The Evolution of Special Needs Trusts Law:
Part I, Establishing the Trust
Special Needs Trusts are an evolving creature of statute. This process of Trust development has been fueled by court decisions, statutory changes, and the Social Security Administration’s own interpretation of its rules. The purpose of this multi-part article is to explain how the establishment and management of Special Needs Trusts has evolved over the past several years culminating with the Social Security Administration’s recently updated rules found in the Program Operations Manual System (“POMS”). The updated POMS were issued on May 6, 2018 and became effective on July 1, 2018. Simply put, the new rules bring into sharper focus the Social Security Administration’s attempt to become less hyper-technical and more reasonable in this formidable area of the law.
What is a Special Needs Trust?
Certain needs-based government benefits were created to provide impoverished individuals who are aged, blind, or disabled with medical benefits and a small amount of income for food and shelter. To qualify for these benefits, an individual can only have a minimal amount of income and resources. Individuals with disabilities under 65 years of age may be able to access needs-based benefits by transferring excess income and resources to a Special Needs Trust. 42 U.S.C. § 1396p(d)(4)(A). This irrevocable Trust may be funded with the income and/or resources of an individual with disabilities for the express purpose of qualifying him or her for needs-based government benefits such as Medical Assistance and Supplemental Security Income (“SSI”). These individuals can avoid the process of spending-down all their assets to qualify for needs-based benefits.
Although the law and policies regarding the operation of Special Needs Trusts are quite complicated, the concept itself is simple. The income and resources in the Special Needs Trust will not count against the income and resource limits of the Medical Assistance and SSI programs during the lifetime of the disabled beneficiary. Upon the passing of the beneficiary, or earlier termination of the Special Needs Trust, the State Medicaid Agency receives a payback from the remaining funds in the Trust. Subject to the rules of the Social Security Administration and the State Medicaid Agency (which is the Department of Human Services in Pennsylvania), a disabled person under age 65 could transfer an almost unlimited amount of his or her monies into the Special Needs Trust, qualify for needs-based government benefits, and have the Trust funds managed, invested, and distributed for his or her benefit during their lifetime.
The purpose of a Special Needs Trust is, therefore, to allow the individual to shelter his or her funds during his or her lifetime and access needs-based government benefits. The Trust is the vehicle by which the individual can sustain himself or herself in the community, acquire services and items not provided by government programs, and enjoy a greater quality of life while still receiving critical benefits.
The Key Components of a Special Needs Trust.
The Social Security Administration’s recently updated POMS SI 01120.203 addresses the Special Needs Trust exception to the Medicaid and SSI rules. The general rule is that trusts count as income and resources for the purpose of the determining the beneficiary’s eligibility for Medicaid and SSI. The Special Needs Trust exception, found in Section 1917(d)(4)(A) of the Social Security Act (42 U.S.C. § 1396p(d)(4)(A)), states that income and resources in a properly established Special Needs Trust are not counted when determining eligibility. There are multiple technical criteria for determining whether a Special Needs Trust is valid.
A Special Needs Trusts will be determined to be valid if it meets several criteria in accordance with the Social Security Act and the POMS. A valid Special Needs Trust is a Trust:
– which is established for an individual who is under age 65 and disabled; and
– is established for the benefit of such individual through the actions of a parent, grandparent, legal guardian, or court; and
– provides a payback to the State(s) up to all amounts remaining in the trust upon the death of the individual or earlier termination of the trust up to the amount of total medical assistance paid.
These provisions apply to all Special Needs Trusts established on or after January 1, 2000.
However, a major revision to the law was enacted at the end of 2016. On December 13, 2016, the President signed into law the 21st Century Cures Act. Section 5007 of the Act allows individuals to establish their own Special Needs Trusts. See, Emergency Message EM-16053. The Act allowed, for the first time, the individual to self-settle his or her own Special Needs Trust. (EM-16053 may be found at: https://secure.ssa.gov/apps10/reference.nsf/links/12152016025223PM)
It may seem like common sense that an individual can establish a trust for himself or herself with his or her own funds. However, this logical concept was not reflected in the Social Security Act. The individual was not one of the named entities that could establish a Special Needs Trust. If the individual did not have a guardian (because he or she retained his or her capacity) and the individual’s parents and grandparents were deceased or not available, the only option was a petition to establish a Special Needs Trust in the local Orphans’ Court. For an individual who was just shy of his or her 65th birthday, establishing and funding the Special Needs Trust through the court may not have been possible due to timing. A Special Needs Trust may only be established and funded up to the day of the individual’s 65th birthday. Afterwards, the option of a Special Needs Trust is foreclosed forever.
Timing is Everything: Age and Disability.
The cut-off date to establish a Special Needs Trust is the individual’s 65th birthday. A Special Needs Trust cannot be established for an individual after age 65. If the Trust is established just one day prior to age 65, the Special Needs Trust will continue in effect after the individuals’ 65th birthday until the Trust is terminated.
