property also helps to avoid any potential creditor issues the disabled person might have exposure to, and eliminates possible “spendthrift” concerns.
From an estate planning standpoint, special needs trusts serve as a valuable protector of the benefits received from means-tested government programs the disabled person currently receives, or may be eligible for in the future. Leaving money and/or property outright to a disabled person is likely to disqualify the individual from such programs, or risks preventing the individual from qualifying for such programs in the future. By designating the individual’s special needs trust as the recipient of property intended for the disabled person’s use, such assets are removed from the individual’s countable asset tally. Assets held in a special needs trust are limited to use for the “supplemental needs” of the disabled person, meaning that they are to be used only for those purposes not currently being provided for by any government program. In other words, the trust holds assets for the benefit of the disabled person in order to provide him or her with the “extras” in life, and not to supplant already existing services received via a government program.
Choosing the Right Kind of Special Needs Trust
It is important to note the distinction between the two main types of special needs trusts that can be created on an individual planning basis: the D4A Trust (also known as the First Party Trust, or the Medicaid Payback Trust) and the Supplemental Needs Trust (also known as the Third Party Trust). Throughout the remainder of the article, the two types of special needs trusts will be referred to using these various terms interchangeably. For the practitioner, it is important to be able to read and hear the varying terms, and to make the appropriate distinctions. While both trusts serve the same purposes mentioned above, they differ in several important respects.
THE D4A TRUST. First, the D4A Trust, which derives its name from the federal statute authorizing it (42 USC 1396p(d)(4)(A)). It is used to hold assets already belonging to the disabled individual, or assets to which the disabled individual is already legally entitled to. For instance, a bank account held in the name of the disabled person, or an inheritance previously received by the same individual, would both be held by the D4A, or First Party Trust. In essence, if the asset is already in the disabled individual’s name, proper planning necessitates that it be held by a D4A Trust, and not a Supplemental, or Third Party, Special Needs Trust, which trust is discussed in greater detail below.
D4A trusts are also created to hold personal injury or medical malpractice awards received by disabled individuals. Because these individuals are often already recipients of means tested programs like Medicaid or Supplemental Security Income (SSI), or will become recipients of such programs as a result of their injury, a substantial monetary award could very well disqualify them from the receipt of such benefits. It is important to note that although the disabled individual is technically not “in possession” of a personal injury award prior to finalization of the judgment or settlement, he or she is nonetheless the only bona fide legal recipient of the award, and so the D4A Trust is the appropriate recipient of such an award.
Because the D4A Trust is a statutory creature, several important guidelines must be followed when creating the trust. According to 42 USC 1396P(d)(4)(a), such a trust must: (1) contain the assets of an individual under age 65 (2) be for the benefit of an individual who is disabled as defined by the regulations, (3) be established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court (and not the beneficiary himself) and (4) contain language mandating that the State will receive reimbursement for sums paid out to the disabled beneficiary during his or her lifetime.
D4A PAYBACK PROVISION. Perhaps the most important of these statutory dictates is number four. The D4A Trust is subject to a state payback provision; hence the monicker “Medicaid Payback Trust”. Upon the disabled person’s death, any funds remaining in the trust must be used to reimburse the state for services rendered during the individual’s lifetime. As a result, a beneficiary who receives significant benefits from the State, and who utilizes the D4A Trust over an extended period of time, may well have his or her entire remainder of trust funds, if any exist, wiped out upon death. Alternatively, if government benefits received by the individual during his or her lifetime were insubstantial, or if the individual did not survive very far into the tenure of the trust, there will likely be a remainder sum. Where a remainder amount exists after reimbursement to the State, it can be distributed to other private beneficiaries named under the trust, just like any other trust instrument.
The payback provision is the all-important feature of the D4A trust. Failure to include the appropriate payback language can be catastrophic. Such a failure will likely result in the disqualification of the individual from his or her government benefits, as the trust will be considered invalid under the statute, and the trust assets deemed available to the beneficiary. Also, commingling of funds already owned by the disabled beneficiary with third party funds, if all lumped into the D4A trust, will result in the availability of the third party funds for state payback upon the beneficiary’s death. As discussed below, third party funds are not otherwise available for State payback under an estate plan that properly incorporates special needs provisions.
THIRD PARTY SPECIAL NEEDS TRUST. The Supplemental Needs Trust, or Third Party Trust, in contrast to the D4A Trust, serves as the holder of monetary or non-monetary assets others wish to gift and/or leave to the disabled person either during the donor’s life or upon the donor’s death. For example, if an aunt or uncle wishes to gift money or leave an inheritance via his or her Last Will and Testament to a disabled niece or nephew, they would do so by designating a bank account held by the Supplemental Needs Trust as the recipient. Such a designation allows the disabled individual to remain qualified for any program he or she is currently receiving benefits from, while at the same time allowing the individual to reap the benefit of the gifted assets. From a document drafting standpoint, a parent desiring to make a $20,000 bequest to a disabled child upon the parent’s death should do so by including a provision in his or her Will stating that “I give and bequeath the sum of $20,000 to the Trustee of the John Smith Supplemental Needs Trust, to be administered in accordance with its terms.” As such, prior to the creation of the parent’s Will, the Third Party Trust would need to be created. Otherwise, leaving this amount outright to John Smith would disqualify John from programs like Medicaid or Supplemental Security Income immediately upon John’s receipt of the funds.
