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Supplemental Needs Trusts for Disabled Beneficiaries - Module 5 of 6

Module 5: Supplemental Needs Trusts for Disabled Beneficiaries

Supplemental Needs Trusts: Introduction

A supplemental needs trust is a legislation-created device that allows chronically disabled people to benefit from income and asset-based government assistance programs even when they might have other sources of revenue.

The theory behind the allowance of this device is that if a disabled person’s assets were required to pay for his or her healthcare, there would be nothing left to pay for quality of life expenses. In addition, the risk to eligibility for government assistance would otherwise greatly discourage gifts to people with disabilities.

            A supplemental needs trust can be established as a lifetime or testamentary trust. That is, a supplemental needs trust can be set up either while the grantor is living or by a will, to take effect only upon the death of the client. The latter is a common approach for people who have disabled children. Rather than giving the disabled child an inheritance outright, thereby potentially threatening her eligibility to receive government assistance, the disabled child’s share can be held for her benefit in a testamentary supplemental needs trust.

            The provision establishing that one child’s share is held in trust need not even specifically reference the disabled child. It can be worded something to this effect:

Upon my death, my assets shall be distributed among my children, in equal shares, provided, however, that if any beneficiary under this Paragraph suffers from a severe and chronic disability, then his or her share shall not be distributed to the beneficiary outright, but shall instead be held for the benefit of the beneficiary in a “supplemental needs trust.”

Although this type of trust is respected by courts even without statutory recognition, many states have given formal statutory recognition to supplemental needs trust.  In addition, since the passage of the Omnibus Budget Reconciliation Act of 1993, there is also federal statutory recognition of supplemental needs trusts. 

Supplemental Needs Trusts: The Provisions

            The exact language by which a supplemental needs trust should be established may vary from state to state. However, a common thread is that the trust must evince a clear intent that the trust assets are intended to supplement, and not supplant, government assistance to the disabled beneficiary. In addition, the trust may be used only to pay expenses that would not otherwise be paid for by government assistance programs. 

Assets held by a supplemental needs trust are typically used to pay for things like the education, clothing and luxuries of the beneficiary (such as travel, entertainment, etc.). The trustee may be given discretion within this range of possible uses of the trust funds, as long as the trustee may not pay for expenses that government assistance would pay for.

            The trust may give the trustee the authority to invest the trust assets and to manage the trust in the same manner that trustees are given these authorities in other trusts. Beyond the clear intent that the trustee cannot use assets that would supplant government benefits, there is little to distinguish supplemental needs trusts from other trusts.

Third Party Supplemental Needs Trusts

            A third party supplemental needs trust is the most straightforward of the supplemental needs trusts. A supplemental needs trust is a “third party” trust when assets other than those assets belonging to the disabled person are used to fund the trust. To keep its status as a third-party trust, no funds belonging to the disabled person nor funds to which the disabled person is entitled should be used to fund the trust. These trusts are usually funded by relatives or friends of the disabled beneficiary. Testamentary trusts, because they are funded by the will of another person, are inherently third-party supplemental needs trusts.

            A testamentary supplemental needs trust can be quite broad in the discretion it gives to the trustee, while protecting the eligibility of the disabled beneficiary. As long as the disabled beneficiary does not have control over the distributions from the trust (i.e., the decision is made by an independent trustee), the assets in the trust should not be considered an available resource to the disabled beneficiary. 

Third party supplemental needs trusts have little to distinguish them from other trusts. But it is critical that the trust avoid directing the trustee to pay for the healthcare (or similar) expenses of the beneficiary. Where the trustee is directed to pay for the healthcare or general support needs of the disabled beneficiary, or perhaps even where the trustee has the authority to do so, it is possible that a local department of social services will consider the trust assets to be an available resource to the beneficiary.

(It is important to note, however, that even when the provisions of a third-party trust do not conform to the supplemental needs trust requirements, courts do have the authority to reform a provision to turn a trust into a qualifying supplemental needs trust.)

Self-Settled Supplemental Needs Trusts

            Things become more complex when supplemental needs trusts are established using the assets of the disabled person. Despite the general rule that assets held in self-settled trusts are vulnerable to the creditors of the grantor, federal law exempts the assets in qualifying supplemental needs trusts from inclusion as “available resources” to the disabled person who funded it. In other words, if a disabled person has resources that would make him ineligible for government assistance, he can create a supplemental needs trust, use those assets to fund it and then continue receiving government assistance.

