2005 Spring, 28. Special Needs Trusts in the Era of the Uniform Trust Code.

AuthorBar Journal Author - Attorney Jan P. Myskowski

New Hampshire Bar Journal


2005 Spring, 28.

Special Needs Trusts in the Era of the Uniform Trust Code

New Hampshire Bar Journal Volume 46, No. 1, Pg. 28 Spring 2005 Special Needs Trusts in the Era of the Uniform Trust Code Bar Journal Author - Attorney Jan P. Myskowski

I. Introduction

The enactment of the Uniform Trust Code in New Hampshire(fn1) and recent developments in the treatment of distributions from special needs trusts by various public benefits programs make this an opportune time to review the issues involved in the creation, funding and administration of special needs trusts in New Hampshire. This article provides an overview of the types of special needs trusts, the mechanics for creating and funding special needs trusts, special drafting considerations, matters concerning distributions, tax issues, and creditor protection issues particular to special needs trusts.

The article discusses the effect certain sections of the Uniform Trust Code will have on special needs trusts, but this article should not be considered a comprehensive study of the Uniform Trust Code's impact on New Hampshire trusts in general. [Editor's Note: Additional commentary on the Uniform Trust Code will appear in a future issue of the Bar Journal] Experienced trust and estate practitioners more interested in the author's comments regarding the impact of the Uniform Trust Code on special needs trusts will want to focus on the discussion in sections III and IV.

II. Creating and Funding Special Needs Trusts

A. Types of Special Needs Trusts

1. Terminology

The terms "special needs trust" and "supplemental needs trust" are used interchangeably, along with other similar terms, to describe a trust that relies on a trustee's discretion to insulate trust income and principal from the beneficiary's countable resources for public benefits eligibility purposes. Occasionally, some practitioners will use the term "supplemental" rather than "special" to identify a trust that contains express language indicating the grantor's intent that the trust be used to supplement and not supplant the beneficiary's public benefits entitlements. That distinction is not universal, and for the purposes of this article, the term "special needs trust" will be used to describe all trusts used to manage assets in coordination with a beneficiary's public entitlements.

Special needs trusts fall into three categories. For the purposes of this article, those categories will be referred to using the following terminology: "Self-settled" trusts are those trusts created to hold assets belonging to the intended beneficiary of the trust. "Third party" trusts are those created to hold assets belonging to someone other than the intended beneficiary of the trust. A "pooled trust" is a special arrangement with a non-profit organization that serves as trustee to manage assets belonging to many disabled individuals, with investments being pooled, but with separate trust "accounts" being maintained for each disabled individual. An account with a pooled trust is a hybrid form of self-settled trust since assets belonging to the disabled individual are used to establish the account.

The primary distinction between self-settled and pooled trusts on the one hand, and third party trusts on the other, is the source of the assets used to fund the trusts. This is an important distinction because, as will be seen below, a parent of a disabled individual may be the person to create a self-settled trust instrument, which can make it confusing to distinguish the types of trusts based upon the identity of the person creating the trust documentation.

2. Common Motivating Events

(a) Self-Settled and Pooled

(1) Spend down of existing assets

A disabled individual may already have significant accumulated resources when he or she becomes disabled. Those existing resources probably disqualify the individual from various public benefits programs and need to be reduced before the individual will qualify. In that event, the motive to establish a special needs trust would be to reduce the assets for public benefits purposes, while at the same time preserving the availability of the assets to the disabled individual.

(2) Receipt of personal injury or back benefit settlement

A disabled individual may be a plaintiff in a personal injury suit, or may be seeking a retroactive award of benefits, such as Social Security disability benefits, either of which may result in a significant lump sum receipt of cash when the disabled individual is already receiving public benefits. In that event, the motive to establish a special needs trust would be twofold: (i) to create a vehicle to receive the lump sum payment so as to prevent it from disqualifying the disabled individual from public benefits; and (ii) making the lump sum available to the disabled individual.

(3) Receipt of gift or inheritance while receiving benefits

The disabled individual may receive a gift or inheritance from a relative, creating a potential outright receipt by the disabled individual. The disabled individual may transfer such a gift or inheritance to a special needs trust in the same manner as discussed in (2) above.

(4) Non-trust transfers should be considered

Before establishing a special needs trust in any of the foregoing circumstances, the disabled individual should investigate whether there are other options available for reducing the resources. For example, Medicaid provides an exception to its asset transfer penalty provisions for transfers to minor or disabled children. See C.2.(a) below. It may make more sense for the disabled individual to transfer assets under such an exception than to establish a special needs trust for his or her own benefit.

(b) Third Party

(1) Lifetime gift

Third party trusts are typically created by the parent or parents of a disabled child. Parents usually support the disabled child from the parents' own funds while the parents are living, coordinating that support with public benefits entitlements as needed. Special needs trusts are often not considered for creation until the deaths of the parents. However, as parents age, sometimes they are faced with tax planning or long-term-care planning incentives to part with property before death. In those situations, a special needs trust may be created to receive a lifetime transfer of assets. In addition, changes such as a divorce of the parents may create circumstances in which the lifetime funding of a permanent source of support for the child makes sense.

(2) Transfer on death

As mentioned above, many third party special needs trusts are created upon the death of the surviving parent of a disabled child to provide continued support for the child. Documentation of the special needs trust is often prepared when the parents' other estate planning documents are prepared, while funding of the trust occurs at the parents' deaths through distributions to the special needs trust from the parents' wills, revocable trusts or life insurance policies.

B. Possible Conflicts with Public Benefits Programs

1. Countable Resources

Many public benefits programs, such as Medicaid and Supplemental Security Income ("SSI"), are needs-based programs, meaning that entitlement is conditioned in part on the applicant demonstrating that he/she has assets and income below certain allowable limits. As discussed above, the incentive for creating many self-settled or pooled trusts is often to reduce the disabled individual's assets to meet such limits. Regardless of whether the special needs trust is self-settled, third party or pooled, a major concern is whether or not the disabled individual's assets, having been transferred to a special needs trust, will be considered a countable asset for public benefits purposes from the trust beneficiary's perspective. The primary utility of a special needs trust is to hold assets in a form that will not be countable.

2. Countable Income

Even if assets held in a special needs trust are non-countable under the asset tests of the various public benefits programs, distributions to or for the benefit of the beneficiary, whether paid from trust income or trust principal, may be considered countable income to the beneficiary under the income tests of the various programs.

3. Asset Transfer Penalties

Many public benefits programs penalize transfers of assets made with the intention of qualifying. Generally, asset transfer penalties do not apply upon the funding of self-settled special needs trusts.(fn2) The conflict arises only in the context of third party trusts where the person transferring assets to the special needs trust, such as the disabled beneficiary's parent, is concerned with qualifying himself or herself for public benefits. For example, an elderly parent may be entering a nursing home and may be applying for Medicaid in connection with the transfer of assets to a special needs trust for a child. In that case, the third party trust grantor must consider whether the transfer of assets to the trust will be disqualifying from the grantor's perspective.

C. How Special Needs Trusts Minimize Public Benefits Conflicts

1. Self-Settled and Pooled

(a) Government reimbursement of benefits provisions

For the purposes of Medicaid and SSI, special exceptions have been created by statute allowing a disabled individual to transfer assets to a special needs trust for his or her own benefit without the transfer being considered a disqualifying transfer...

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