Ten years ago a quiet revolution took place in the planning of estates and benefits for people with disabilities. On Aug. 10, 1993, President Clinton signed the Omnibus Budget Reconciliation Act, which included a provision authorizing the creation of a new form of special needs trust. This unique vehicle, called the OBRA trust and funded with a disabled beneficiary's own assets, allows the beneficiary to shelter unlimited amounts of assets but still qualify for medical assistance under Title XIX of the Social Security Act.

The availability of these trusts means disabled people can enjoy the financial benefits of personal injury or medical malpractice awards and inherited property, yet still preserve their eligibility for government-funded medical assistance. The federal law does not limit the amount that may be held in trust. And while these trusts are required, upon termination, to pay back to the states all monies expended for the beneficiary's medical care (to the extent that the trust can), there is no authority for the states to seek interest on those expenses.

Understandably, planners working with disabled individuals and their families see OBRA trusts as a wonderful opportunity, and over the last decade these trusts have become a standard planning technique, used whenever a person with disabilities receives an award or inheritance. Extensive and valuable literature has examined many aspects of OBRA trusts, and almost without exception, commentators praise them.1

But OBRA trusts are not without their difficulties. Many problems stem from the fact that state agencies and the assistant attorneys general who represent them have an interest in overseeing the disposition of OBRA trust funds — and often that interest can run counter to that of the beneficiary and his family. While we are strong proponents of the OBRA trust, we suggest planners stop to consider the alternatives. Sometimes, a client is better served by what we call a conversion trust: a living trust for adults and a minor's trust for children, each containing a clause granting the trustee the authority, perhaps even the responsibility, to seek court permission to convert it to an OBRA trust if, and when, the disabled beneficiary needs public assistance.

THE OBRA TRUST

The need for an OBRA trust most often arises when a disabled person receives unplanned-for money from an inheritance or litigation award. Without these funds, a disabled person who is unable to seek employment and provide for himself would be entirely dependent upon government benefits, particularly Social Security Disability (SSD),2 Supplemental Security Income (SSI)3 and Medicaid4 (which, even cumulatively, satisfy only the most basic needs). Personal injury awards or inheritances don't normally affect SSD eligibility, but such monies generally render their recipients ineligible for SSI and Medicaid — unless an OBRA trust is utilized. The 1993 act eliminated the Medicaid penalties for transfers of assets to OBRA trusts,5 and the Foster Care Independence Act of 1999 incorporated the OBRA trust exception with respect to SSI benefits and transfer penalties.6

To qualify as an OBRA trust, the grantor must be a court or the disabled beneficiary's parent, grandparent or legal guardian. There can be only one beneficiary. That beneficiary must be under the age of 657 and qualify as disabled under the Social Security Act. The trust is funded with the disabled beneficiary's assets,8 and must provide that upon the death of this beneficiary, the state (or states) that provided him with medical assistance will be reimbursed from any remaining trust assets. Trust assets in excess of amounts paid back to the state can pass to other designated beneficiaries.

Many states, by legislation, regulation or court practice, also require that the trust agreement include such additional provisions and restrictions as mandating that a trustee post a bond, file annual accountings with the court, and obtain prior court approval for certain types of disbursements.9 Some states, such as Maryland, have expansive restrictions requiring, for example, that the trust prohibit the use of its assets to compensate the beneficiary's family members in any way, including for giving care to the beneficiary, accompanying him on travel, providing companionship, or serving as a trustee.10 (Such restrictions are, in our opinion, inappropriate and misguided. But such is the current law.)

While there is no federal statutory limit upon the amount of assets that can be placed in an OBRA trust, Medicaid rules impact how much of a personal injury award can be included. If the beneficiary has received state-funded medical assistance in connection with accident-related injuries, he first must repay the government for that care before he can fund the trust. All Medicaid recipients, as a condition of receiving assistance, must assign to the state funding their medical care any rights they have to recover from a third party for their treatment.11 Federal and state courts have consistently upheld this prior right of recovery (the so-called “Medicaid lien”).12 The rationale is that OBRA trusts were intended to preserve Medicaid eligibility for disabled beneficiaries, but not to eliminate states' reimbursement rights for then-existing Medicaid liens.13

In most cases, court involvement in the creation and funding of OBRA trusts is necessary because the beneficiaries are minors or mentally disabled.14 Yet even when a mentally competent but physically disabled adult (with a surviving parent) is the beneficiary, and applicable law does not mandate court involvement, judicial oversight can assure the trust assets are being used most appropriately for the beneficiary's needs. A court's involvement also can protect the trustees from future claims of improper investments or unnecessary expenditures, particularly if the trust assets are depleted in providing for the beneficiary.