The Special Needs Trust must also be funded before the individual’s 65th birthday. Funds transferred to a properly established Special Needs Trust before the individual reaches age 65 will not be counted when determining the individual’s eligibility for Medicaid and SSI. However, if the individual receives funds from an inheritance or personal injury action, for example, and he or she is 65 years of age or older, the individual will become ineligible for Medicaid and SSI until those funds are spent-down. This is the case even if the individual had a properly established Special Needs Trust prior to age 65. Monies deposited into a Special Needs Trust after the individual is age 65 may be counted as income or resources or could be considered a transfer of assets for less than fair market value, which would affect eligibility for Medicaid and SSI.
Although there is no exception to the rule stating a Special Needs Trust can only be established for an individual under age 65, there are some exceptions to the rule prohibiting funding the Trust after age 65. Interests and dividends accruing due to funds already in the Trust do not invalidate the Trust after the individual reaches age 65. The interests and dividends will not be counted as available to the individual. Similarly, if the individual has the right to receive a payment from an annuity, structured settlement, or a support payment which is irrevocably assigned to the Special Needs Trust before age 65, these payments will not count for the purposes of Medicaid and SSI eligibility, even after age 65.
An important change in the law occurred in 2015. The Howard P. “Buck” McKeon National Defense Authorization Act (“NDAA”) permitted the annuity from a military Survivor’s Benefit Plan (“SBP”) which is assigned irrevocably to a Special Needs Trust to be exempt from counting for eligibility purposes. Prior to the NDAA, the Federal Government took the position that the annuity could not be assigned to a Special Needs Trust because a Trust was not considered a “person” for purposes of the annuity. The end result was a service person’s disabled child would have to choose between foregoing the annuity or risk receiving too much income to qualify for benefits.
The above exceptions are critical to maintaining an individual’s eligibility for Medicaid and SSI. Interest, dividends, annuities, support, etc. are all considered income to the individual in the month they are received. Transferring these monies to a Special Needs Trust after they are received will not exempt them from being counted as income. However, if these sources of income are properly, and irrevocably, assigned to a Special Needs Trust then they will not count as income to the individual. It is extremely difficult for an individual to qualify for any needs-based benefits if his or her income is above a very minimal amount (and this individual with disabilities may be precluded from receiving much needed benefits).
The individual must be disabled according to the SSI definition of disability at the time the Special Needs Trust was established for it to be valid. However, he or she does not need to actually receive SSI or Medicaid benefits at the time the Special Needs Trust is established. The individual must meet the test of disability specified in 42 U.S.C. § 1382c(a)(3). If the individual is not disabled, the trust is evaluated as an irrevocable trust to determine if the monies in the Trust are available as income or resources or if a transfer for less than fair market value occurred.
Who Established the Trust: Special Needs Trusts established by the Guardian and Courts.
For many years prior to the passage of the 21st Century Cures Act, the only way for a capacitated adult to establish a Special Needs Trust was to petition the local Orphans’ Court to establish the Trust for his or her benefit. Upon receipt of a petition, likely filed the by beneficiary, the Court would establish the Trust and order that the Trust be funded. There were obvious problematic consequences in having the court establish a Special Needs Trusts: time and expense come immediately to mind. The most tragic consequence was not obvious in that Pennsylvania law does not state that a court can “establish” a trust.
Federal law and regulations do not always mesh with State statutory and common law. Pennsylvania’s Uniform Trust Code does not give the courts authority to create, or “settle,” a Trust and does not use the term “establish” regarding trusts. 20 Pa. C.S. § 7701, et. seq. A “settlor” of a trust is defined as person who creates and contributes property to a trust. 20 Pa. C.S. § 7703. A court is not considered a person and most Judges were reluctant to contribute their personal funds to another person’s Trust. Therefore, many courts took the position that they could approve, but not settle, a Special Needs Trust.
The Social Security Administration’s position prior to the issuance of the updated POMS was that a Trust is only properly established by the court if the order specifically states it is establishing the Trust. POMS SI 01120.203B(8). Many older court orders only approved the Special Needs Trust but did not direct the Trust’s creation. The consequence of a court’s approving, but not settling, a Special Needs Trust was that the Social Security Administration determined those Trusts were not valid. All of the funds in the Trusts were determined available to the beneficiary. If the beneficiary received needs-based benefits, while the Trust was funded, those benefits were considered improperly paid and the subject to recovery and collection.
Based on the consequences of this incongruity in the Special Needs Trust law, both the courts and the Social Security Administration have revised their respective positions. Courts are now routinely signing Orders that state a Special Needs Trust is “approved and established.” The updated POMS states the Special Needs Trust exception is met when the court order establishes the Trust, which suggests that a third-party can establish the Trust at the direction of the court. POMS SI 01120.203B(8). The best practice is to present the court with a draft, unsigned version of the Trust and specifically request in the proposed order that the court approve and establish the Trust and direct its funding.
It is not necessary that the Special Needs Trust have a settlor sign the Trust. The Trust should state that it was approved and established by a court order. In fact, presenting the court with a signed Trust and requesting it be approved and established is specifically prohibited. POMS SI 01120.203B(8). Also, the court order establishes the Trust and petitioning the court to establish a trust is not sufficient establishment by the individual. Id.
