THE PURPOSE OF A SPECIAL NEEDS TRUST
Special needs trusts (“SNT”s) allow a beneficiary to remain eligible for needs-based government benefits without having to completely forego their inheritance or other gifts from loved ones and, in some cases, settlement proceeds from lawsuits. Special needs trusts can address a variety of situations. One of the most common is to manage a personal injury settlement, keeping the injured person qualified to receive disability or injury benefits paid by the government while retaining access to funds from the settlement. The other common type of SNT is one established by a parent or grandparent to provide additional income to a person receiving benefits. A well designed special needs trust will give the beneficiary access to government benefits while also having resources available to supplement those benefits first before having to spend personal funds. In California, assets held in an SNT will not be counted toward SSI, Medi-Cal, or IHSS asset limits.
FUNDING THE TRUST
A trust can be funded in one of two ways: self-settled or third party settled. The distinction lies with the source of the funds. A self-settled special needs trust is funded with the beneficiary's own assets, while a third party special needs trust is funded with the assets of someone other than the beneficiary. The guiding principle that distinguishes the two funding types is that if the beneficiary had the legal right to receive the funds in the trust for even a single moment, the resulting special needs trust is self-settled; if not, it is third party settled. Importantly, leaving assets in an SNT does not disqualify the beneficiary from government benefits, even though the beneficiary is legally entitled to funds from the SNT. The funding classification will have various implications for the beneficiary.
IMPACTS OF CLASSIFICATION
Generally, self-settled and pooled trusts are subject to greater restrictions than third party trusts. In order to establish a self-settled special needs trust, the trust must be established with the assets of the individual, the beneficiary must be under age 65 at the time of establishment and funding, the beneficiary must be disabled per the requirements of the Social Security Act, the trust must be established for the benefit of the disabled individual, and the trust must be established by a parent, grandparent, or court. In the case of a court approved SNT, the trust is subject to ongoing court supervision. In addition, the SNT must contain a payback provision stating that Medi-Cal must be repaid for all amounts of medical assistance paid to the beneficiary upon the beneficiary's death or the termination of the trust for any other reason.
In certain rare circumstances — such as not having a very high asset amount to fund an SNT, pooled special needs trusts can be a simpler and more cost effective alternative to a self-settled SNT. Like self-settled SNTs, pooled SNTs also require the Medi-Cal payback clause. However, rather than writing a complete custom trust for the individual, pooled SNTs allow an individual to simply join a master trust. The tradeoff is that the beneficiary loses the advantage of a customized trust, so the choice to join a pooled SNT should be carefully considered.
The major advantage of a third party settled trust is the lack of a payback clause requirement. In a third party SNT, the individual establishing the trust can designate anyone to receive the remainder, without any requirement that government agencies get repaid upon the beneficiary's death. When establishing a third party SNT, the trust must indicate that the settlor intends to supplement but not supplant public benefits, and that such benefits should be considered prior to any distribution of SNT income or principal. The SNT must also be irrevocable and give the trustee absolute discretion to pay or refuse to pay income or principal from the trust to the beneficiary.
To be permissible, any distribution from any SNT to a beneficiary must satisfy two tests. First, the distribution must be reasonably related to the needs of beneficiary. The purpose of this restriction is to prevent abuse of SNT funds to support extravagant luxuries. Certain distributions can be considered safe because they fit squarely within the realm of immediate beneficiary expenses. For example, safe distributions commonly include: eyeglasses, telephone service, cable television service, transportation, out of pocket medical expenses, gym or health club memberships, vacations, tuition and certain educational expenses.
The second test a disbursement from a special needs trust must satisfy is that the distribution must primarily benefit the beneficiary. The question of who will derive the primary benefit is highly fact-specific, however, some common guidelines can help to determine whether a disbursement will primarily benefit the stated beneficiary. First, the distribution should be used to pay for an immediate need of the beneficiary, rather than a speculative future event. Second, the distribution should be made directly to the entity or person the beneficiary needs to pay, and should not be distributed as cash or a cash equivalent (such as gift cards) to the beneficiary. Distributing cash directly to the beneficiary undermines the purpose of the SNT by allowing the beneficiary to spend the distributed funds for unqualified expenses. This raises a serious question about the integrity and validity of the SNT, opening the trust to legal attack that could jeopardize the beneficiary's eligibility for government benefits. Finally, the distribution should be restricted to only include debts or expenses the beneficiary has directly incurred, and if the beneficiary shares debt with other persons, the trust distribution should be clearly arranged to pay only the beneficiary's portion.
CHOOSING A TRUSTEE
While it can be tempting to name a parent, sibling, or other family member as the trustee of an SNT, there are at least two strong issues to consider before doing so. First, family members are often the stated or presumptive remainder beneficiaries of the trust, and thus have an obvious conflict which might lead to self-interested behavior such as skimping on distributions to the primary beneficiary or withholding distributions completely. This sort of self-dealing can expose the SNT to legal attack and court scrutiny, introducing additional costs and potentially compromising the trust. Using a professional trustee avoids this problem altogether.
Second, administering an SNT can be highly labor intensive, requiring a great deal of time and attention to detail. This effort can be burdensome to inexperienced trustees. Many first time trustees who casually approach the duties of administering an SNT quickly realize that administering the trust will be an ongoing and serious legal commitment. Naming a corporate trustee or a licensed private professional fiduciary will help ensure the effectiveness of the SNT and prevent unforeseen interruptions to the administration of the trust that would occur upon the death or incapacity of an individual appointed trustee.
PROTECTING YOUR INTERESTS
Special needs trusts are complex devices that require careful planning and drafting. Rebecca Gardner at HMS Law Group has experience helping clients with a variety of special needs trusts matters. If you or a loved one has recently become eligible for needs-based disability benefits, received an injury settlement, or are curious how a special needs trust can help you augment your financial situation, contact HMS Law today to discuss how we can help.