THE DOWNSIDE

While judicial oversight is usually helpful, state agencies' involvement often is less so. Because Medicaid is a joint federal-state program, its operation varies significantly among the states. It is common for state agencies and assistant attorneys general to be extremely interested in these trusts' details, as the states have extensive rights of recovery upon trust termination.

Unsurprisingly, this bureaucratic attention may at times exceed what the beneficiary and his family regard as reasonable; it may even impede efficient administration of the trust. Certainly, agency inquiries are reasonable when they concern remaining trust assets and the present and future needs of the disabled beneficiary. But sometimes even bona fide concerns about the use of scarce public resources to provide care for a wealthy beneficiary become oppressive. In our experience, court oversight normally is more than sufficient to protect the states' right of recovery and the interests of the disabled beneficiary; state agencies' interference usually serves little additional constructive purpose.

The potential for overly zealous monitoring by an assistant attorney general can be a significant consideration in deciding whether to use an OBRA trust. Do the trustees really want to justify to the state their decision to purchase a deluxe handicapped van rather than the standard model? Or to explain why a second (or third) bathroom is necessary in the house they want to build with trust funds for a disabled beneficiary and his family? In situations where medical assistance benefits are limited and/or the trust itself is large, the state agency's role can become more than an expensive nuisance. As an interested party, the state has the right to object to expenditures and even appeal judicial decisions. Certainly not every intervention in OBRA trusts by counsel for state agencies is inappropriate or obstructionist. But in some instances, the interests of the state may be adverse to those of the disabled beneficiary — and the state can be a difficult adversary, unencumbered as it is by concerns about the efficiency and expense of litigation.

One area of particular concern is the state agencies' inability, perhaps even unwillingness, to acknowledge that the parental support obligation due to a minor child can be fulfilled in non-financial as well as financial ways. When a disabled child has received a substantial medical malpractice recovery, the typical parent's economic contribution may be largely irrelevant, but the parent's love, support and constant attention continue to be invaluable. The parent's efforts on behalf of a disabled child often will be at the expense of a job, other children and even a marriage. The parent may have endured huge financial sacrifices to obtain services for the disabled child and, not unreasonably, may view any derivative financial benefit from the child's award as perfectly fair. The fundamental disconnect between the perceptions of most parents and those of state agencies in such situations can lead to enduring problems. That disconnect (and its resulting complications) can be avoided by eliminating the state as an interested party through the use of a conversion trust.

Even when state involvement does not create difficulties for the efficient administration of the trust, OBRA trusts, by statute, require that the trusts be created and administered for the “sole benefit” of one disabled beneficiary. This mandate in effect eliminates traditional estate-planning opportunities, such as annual gifting to family members, tuition assistance, even holiday gifts. Such restrictions on the use of one's own assets are highly unusual. While it might be reasonable to constrain the use of those funds needed for repayment to the state, it is unnecessary and harsh when repayment will not be jeopardized. Nevertheless, such restrictions are unavoidable in the OBRA trust context.

In addition, while the assets due to the disabled individual are usually easy to quantify, the beneficiary's need for future medical assistance is often unclear, particularly if the individual is a child with, for example, neurological injuries (the extent, or at least ultimate consequences, of which may be very difficult to measure). In other cases, often involving disabled adults, the greatest financial exposure may be from possible future hospitalizations for which private medical insurance is unavailable. This exposure may significantly decrease when the disabled person qualifies for Medicare benefits.15 Unlike private insurers, Medicare generally covers all medically necessary hospitalizations, regardless of cost.16 There are also some situations in which the costs of the anticipated medical care may indeed be significant by ordinary standards — for example, around-the-clock aides at a cost of perhaps $200,000 per year. But when trusts hold $5 million (or more), such costs are manageable without resorting to public assistance.