Whereas the court is generally not going to sign the Special Needs Trust, the Trust should reference the court order that established it. For example, the first provisions of the Trust should specify that “this Trust is established and approved by the order of the Orphans’ Court
of County, this day of .” Of course, the Trustee must sign the Trust.
The guardian of an incapacitated individual may also sign and establish a Special Needs Trust for the individual. Because the individual is incapacitated, his or her guardian will not be permitted to transfer funds to the Trust without approval of court. In Pennsylvania, only the court, upon petition and for good cause shown after notice, can authorize the application of principal on behalf of its incapacitated ward. 20 Pa. C.S. § 5536 (a). The guardian will be required to file a petition. It is good practice to have the Trust approved by the court, to have the guardian directed to establish the Trust, and have the guardian directed to fund the Trust.
An interesting aspect of Pennsylvania law is that several County Orphans’ Courts consider the funds in the Special Needs Trust to be part of the incapacitated individual’s estate. Therefore, as will be examined in Part II of this article, distributions from Trust principal will require court approval.
Who Established the Trust: Special Needs Trusts established by Parents and Grandparents.
Parents and grandparents can establish a Special Needs Trust for the individual. Prior to December 13, 2016, an available parent or grandparent could establish a Special Needs Trust for a capacitated adult and avoid the necessity of a court petition. The individual could then transfer his or her assets into the Trust. As long as the individual had capacity or a valid power of attorney, legal authority existed to fund the Special Needs Trust. POMS SI 01120.203B(9).
The Social Security Administration has taken the position that a parent or grandparent may establish a “seed” trust with a nominal amount of his or her own money, unless their State permits “dry” trusts. POMS SI 01120.203B(7). This technical rule has caused significant problems for many individuals. If the Trust was not properly “seeded” then the Trust will be counted for purposes of the individual’s eligibility for benefits. If the individual received SSI or Medicaid after the Trust was funded, those benefits may likely be incorrectly paid to the individual and would need to be recovered.
This problematic issue was exemplified in 2015 with the Eighth Circuit Court decision in the case of Draper v. Colvin, 779 F.3d 556. In Draper, parents established a Special Needs Trust for their disabled daughter, who received a substantial personal injury settlement. The personal injury proceeds were deposited directly into the Special Needs Trust and parents did not initially seed the Trust. Id. Daughter previously named parents as her agents pursuant to a Power of Attorney. Id. at 558. The Court first stated that the Trust was not correctly seeded by parents and was, therefore, invalid. Id. at 563. The Court determined that parents acted as daughter’s agents, and not as parents, in establishing the Trust. Id. Because they acted as her agents, the Court ruled that daughter established the Trust through her own actions, which was also an invalid method of establishing a Special Needs Trust at that time. Id. The Trust was therefore available to daughter, who lost her benefits and was required to repay funds to the Social Security Administration. Id. at 565. If parents had properly seeded the Trust, daughter would not have had her benefits interrupted or had to repay the Social Security Administration.
Any Special Needs Trust in Pennsylvania established by a parent or grandparent after November 6, 2006 must have been properly seeded. POMS PS-01825.042C. The Social Security Administration determined that Pennsylvania, with the passage of the Uniform Trusts Code, 20 Pa. C.S. § 7701, et. seq., no longer permitted dry trusts and all Special Needs Trust established by parents or grandparents must be seeded. Luckily, seeding a Trust can be as simple as attaching a five dollar bill to the Trust, opening a bank account with a check from parent or grandparent, or attaching Schedule A stating the Trust is funded.
Who Established the Trust: Special Needs Trusts established by the Individual after December 13, 2016.
As noted above, on December 13, 2016, the 21st Century Cures Act, which allows individuals to establish their own Special Needs Trusts, was signed into law. The Draper case would probably have been decided very differently after the Act became effective. The updated POMS clarified several of the issues in Draper.
Since the individual can now establish his or her own Special Needs Trust, an agent under a Power of Attorney can also establish the Trust. POMS SI 01120.203C.2(a). As prior to the Cures Act, the agent also has legal authority to fund the Trust. POMS SI 01120.203C.3. However, if the individual’s parent or grandparent established the Trust, it must still be properly seeded. POMS SI 01120.203C.2(b).
When an individual establishes his or her own Special Needs Trust, the drafting attorney must ensure that the individual does not have any power over the funds in the Trust. For example, the individual would be the trust settlor. If the drafting attorney’s form permits the settlor to name himself or herself trustee, the Trust will not be valid.
A properly established Special Needs Trust is a crucial tool which permits an individual to access needs-based government benefits. Establishing the Trust is highly technical and fraught with traps for the unwary, as the Draper family discovered. The rules have changed. Although the rules have addressed a truly monumental issue by permitting a capacitated individual to establish and fund his or her own Special Needs Trust, a qualified and experienced Special Needs Trust attorney is the best way to ensure the individual’s Trust is properly established and funded.
The next part of this Article will address distributions from a Special Needs Trust and the changing definition of “sole benefit.”