In recent years, estate planners have been hearing the term “special needs trust” (SNT) more frequently. These vehicles are increasingly used to administer tort recoveries for plaintiffs who want to maintain their eligibility for public assistance. But they also have been surfacing more in charitable-trust and elective-share planning.

Traditionally, SNTs have been used to address the planning concerns of parents with disabled or dysfunctional children. The estate planner's role in creating ways for clients to identify and achieve their goals is rarely as poignant as when enlisted on behalf of the parents of a disabled child. Of course, disabled offspring are just as likely to be part of a wealthy family as any other, and the parents of such a child will be intensely concerned about ensuring that the child's needs are met after their deaths.

The fundamental objective of using an SNT is to leverage the beneficiary's health-care costs, first from available public-benefit funds and only then from the discretionary trust. The settlor's intent is to use trust income and principal as a supplement to, not substitute for, benefits and support provided by governmental programs.

Current efforts by the federal and state governments to tighten budgets by reducing or eliminating public-assistance programs have sparked concern that disabled children may be left without assistance to secure necessary medical care. Exhausting trust funds may mean destroying the only true safety net these children have. Protection and maintenance of the trust are essential — especially when a child has limited or no capacity to independently generate replacement funds to pay for health care, protection and maintenance.

Because SNTs are intricately entwined with the public entitlements of the beneficiaries, many estate planners shy away from them. Others undertake to draft SNTs but, confused with the varieties of trusts used in these contexts, overcompensate with superfluous and often detrimental language.

In contrast to self-settled trusts, when drafting third-party trusts, routine clarity with only limited attention to the public-benefits issue may be a superior approach. Paying too much attention to the intricacies of public benefits may unduly restrict the trustee from achieving the settlor's intent.

In fact, it is not these trusts that are “special” but the needs of the beneficiary. Keeping this in mind makes drafting manageable — and rather traditional. After all, as with any trust, it is the beneficiary's needs that should dictate the purposes, limitations and opportunities for distributions by the trustee.

SNT BASICS

An SNT is fundamentally a discretionary trust. In contrast, mandatory trusts (which specify an amount of income or principal that must be distributed to a disabled person) are likely to distribute more income or principal than the beneficiary is allowed to have under various program-eligibility limits. This would defeat a settlor's goal that the trust supplement public benefits.

In an SNT, an identifiable subset of distribution purposes (generally detailing all the services and items the beneficiary may need that are not provided by such benefit programs as Medicaid) is set forth in the instrument. The purpose of describing the distribution purposes is to guide the trustee in implementing his discretion. In contrast, in a “supplemental needs trust” (SuppNT), the trustee has discretionary authority to make distributions on behalf of the beneficiary without a laundry list of descriptive distribution possibilities. The only limitation on the trustee's discretion is a directive that distributions be supplemental to otherwise available benefits. (We chose not to distinguish between these two types of trusts for purposes of this piece and refer to both as SNTs.)

We are applying the term “special needs trust” only to a trust created by a third party that is intended to preserve a disabled beneficiary's eligibility for Medicaid and Supplemental Security Income (SSI). Self-settled trusts, or trusts established by third parties on behalf of and with assets belonging to the beneficiary, have different considerations and consequences. Self-settled trusts are governed under the rules for treatment of trust income and/or corpus in determining the settlor-beneficiary's eligibility for Medicaid and SSI.

Knowledge of Medicaid and SSI basics is essential to appreciate the drafting idiosyncrasies of the SNT. Medicaid and SSI are programs designed for low-income, low-asset individuals, each with independent eligibility criteria setting maximum levels of income and resources the individual can maintain. SSI is a federal cash-assistance program for disabled individuals who have minimal income and resources; it carries automatic co-eligibility for Medicaid.

While access to food stamps or rental subsidies also may be involved, the predominant concern of the beneficiary is typically medical care. The medical expenses can be significant and, absent public assistance, could not be covered by the child's own funds. Further, the costs might be so high as to exhaust a trust's principal if it is the primary source of payment (under a traditional standard of principal invasion for the beneficiary's health care).

SETTING LIMITS

Because mandatory distribution criteria are likely to expose the trust income and/or corpus to a claim of availability to the beneficiary, resulting in the trust being the payer of first resort until exhausted, the use of discretionary standards is the appropriate format. However, the tension lies in whether the discretion should be unlimited or in some manner encapsulated. Too much encapsulation may defeat the settlor's purposes; too little might make a trustee uncomfortable.

If the trust is established for a beneficiary for whom the settlor has a legal support obligation, a discretionary trust would nevertheless be considered available to the beneficiary in substitution of the state's obligation for care. If no support obligation exists, such a trust should be effective in preserving the beneficiary's Medicaid eligibility because the use of the trust's principal can be restricted and thereby made legally unavailable to the beneficiary. However, a trust that provides for trustee discretion but adds ascertainable standards or other indicia that the beneficiary's support is intended may override that protection and be determined to be the equivalent of a support trust. The early case law in this area generally involved attempts by a state to obtain reimbursement from discretionary trusts for the costs of the beneficiary's institutionalization. The reimbursement was based on findings that the discretionary trust was responsible for the beneficiary's support.

