THREE MAJOR ISSUES INVOLVED IN A SPECIAL NEEDS TRUSTS
by: Thomas D. Begley, Jr.
There are three major issues involved in special needs trusts: availability, transfer rules, and payback requirements.
The first issue is whether the assets in the trust are available to the beneficiary.
Assets held in a properly drafted special needs trust are not available to the disabled beneficiary and are not considered in determining public benefits eligibility. The key to whether or not the trust assets will be held to be available is the discretion of the trustee. Under the POMS, trust assets are available if the individual has the legal authority to direct a distribution from the trust for his or her support and maintenance or has the right to revoke the trust. Therefore, the discretion of the trustee determines availability of trust assets. A spendthrift clause is mandatory to keep the trust assets from becoming available.
Central to the issue of availability is the distribution standard used in the trust document. If the distribution standard is too broad, the trust may be considered an available resource in some states. If the distribution standard is too narrow, the trustee is restricted from making distributions for the maximum benefit of the beneficiary. A distribution standard should never contain a HEMS standard. The support language in the HEMS standard would make the trust assets available to the trust beneficiary. A spendthrift clause is mandatory to keep the trust assets from becoming available.
Crummey powers present a special problem with respect to a special needs trust because, as a general rule, the Crummey provision is a noncumulative withdrawal right to the beneficiary. The rule is that if the gift is subject to withdrawal by the beneficiary in the same month that it is made to the trust, the gift is income for SSI purposes. If the withdrawal rights do not begin until the following month, the gift is not income in the month it is made. However, if the withdrawal rights begin after the first day of the following month and the funds are subsequently withdrawn, the funds are unearned income in the month the withdrawal rights are exercised. If the gift is subject to withdrawal as of the first moment of any month, the funds are income to the individual in that month. The solution is to give remainder beneficiaries the right to withdraw. The power of remainder beneficiary to withdraw is known as a Cristofani power.
SSI/Medicaid Transfer Rules
The second key in drafting trusts is whether the funding of the trust constitutes a transfer subject to the transfer penalty rules of SSI and/or Medicaid. The transfer rules would be applied to the grantor of the trust not to the beneficiary.
Whether transfer rules apply to the grantor of a third-party special needs trust depends on whether the trust is revocable or irrevocable, as discussed in the following paragraphs. The transfer rules do not apply to the beneficiary.
- Revocable. If the third-party special needs trust is a revocable inter vivos trust, then the assets are still available to the grantor; therefore, no transfer has taken place. A transfer will be considered to have taken place on the date of the payment from the trust to a beneficiary other than the grantor, or upon the date the trust becomes irrevocable (i.e., through funding of the trust by a third party).
- Irrevocable Inter Vivos Trust. If a transfer is made to an irrevocable inter vivos third-party special needs trust during the lifetime of the grantor, the transfer is subject to the SSI and Medicaid transfer rules with respect to the grantor.
- Irrevocable Testamentary Third-Party Special Needs Trust. A trust is defined as including any legal instrument or device that is similar to a trust, but not including testamentary trusts. Therefore, testamentary transfers to a third-party special needs trust are not subject to SSI or Medicaid transfer rules.
- Self-Settled Special Needs Trust. There is no transfer penalty for transfer to a self-settled special needs trust, because such transfers are exempt by statute if they comply with the payback or pooled requirements of the federal law.
The Medicaid payback provisions were established in OBRA ’93 and The Foster Care Independence Act of 1999, §205 which authorized self-settled special needs trusts for SSI recipients. The language in both statutes requires payback only to the state Medicaid agency, not to the Social Security Administration for SSI benefits.
There is no payback requirement to the state Medicaid agency from third-party special needs trusts. Those trusts may provide that upon the death of the disabled beneficiary, assets are distributed to remaindermen.
Recent POMS revisions now state that the payback must be for all Medicaid whether before or after establishment of the trust since birth. In cases where a Medicaid lien was reduced prior to trust funding, the amount of that reduction must be included in the payback. In most states, the state is considered a creditor not a residual or contingent beneficiary. Therefore, reimbursement is repayment of a statutory debt, unless the trust instrument reflects a clear intent that the state be considered a beneficiary rather than a mere creditor.
 POMS SI 01120.200D.1(a).
 POMS SI 01120.200.B.16 and POMS SI 01120.200.D.1.a.
 POMS SI 01120.200.B.16 and POMS SI 01120.200.D.1.a.
 Cristofani v. Commission, 97 T.C. 74 (1991). See§3.07 for a discussion of the use of life insurance policies to fund a third-party special needs trust.
 42 U.S.C. §1396p(d)(6); HCFA Transmittal 64 §3259.1A1.
 42 U.S.C. §1396p(d)(4)(A); 42 U.S.C. §1396p(d)(4)(C).
 42 U.S.C. §1396p(d)(4)(A).
 42 U.S.C. §1382(b).
 POMS SI 01120.200.H.1.b.