CONSIDERATIONS

Although strong arguments can be made against an OBRA trust, there are equally good reasons even in these situations to consider using one. What if the hoped-for improvements in a child's neurological functioning fail to develop? What if an unanticipated complication might respond to experimental medical care for which public assistance is not available? What if the costs of custodial care exceed all expectations? What if the trust's investments fail to perform in accordance with the advisor's projections — as has so often been the case in recent years? These risks are real and extremely threatening to the disabled person and his family. The medical malpractice or personal injury recovery, in particular, is normally available only once and its preservation is often the overriding goal, so that inconveniences such as state agency involvement in a trust are an acceptable price to pay.

Also, with disabled children, parents are often quite legitimately concerned about the possibility that at the age when the guardianship passes into majority control, funds must pass to the child — unless the guardianship can be extended (which, in the case of a young adult who is cognitively unimpaired, is only available with his consent).

CONVERSION TRUSTS

There is, however, a good alternative to either the irrevocable OBRA trust or the extremes of a guardianship or giving the beneficiary total control of the funds.

First, a trust can be established that includes the power to convert to an OBRA trust — let's call it a pre-conversion trust. For an adult beneficiary: A grantor creates a standard living trust agreement; he reserves the right to receive income and/or principal from the trust, at the discretion of a trustee. For a minor: A parent, guardian or the court creates a trust agreement for the benefit of the minor, giving the trustee discretion to make distributions of income and/or principal to, or for the benefit of, the minor beneficiary, so long as a court approves the distribution. A minor's trust also provides that, when he reaches the age of majority, he or his legal representative may apply to the court for an order to terminate the trust and transfer all trust assets to the beneficiary or his estate.

Next the planner should add the conversion element. Both the living trust and the minor's trust would include a conversion clause giving the guardian or conservator of a disabled beneficiary the ability to apply to the court for authority to amend the trust to qualify it as an OBRA trust.17 This flexibility can be coupled with the usual advantages available in any self-funded trust.18 For example, using the trust, pre-conversion, to purchase a fully accessible residence for the beneficiary and his family will not entail convincing an assistant attorney general of the reasonableness of the proposal. While the pre-conversion trust also provides opportunities for intra-family annual gifting, tuition assistance and other planning opportunities that an OBRA trust, by definition, denies, it also can continue far into the beneficiary's majority, or even permanently, lending both stability and security to the family arrangements.

Caring for a disabled person often becomes the lifelong work of family members, who frequently sacrifice their own educational, professional and personal goals to provide a quality of care and life otherwise unavailable to the disabled person. Take for example, the case of a sibling who forgoes an out-of-state college in favor of a local community college to assist elderly parents with the around-the-clock care needed by his disabled sibling, or the parents who have not taken a vacation since the injury that disabled their child. Enabling a trustee to make a distribution to the sibling to assist with tuition payments, or to the parents to pay for a full-time caregiver while they travel, only begins to compensate them for the sacrifices they have endured and to enhance family harmony — which ultimately benefits the disabled beneficiary.

The conversion trust, however, would be appropriate only for cases in which the future need for substantial medical assistance is uncertain. Implementing the conversion element normally requires a court hearing with the state as an interested party. In addition to the need to amend the trust to comply with OBRA, and to petition the court to approve those amendments, it might be necessary to seek appointment of a guardian ad litem or a conservator for the disabled beneficiary. At any step along the way the assistant attorney general may object or the court may rule against the conversion.

IMPLEMENTATION

Once the decision has been made to explore alternatives to an OBRA trust for a disabled adult, the planner's analysis should be similar to that which would be undertaken for an adult client who is not disabled. Ask and answer questions such as: How involved does the beneficiary want to be in asset management? To what extent should the trustee be involved in such routine tasks as paying bills? Will the trust's existence avoid the need for the appointment of a guardian in the event of future or increased incapacity? And then ask: What circumstances will warrant pursuing the conversion?

We believe that minors with significant assets almost always benefit from a trust that may be extended beyond the age of majority and, if the minor has a significant disability, a trust that also has the potential to convert to an OBRA. Theoretically at least, the beneficiary would have the right to seek to terminate a self-funded minor's trust upon attaining the age of majority. Presumably, though, his counsel would have to persuade the court overseeing the trust that such a change is reasonable. Certainly, at some point a legally competent adult, physically disabled or not, should be entitled to control his assets if he wishes. Yet to conclude that simply because such control is permissible at the age of majority that it is also necessary, is not only an inappropriately formalistic reading of most relevant statutes, but also contrary to what any rational person would believe the law should be. While clearly some form of substituted judgment is legally (and almost always practically) necessary when a minor is entitled to receive assets, there are obvious advantages to a minor's trust that not only extends beyond the age of majority to a more reasonable age for termination, but also includes dispositive provisions in the event of premature death, and in the case of a disabled child, the potential to convert to an OBRA trust.