One of the earliest and most prophetic commentators on the subject, Lawrence A. Frolik, a professor at University of Pittsburgh Law School, suggested that along with the question of whether the particular discretionary trust was liable for its beneficiary's institutionalization costs, there was another, broader issue at play: “whether a discretionary trust should ever be allowed to supplement state-supplied services while avoiding the burden of supporting the cost of institutionalization.” After an exhaustive analysis of the case law, he concluded that drafters' reluctance to rely purely on trustee discretion, with attempts to encapsulate the discretion in descriptive language, exposes a trust to unnecessary risk.

Courts have relied on standards such as “proper care, support and maintenance” or “care, comfort, maintenance and general well being” to hold that the trust morphed into a de facto “support trust” or into a hybrid “semi-support trust.” The inclusion of the discretion qualifiers has enabled courts to focus on the standard as establishing, subject to judicial mandate, that the trust distribute a minimum level of support to the beneficiary who lacks any other means of support. But a number of courts have held that discretionary distribution authority, even with similar standards, was nevertheless sufficient to insulate the trust beneficiary. So predictability of success is still spotty at best.

Even if it's true that purely discretionary trusts are preferable for insulating trusts for public-assistance beneficiaries, this still isn't the end of the inquiry. Even without invasion standards couched in terms of comfort, support, maintenance, etc. (the support-trust model) or the inclusion of such standards but with only discretionary authority to exercise them (the semi-support trust model), can we conclude that a purely discretionary trust is the safe choice? Perhaps not in light of statutes such as those found in New York and Ohio, under which even a discretionary trust can be deemed available to a public-assistance beneficiary, regardless of whether or not distributions are made.

CLARIFYING LANGUAGE

Even when the draftsperson has no discomfort with a purely discretionary authority in the trustee, most practitioners add to either the SNT or the SuppNT language confirming the settlor's intent that the trust supplement and not supplant otherwise available governmental benefits. In addition, to protect against the characterization as a semi-support trust, a declaration of the non-support purpose of the trust could be added.

One expert has suggested a variant, described as a “fully discretionary, precatory language” model. Here, the draftsperson uses a purely discretionary formula, articulates the supplemental intent and makes a non-binding request for how the trustee should exercise his discretion, without using the special-needs laundry list. For example, in addition to the statement of absolute discretion, the following modifying language could be used:

“My son is disabled and will rely on public programs for much of his life. I will not always be there to help him and oversee his care. I know that he will have supplemental and special requirements, including a need for advocacy that will not be provided by the publicly funded programs. I urge my trustee, in the exercise of his unfettered discretion, to make distributions that enhance my son's day-to-day existence and allow him the highest possible development of his abilities.”

Another option is a “discretionary, explicit authority to reduce benefits” model, also referred to as a “spigot trust.” While confirming that the principal intent is to create a supplemental-needs-only trust, the spigot model authorizes the trustee to make distributions that might disqualify the beneficiary for public-benefit programs if, in the trustee's sole discretion, it would be preferable to provide the beneficiary with a higher standard of living. This is particularly important in those cases where a beneficiary's health improves or the beneficiary no longer needs the costly medical treatment that would otherwise bankrupt a modest trust fund. Reliance on this kind of clause is based on the argument that describing the outer limits of the trustee's discretion does not make the trust less discretionary or more accessible to the beneficiary.

Finally, there are two issues the drafter should avoid. First, stay away from a frequently encountered but ill-advised qualification that “no part of the principal or income of this trust may be distributed for food, shelter or clothing, or to replace any public-assistance benefits for which the beneficiary may be eligible.” Such a limitation is mistakenly thought to be required for protection of a beneficiary's eligibility for SSI; it is not. Second, the drafter should avoid another often-encountered clause, which generally reads, “The trustee shall exercise its best judgment and fiduciary duty in seeking support and resources for the beneficiary from all available public resources, including, but not limited to, Medicaid and SSI.” This statement can place the unsuspecting trustee in the untenable position of having a fiduciary obligation to monitor and apply for public benefits without any authority to act on behalf of a beneficiary.

Thus, when designing a trust for a special-needs beneficiary, the drafter has the following options: 1) rely exclusively on a purely discretionary distribution standard; 2) add a descriptive list of special needs; or 3) employ precatory authority to exceed program limits. In most cases, it would be prudent to add a declaration of the supplemental nature of the permissible expenditures and, most important, to confirm the non-support nature of the trust's purpose.

