The “Special Needs Trust” - Critical Planning for Family Members with Disability

Jul 11, 2010

Wills, Trusts, Durable Powers of Attorney, and Health Care Patient Advocate Designations are all basic tools used in the Estate Planning process. There are also some special purpose tools which are important to consider in any good planning process.

One of the areas we always cover in the initial client meeting is whether there are any family members who have a disabling condition. While we are generally exploring the immediate family, it is worth noting that the considerations important to this area can also be important to more remote family members such as parents, grandchildren, siblings and their children.

The Dilemma For Parents

The classic dilemma for parents of a disabled child is that under our current system of governmental support, the child may not own significant assets; yet caring parents know that one they are no longer their to take care of their child’s needs, there may be nobody else who can do that.
A traditional approach to such planning was to “disinherit” the child and leave his or her portion of the estate to someone else (usually siblings) with the tacit agreement for that person to hold the assets and use them for the child’s benefits. Leaving assets to the disabled child (even in trust) can have devastating impact on that child’s established benefit program (including among other programs, SSI, State Programs, and the all-important Medicaid), by disqualifying them from those benefits.

Traditional trust planning simply doesn’t work (even with a so-called “spendthrift” trust), because these all-important programs are often referred to in legal terms as “necessary services” and traditional trust law allows providers of such “necessary services” to reach even well-drafted spendthrift trusts.

The Special Needs Trust

Most states recognize a special purpose trust, however, generally known as a Special Needs Trust. In Michigan, a properly drafted Special Needs Trust (know as a Michigan Discretionary Trust under Michigan case law) cannot be reached by creditors: even the Michigan Department of Human Services, which administers Medicaid and SSI for Michigan residents. In recent years, estate planners working in the relatively new field of “Elder Law,” have used these trusts in their quest to assist elder residents of Long Term Care facilities to qualify for Medicaid, while protecting their assets. There has been a rather long history of government measures tightening the rules on these trusts so that their use has become much more limited.

However, Congress has carefully limited these measures’ application to the true, third-party Special Needs Trust for the developmentally disabled community. In this context they remain completely viable and are still (in most cases) the most effective planning tool to provide for disabled children. Indeed, in one of the more sweeping congressional acts, the legislative history not only specifically addressed the continuing viability of these trusts for disabled children, but actually enhance their use by creating another favorable exception.

The advantage of the Special Needs Trust is that parents can leave substantial assets, in Trust, for the benefit of their child without exposing them to the risks of the above-mentioned, more traditional approach. There were always the concerns that the sibling would die, become disabled themselves, have legal problems (such as bankruptcy or divorce), all of which would put the assets intended for the disabled child at risk. In a word, there was a lack of certainty. The Special Needs Trust provides that certainty, by assuring that the sibling can be “in charge of” the assets without owning them. It can provide also for succession of management.

It is important to understand the legal implications of this trust. “Disinheriting” a child is a very emotional hurdle. But good planning doesn’t really disinherit - at least not morally. Rather, it ensures that the child will continue to receive (often essential) governmental benefits, while the “inheritance” intended for them is preserved, to be used for those very things the parents are doing for their child while they are still living.

Care must be taken, both in the creation of a Special Needs Trust and in its administration. The primary important point is that the Trust language establish the intent of the grantor(s) that the asset not belong to the child, but that it be used for very specific and limited purposes for the benefit of the child. Once activated, the Trustee must understand the rules, in order not to jeopardize the status of the Trust. An “active” special needs trust will be scrutinized by the Michigan Attorney General’s office, so it is critical that it be drafted by someone with knowledge and experience in this area. And, because of this requirement (relatively recent), we currently generally structure these trust as “stand-alone” documents rather than as part of a general family trust document.

The Traditional Third Party Special Needs Trust

There are two different Special Needs Trust recognized by the government as effective. The traditional Special Needs Trust is a “third-party” trust. In other words, it is created by a person or persons who have no legal responsibility to provide for the beneficiary and is established in such a way that the beneficiary has no legal right of withdrawal for any reason. Distributions from the trust are solely at the discretion of the Trustee. It is critically important that such trusts never be “tainted” with assets that in any way or at any time “belong” to the disabled person (thus, benefit payments and inherited assets should not be used to fund the trust). There may be ways to use such assets creatively and that should be discussed with an expert.

The Payback Trust

The second variety is what I referenced earlier as an “enhanced” planning capability. The law now provides that a Special Needs Trust may be created with assets belonging to the disabled person; but with some tradeoffs. If the disabled person is under age 65, a Special Needs Trust may be funded with their own assets, as long as the trust provides for a “payback” provision. After the death of the disabled person (or on termination of the trust in some cases for other reasons) this “payback trust” must pay the governmental provider back for its expenditures, first, before distributing assets to other heirs. The benefit of a “payback trust” is that it allows the disabled person to qualify (or remain qualified) for governmental benefits without any interruption. In the meantime, the assets within the trust can be managed and used for the benefit of the disabled child during their lifetime.

It is important that these two types of Special Needs Trust be distinguished and where applicable done separately (it is not unusual to have both types in place for clients where it is appropriate). We have effectively established “payback trusts” to hold the proceeds of law suits. We have also had good success with our local Probate Court jurisdictions in converting Conservatorship and Guardianship assets into “payback trusts.”

Our standard trust documents contain a “catchall” provision that provides that any time a distribution is to be made to a person with a disabling condition, it may be paid to the trustee of an existing Special Needs Trust or held as a Special Needs Trust for that person.

If you have a family member with a disabling condition, have had concerns about their ultimate welfare, and have not consulted with an Estate Planning Professional about a Special Needs Trust, this is a clear opportunity to put some essential planning in place and achieve peace of mind.


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