To what extent can such trusts for minors and disabled adults be created? In the litigation context, obtaining court approval for the creation of such trusts should not be difficult,19 although the actual terms (particularly any that appear to be an attempt to make testamentary dispositions) may require some justification. A Connecticut statute, for example, expressly grants conservators the power to make gifts under certain circumstances, subject to court approval, “outright or in trust,” and by analogy the same powers have been held to apply to transfers in trust by the guardian of a minor's estate.20 There is no apparent public policy reason that should lead a court to disapprove such arrangements, whether arising out of a litigation award or an inheritance, especially as they not only make perfect sense but also, in most cases, mean that a disabled person, at least for the time being, will not be relying on public assistance.

Conversion trusts offer another planning technique that can enable disabled individuals to maximize their independence while minimizing the risks inherent in doing so. They provide flexibility for future estate planning by the disabled individual and limit state agencies' interference with efficient administration of the trust, while preserving ample judicial oversight. Professionals who serve the needs of people with disabilities and their families know how crucial it is to take every possible step to improve the quality of clients' lives. In the appropriate circumstances, conversion trusts are another step toward that goal.

Endnotes

  1. For example, Clifton B. Kruse, Jr., Third-Party and Self-Created Trusts: Planning for the Elderly and Disabled Client (3d ed. 2002); Lawrence A. Frolik and Melissa C. Brown, Advising the Elderly or Disabled Client (2d ed. 2002); G. Mark Shalloway, “Selecting and Advising Trustees of Special Needs Trusts,” NAELA Quarterly, Spring 2002; Sterling L. Ross, Jr., “The Special Needs Trust: A New Wrinkle No More,” University of Miami, Philip E. Heckerling Institute on Estate Planning, Vol. 36II (2002); Roger M. Bernstein, “Special Needs Trusts: Administration and Compliance,” NAELA Quarterly, Summer 2001; Cynthia L. Barrett, “Special Needs Trust Tax Issues,” The ElderLaw Report, Vol. XIV, No. 3, October 2002.

  2. Title II of the Social Security Act, 42 U.S.C. Section 401 et seq.; 20 C.F.R. Part 404.

  3. Title XVI of the Social Security Act, 42 U.S.C. Section 1381 et seq.; 20 C.F.R. Part 416.

  4. Title XIX of the Social Security Act; 42 U.S.C. Section 1396 et seq.

  5. 42 U.S.C. Section 1396p(d)(4)(A).

  6. 42 U.S.C. Section 1382b(e)(5).

  7. An OBRA trust established before the beneficiary reaches age 65 remains exempt even after the beneficiary turns 65, but the beneficiary's own assets cannot be added to the trust after that time without transfer penalties.

  8. Although in the vast majority of cases, OBRA trusts are funded with the disabled person's own assets, the 1993 Act allows a third party to use his assets to fund an OBRA trust for a disabled beneficiary. Normally, a third party would not use an OBRA trust, because properly drafted third-party trusts do not disqualify the disabled beneficiary from medical assistance programs (and do not have the payback requirement). But there are reasons to make exceptions. For one thing, a transfer from a third party to a trust would disqualify the transferor from medical assistance eligibility.

    This consideration usually arises when a parent or grandparent faces his own disability and need for long-term care, in addition to the beneficiary's disability. A parent or grandparent in this situation can solve the problem by creating two OBRA trusts: one to hold a portion of his assets for his sole benefit and another to hold the balance for the sole benefit of the disabled child or grandchild. The parent or grandparent would immediately qualify for medical assistance while still providing for the beneficiary's supplemental care.

  9. Statutes commonly provide that such trusts shall be “subject to continuing jurisdiction of the court,” and “court supervision to the extent determined by the court.” Cal. Prob. Code Section 3604.