Estate planners will likely see an increased interest in special-needs trust planning as disabled people live longer, health-care costs keep escalating and governments keep tightening their budgets. Recognizing these issues and understanding the opportunities for using special-needs trusts will enable planners and trust administrators to provide significant assistance to their clients.

Endnotes

  1. Since 1999, the subject of special-needs trusts has generated an annual conference presented by the Stetson University College of Law, the Center for the Study of Law and Aging at Stetson and the Office for Continuing Legal Education.
  2. Haines, Susan G., “Structuring Personal Injury Settlements for Claimants Receiving Public Benefits,” National Academy of Elder Law Attorneys (NAELA) Symposium 2000; Bernstein, Roger M., “Who is Responsible for Pre-Existing Liens and Claims?,” Special Needs Trusts III, 2001, the Stetson University College of Law, the Center for the Study of Law and Aging at Stetson and the Office for Continuing Legal Education; Wiesner, Ira S., “Structuring Settlements to Preserve Public Benefits: A Primer for Trial Practitioners,” Florida Bar, 1992.
  3. Kruse, Clifton B., Jr., “Disability Trusts Using a Charitable Remainder Unitrust (CRUT): Following Rev. Rul. 76-270, 1976 C.B.-2 194,” NAELA Quarterly (fall 1996) at 3.
  4. Florida Statutes Chapter 732, Part II, Sections 732.201-732.2155 (2002); Wiesner, Ira S., “Qualified Elective Share Trusts and Qualified Special Needs Trusts,” Florida Bar, 2001.
  5. Frolik, Lawrence A., “Discretionary Trusts for Disabled Beneficiaries: A Solution or a Trap for the Unwary?”, 46 U. Pitt. L. Rev. 335 (1985); Kruse, Clifton B., Jr., Third-Party and Self-Created Trusts, Second Edition, American Bar Association, 1998; Kruse, Clifton B., Jr., “Trust Planning for Incapacitated Persons,” NAELA Advanced Elder Law Institute 2000.
  6. Kruse, Clifton B., Jr., Third-Party and Self-Created Trusts, Second Edition, supra note 5 at 24, American Bar Association, 1998.
  7. Barrett, Cynthia L., “Distribution Standard for the Special and Supplemental Needs Trust,” NAELA Q., vol. 14, no. 3 (summer 2001); Frolik, Lawrence A., “Special or Supplemental Needs Trusts,” NAELA Institute 2000; Schmitt Smith, Mary T., “A Trust Dissected: Article by Article,” p. 6, Special Needs Trusts, 1999, the Stetson University College of Law, the Center for the Study of Law and Aging at Stetson and the Office for Continuing Legal Education.
  8. 42 U.S.C. Section 1396p(d)(3)(A), as amended by Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, 107 Stat. 312 (1993)(hereafter OBRA ‘93) Section 13611(b); 42 U.S.C. Section 1396p(d)(3)(B), as amended by OBRA ‘93 Section 13611(b).
  9. The Medicaid program was established in 1965 as Title XIX of the Social Security Act, codified at Title 42, Sections 1396 et seq. of the United States Code. Its regulations, promulgated by the Department of Health and Human Services, are in Title 42, Parts 430-456, of the Code of Federal Regulations.
  10. The SSI program was established by an amendment to the Social Security Act of 1972, Social Security Amendments (SSA) of 1972, P.L. No 92-603. The program details are found in 42 U.S.C. Sections 1381 et seq. of the Social Security Act. The applicable regulations are in Title 20, Part 416 of the Code of Federal Regulations (20 C.F.R. Sections 416.100 et seq.).
  11. In Frolik's article, he examined the use of a hybrid trust, a mandatory supplemental-needs trust not used as a “last resort” fund to provide support beyond applicable benefit programs. Frolik, supra note 5, at 339-340.
  12. Frolik, supra note 5 at 335. .
  13. Frolik, supra note 5, at 393-414.
  14. Frolik, supra note 5.
  15. A point raised by Kruse, supra note 5, at 9, as well as by other commentators (see Mary T. Schmitt Smith, supra note 7), is that it is beneficial in drafting with respect to the settlor's intention to give priority not only to public funds but also to private benefits.
  16. In re Lackmann's Estate, 320 P.2d 186, at 188 (Cal. 1958).
  17. Bureau of Support in Department of Mental Hygiene and Correction v. Kreitzer, 243 N.E. 2d 83, at 86 (Ohio 1968).
  18. N.Y. Est. Powers and Trust Law Section 7-1.6(b)(2002); Ohio Admin. Code 510:1-39-271(A)(2)(e).
  19. Kruse, supra note 5, at 37.
  20. Barrett, supra note 7.
  21. Ibid.
  22. Ibid.
  23. See, generally, Lillesand, David, “More on SSI and SSDI,” 5th Annual Public Benefits Seminar, Florida Bar, 2001.