Fund drives organized for the benefit of a disabled individual should also earmark proceeds for such a third-party trust account. In contrast to the D4A Trust, the Supplemental Needs Trust has no State payback provision, which means that assets remaining in trust at the individual’s death may pass according to the wishes of either the individual or his or her family members, or as designated in the Will of the disabled beneficiary.
Given the payback distinction between these two types of special needs trusts, one can see why utilizing and spending down the assets held in a D4A Trust (where the individual has both kinds of trusts) prior to using the assets held in a Third Party Trust, makes sense. Also noteworthy is that the Third Party Trust need not meet the age or parent/guardian/court establishment requirements.
USE OF TRUST ASSETS FOR SUPPLEMENTAL NEEDS OF THE INDIVIDUAL. One common bond shared by both the D4A Trust and the Third Party Trust is the requirement that each trust must hold assets which are limited to use for the “supplemental needs” of the beneficiary. Improper use of the trust funds, or distribution of the funds directly to the disabled beneficiary, will likely result in disqualification of the individual from government benefits. The term “supplemental needs” encompasses those needs not already being provided for by State programs. Thus, use of special needs trust funds, be they from the D4A Trust or the Third Party Trust, must be for items like vacations, occasional meals out, schooling or other educational programs, entertainment, and the like. These are all purposes and activities which disabled persons do not receive support for from programs like Medicaid or SSI, and corresponding distributions will therefore not displace any government services.
While there are no hard and fast lists or rules governing exactly what constitutes a “supplemental need” of a disabled special needs trust beneficiary, the above uses illustrate well the kinds of distributions a trustee should consider. The primary question the trustee should ask oneself before making a distribution is “does the beneficiary already receive similar support from his or her government program(s)?” When in doubt, the trustee would be well-served by contacting the attorney who originally created the special needs trust for clarification.
The Social Security Administration’s regulations and Program Operations Manual System (POMS) provide some clarity on appropriate special needs trust distributions. Distributions for food and shelter needs, and their equivalents, are generally considered in-kind income to the beneficiary, and are thus considered disqualifying distributions. While there are some exceptions to this general standard, the overarching public policy theme envisioned by the regulations is that government programs aim to fulfill basic needs, such as food and shelter, while special needs trusts are allowed in order to provide for the beneficiary’s enhanced quality of life. As a result, while a weekly trust distribution for a disabled beneficiary’s groceries may be considered in-kind income, a distribution for a birthday meal at a restaurant, would not. Until recently, distributions for clothing needs of the disabled individual were also considered disqualifying, but that restriction no longer exists.
The POMS provisions governing in-kind support and maintenance list only a handful of items which would constitute food and shelter equivalents, such as food, mortgage, property insurance, taxes, rent, heating fuel, gas, electricity, water, sewer and garbage removal payments, so anything akin to these items is of questionable legiticacy. Again, at any point the trustee begins to question whether a distribution is appropriate, legal counsel should be sought.
The trustee of the special needs trust must also be cautious not to distribute funds directly to the individual, even if the distribution is intended for a legitimate purpose. Such a direct distribution to the individual necessarily entails the disabled beneficiary receiving income and/or assets, which will then be counted against him or her for program qualification purposes. Instead, the Trustee wishing to provide these “extras” for the beneficiary should directly reimburse vendors, or find alternative arrangements that do not include the beneficiary receiving direct cash distributions.
Sole Benefit Rule
Another characteristic that both special needs trusts share is that trust assets may only be used for the benefit of the disabled beneficiary. While this rule seems straightforward enough, problems arise when trustees of special needs trusts consider making distributions for the benefit of family members or caretakers who experience physical, mental, or financial hardship in caring for the disabled individual. The sole benefit rule, like many other guidelines surrounding special needs trusts, is often blurred. For example, a trust distribution for the caretaker-mother of a disabled individual, to provide her with a solo vacation, would run afoul of the sole benefit rule. If, however, the distribution were made so that mother and son both went on the vacation, hotel accommodations, meals out, and entertainment for both individuals would probably be permissible.
Likewise, home improvements enabling the disabled individual better or easier access to the home, such as a wheelchair ramp or elevator, would be an appropriate trust expenditure, regardless of whether the disabled individual or his trust is the actual owner of the house. A multitude of cases exist, however, detailing home improvements that were not clearly for the sole benefit of the disabled individual. If the renovation could in any way be interpreted as benefitting someone other than the disabled individual, it should not be undertaken.
Special Needs Trusts in the Larger Estate Planning Context
Given this broad overview of special needs trusts and the various issues surrounding them, the practitioner should be able to see that what may initially appear to be a routine estate planning client may well be a complex matter worthy of a more in depth investigation. Often, clients are wholly unaware that having a disabled child or relative completely changes the face of their estate plan. Practitioners cannot and should not count on lay persons unfamiliar with these intricate legal concepts to divulge all of the necessary information. In taking on an estate planning client, it becomes crucial that the attorney conduct a thorough review of all of the client’s family members and intended beneficiaries.
In addition to the regulations and caselaw surrounding the proper setup and administration of special needs trusts, there also exists a diverse catalog of case law and disciplinary decisions governing legal malpractice committed by attorneys who have failed to appropriately think through the issues discussed in this article. Even a slight mistake, such as a missed payback provision or an incorrect recommendation regarding a trust distribution could potentially cost a client thousands, or even tens of thousands of dollars.
So while we can take comfort in knowing that tools exist to help disabled individuals and their families plan for their financial future without jeopardizing other available resources, all parties involved, including attorney and client, must be cognizant of the many issues, and must be diligent when drafting, shaping and administering these complex legal instruments.