  10. COMAR Section 10.09.24.

  11. 42 U.S.C. Section 1396k(a)(1)(A)

  12. Cricchio v. Pennisi, 660 N.Y.S.2d 679, 683 N.E.2d 301 (N.Y.Ct. of App. 1997); Link v. Town of Smithtown, 616 N.Y.S.2d 171 (Sup. Ct.); 620 N.Y.S.2d 729 (N.Y. Sup. Ct. 1994); Norwest Bank of North Dakota, N.A. v. Doth, 159 F.3d 328 (8th Cir. 1998); S.S. v. State of Utah, 972 P.2d 439 (Utah 1998); Waldman v. Candia, 722 A.2d 581 (N.J. Super. Ct. App. Div. 1999); Calvanese v. Calvanese, 93 N.Y.2d 111, 710 N.E. 2d 1079 (N.Y. 1999).

  13. Notably, in most states, if not all, assets held in OBRA trusts are not sheltered from the claims of the beneficiary's general (non-Medicaid) creditors during the beneficiary's lifetime, and upon death, the assets are subject to the claims of both Medicaid and third-party creditors. This is because the assets funding the trust belong to the beneficiary, and therefore constitute “self-settled” trusts.

  14. Although state practice varies, in Connecticut, for example, most probate judges will waive bond for a court-supervised trustee when the funds are held in a “restricted account,” and all withdrawals must comply with a court-approved budget. Thus, the added cost of court supervision is a small price to pay for the protection afforded to the trustee — and, in our view, the disabled beneficiary.

  15. Medicare is available to disabled individuals after 24 months of receipt of SSD benefits. 42 U.S.C. Section 426(b) (Title II).

  16. While Medicare is a federally funded program of health insurance, benefits are subject to deductibles and copayments. Title XVIII of the Social Security Act; 42 U.S.C. Section 1395 et seq.; 42 C.F.R. Part 400.

  17. A sample conversion clause would read as follows: “Notwithstanding any other provision of this agreement, in the event that BENEFICIARY is disabled, as said term is used in section 1614 (a) (3) of the Social Security Act, 42 U.S.C. §1382c (a) (3), and the guardians or conservators (as the case may be) of BENEFICIARY's estate, or his parents, determine that it would be in his best interests, any one or more of such guardians, conservators or parents may apply to the Probate Court for authority to amend this trust so as to comply with the provisions of section 1917 (d) (4) of the Social Security Act, 42 U.S.C. Section 1396p (d)(4), and the pertinent state statutes, all as in effect at the time such amendment is effective and further to amend this trust in any way necessary to assure that the trust property and the terms of this agreement do not disqualify BENEFICIARY from benefits of cash, medical and/or other forms of assistance that BENEFICIARY otherwise would be eligible to receive as a result of his disability and/or needs from local, state and/or federal governments or governmental agencies. Such amendment shall take effect upon the Probate Court's approval of same, after notice and hearing, in which event the trust, as amended, shall become irrevocable.”

  18. The self-funded trust also carries with it the disadvantage that its assets are subject to creditor claims of the grantor/beneficiary. A creditor of the grantor/beneficiary can reach the assets of the trust to the maximum extent that the trustee may distribute the property to, or for the benefit of, the grantor/beneficiary.

  19. See, Cal. Prob. Code Section 3604; Colo. Rev. Stat. Ann. Section 15-14-412.8; Conn. Gen. Stat. Section 45a-151; Mass. Regs. Code tit. 130, Section 520.008(H).

  20. Cal. Prob. Code Section 2580; Conn. Gen. Stat. Section 45a-655(e); Fla. Stat. Ann. Section 744.441; 755 Ill. Comp. Stat. 5/11a-18; Iowa Code Ann. Section 633.668; Mass. Gen. Laws Ann. ch. 201, Section 38; N.C. Gen Stat. Section 35A-1340; Ore. Rev. Stat. Section 125.435. Some states' statutes give the court the power to authorize or direct a gift of a disabled person's assets, even without appointment of a guardian or conservator. See, Ala. Code Section 26-2A-136; Alaska Stat. Section 13.26.200; D.C. Code Ann. Section 21-2055; Hawaii Rev. Stat. Section 560:5-408; Idaho Code Section 15-5-408; Me. Rev. Stat. Ann. tit. 18-A, Section 5-408; Md. Code Ann., Estates and Trusts Section 13-204; N.D. Cent. Code Section 30.1-29-08; Utah Code Ann. Section 75-5-408.

    A comprehensive collection of cases dealing with the question of the power of the court, guardian or conservator to make noncharitable gifts out of the funds of an incompetent ward is found at 24 A.L.R. 3d 863.