At least once a week I speak with a prospective client, meet somebody at an event or conference, or even meet somebody socially who asks me, “Annette, how do I know if my special needs trust will work when I need it to?”
This is a tremendous concern for many parents planning for their special needs child. Since most special needs trusts do not get funded until both parents have passed away, a parent worries that a mistake won’t be discovered until the trust becomes “live” or funded and is then in use by their adult child, the beneficiary.
To some extent, drafting special needs trusts is more of an art form than a science. The trusts don’t all look the same. Attorneys have their own style and many have practiced for a number of years and have created their own forms after years of perfecting and honing their skills. However, there are certain criteria that must be in every special needs trust, or it won’t meet its original purpose: to provide supplemental resources to the disabled beneficiary while preserving the beneficiary’s ability to receive public benefits; to provide asset management for a disabled beneficiary who cannot manage their own funds; and to provide asset protection from creditors, government agencies, outside threats and even the disabled beneficiary themselves.
Every public benefits program that has an asset test or limit will request a copy of any trust that lists the disabled person as a beneficiary. This trust will be reviewed to determine if it is a countable asset for the beneficiary or applicant.
Here are some very common mistakes I see in Special Needs Trusts:
1. Using payback provisions when they are not necessary.
There are two kinds of special needs trusts, a first party trust and a third party trust. They are identified by where the trust assets come from. If they come from the disabled person themselves, such as social security payments, accident settlements, or gifts from relatives, then they need to go into a first party or self-settled trust. These trusts by statute must include a payback provision to the Commonwealth of Massachusetts or any other jurisdiction that has paid certain Medicaid benefits for the beneficiary.
Trusts funded by parents are third party trusts. They are funded with other people’s money (not the disabled beneficiary). These trusts are not required to have payback provisions. The Trust Creator can decide where those remaining trust assets should go when the disabled beneficiary passes away; usually other family members or charities.
2. Allowing co-mingling of funds
As noted above, there are two kinds of trusts. If a third party trust allows for funding by the disabled beneficiary, it has effectively become a first party trust and will need to have payback provisions. A parent may leave a substantial life insurance policy for several hundreds of thousands of dollars to this special needs trust and would not want it subject to estate recovery by the Commonwealth. But if even one dollar of the disabled beneficiary’s money is co-mingled, payback is required.
3. Being more restrictive than necessary
This is the most common mistake I see. Many special needs trusts limit the distributions absolutely. They may say the following: “The Trustee must never distribute any trust assets for goods or services that may be paid for by public benefits programs.” This is unnecessarily restrictive. Here’s an example:
Let’s say that your trust has $500,000 in it and your child is receiving SSI benefits and Section 8 housing benefits. Both of these programs provide basic support for housing, food and the basic necessities of life. But the housing offered and available is not necessarily the most optimal for your child and the SSI money is minimal every month. Since your Trust is well-funded, it can afford to pay for nicer housing and restaurants once or twice a week for a nice night out. But your Trust says that the Trustee can never pay for those items.
It is much better to have a distribution clause that allows the Trustee to make decisions about what makes sense for the beneficiary at the time of the distribution. Of course, this means that you need to pick a very savvy and knowledgeable Trustee. But that’s a topic for another article.
4. Wrong distribution standard
Many, many typical trusts used for a variety of purposes and goals use an ascertainable standard in the distribution clause. The most common is “HEMS”, Health, Education, Maintenance and Support, but there are others. It is used to prevent Trustees from refusing to distribute assets of a trust for reasonable items such as food, clothing, housing, education and healthcare. If a Trustee does not distribute for these items, he or she may be in breach of their duties as a Trustee.
However, because this potentially creates a right in a beneficiary to compel distributions, this can be death to a special needs trust. A special needs beneficiary must never have the right to compel a distribution for ANY reason. This means that the Trustee could refuse to distribute assets to pay for housing for a beneficiary who is homeless and the beneficiary may have no recourse. If the Trustee of a special needs trust does not have sole and absolute discretion over distributions, it will be considered an available asset for public benefits purposes.
If you are terrified right about now, don’t be! A good trust drafter can put other protections in place to be sure there is someone watching over the Trustee.
5. Embedded special needs trusts
Embedded trusts are very common in estate planning. It is a single trust instrument (such as a Revocable Living Trust Agreement) that upon a certain event, such as a parent’s passing, creates and funds other trusts written into that same trust agreement.
While there is nothing wrong with this from a technical or legal point of view, it does present practical problems.
Social Security and MassHealth (our state Medicaid program) case workers and eligibility specialists who review applications for benefits are generally not attorneys and are not familiar with trusts. When you turn over this trust to be reviewed for eligibility for benefits, it is likely to be more complex than the average special needs trust that they see. The applicant could be denied benefits erroneously, causing an appeal process that could be long, complicated and expensive if you hire an attorney to help.
In addition, all your estate planning wishes are in your main trusts, including your wishes for other children and grandchildren, the disposition of your Monet painting or your million dollar home on Nantucket, or just any other personal issues that you may not want to share with the world. The beauty of trusts are that they are private instruments and only the parties get to know what is in them. So why share them with Social Security and Medicaid?
What to do now? An estate planning review is a good practice for any family and should be done approximately every three to five years or sooner if other changes in the family, the asset picture or the law dictate it. You should develop a lifelong relationship with your estate planning counsel, so that they may be your trusted advisor in all these matters, stay updated on your family situation and keep you updated on changes in the public benefits programs eligibility rules and trust and tax law.
Part 2 of this series will explore solutions to the issues listed here.