            Unlike the third-party trust, however, there are strict conditions that must be followed for a self-settled trust to gain the benefits of the supplemental needs trust.  First, the trust must be established by the disabled person himself, by the disabled person’s parent, grandparent or legal guardian or by a court on behalf of the disabled person. Second, the trust must be established for a disabled person under the age of 65.

            Third and most significantly, the trust must contain a “payback provision.” This provision must dictate that, upon the death of the disabled beneficiary, any money that is remaining in the trust will be used to reimburse the state that paid healthcare costs for the beneficiary up to the amount that it paid on behalf of the beneficiary. Any amount left over after this reimbursement can be distributed in accordance with whatever the trust dictates (such as to the beneficiary’s heirs).

            Essentially, the government is saying, “we’ll let you (the disabled person) keep your money for supplemental expenses for yourself, but if there’s anything left over when you don’t need it anymore (because you’re dead), we get first crack at whatever is left.” The logic behind this is simple. The purpose of the supplemental needs trust statute was to allow the disabled person quality of life that would be lacking if he used his resources to pay for healthcare expenses. The purpose was not to allow the disabled person’s family a windfall while the government pays for the healthcare of the disabled person.

            Without this provision, a trust will not qualify as a supplemental needs trust. In that case, the entire trust corpus will be considered an available resource to the disabled beneficiary, likely disqualifying him from receiving many types of government assistance.

If there are self-settled and third-party supplemental needs trusts for the benefit of the same disabled beneficiary, the family of the beneficiary should be advised that if any family member wants to give substantial gifts to the disabled person she should do so by giving gifts to the third-party trust. This applies both to lifetime gifts and to testamentary gifts. This is because the third-party trust does not require a payback provision. Placing a gift in a self-settled trust likely means at least some of that money wind up going to the government.

Supplemental Needs Trusts with other Beneficiaries as well as the Disabled Beneficiary

            The next question is whether a supplemental needs trust may benefit additional parties in addition to the disabled person.

            A standard trust, whether a qualifying supplemental needs trust or not, can benefit a disabled person as well as other third parties. As long as the trustee is not required (and certainly, if she is not allowed) to pay expenses for the disabled beneficiary that would be covered by government assistance, the trust should not adversely affect the disabled person's benefits eligibility.

The same applies to supplemental needs trusts. Although supplemental needs trusts typically benefit only the disabled person, there is probably no problem with having other people potentially benefit from a third party supplemental needs trust. In addition, third parties may (and should) be named as remainder beneficiaries if trust assets remain after the death of the disabled beneficiary.

            A self-settled supplemental needs trust is another matter. Since the state must, by definition, have a remainder interest in the trust assets, it naturally has an interest in preserving the trust assets. As such, in a self-settled supplemental needs trust no person other than the disabled beneficiary may be a beneficiary of the trust, whether during the lifetime of the disabled beneficiary or after his death, until the payback provisions has been satisfied. Once the government has been reimbursed, any additional trust assets can be distributed to the heirs of the beneficiary.

Miller Trusts

            The “Miller Trust,” also referred to as a “qualified income” trust, serves as a vehicle to hold income of a disabled person that exceed the state limit for Medicaid eligibility. This excess income, from pensions or social security for example, can be placed into the Miller Trust rather than being held by the beneficiary and thus allow such person to become eligible for Medicaid. Named after a 1990 case of the same name, the Miller trust was codified as part of the 1993 Act that also established the rules for the self-settled supplemental needs trust discussed above.

            Unlike a self-settled supplemental needs trust, this device can be used by people over the age of 65. As with a self-settled supplemental needs trust, the trust assets may be used for the benefit of the disabled person, but only in a manner that will supplement, and not replace, payments that would otherwise be made by government assistance.

            Also, as in a self-settled supplemental needs trust, Miller trusts require payback provisions. So, any trust assets that are unused at the time of the beneficiary’s death must be used to reimburse the state for expenses paid on behalf of the disabled person. Any assets remaining after this reimbursement to the state may be paid to the disabled person’s heirs, in accordance with the wishes of the disabled person.

Pooled Trusts

            An alternative to the Miller Trust, also codified by the 1993 Act, is the “pooled trust” that is held by a non-profit organization.  The non-profit organization establishes a trust where many disabled people “pool” their resources to be managed and invested by the organization.  Separate accounts must be held for each disabled beneficiary and the separate account must be set up by the disabled beneficiary or the parent, grandparent, or legal guardian of the beneficiary (or by a court).

            The disabled person can fund his or her account in the pooled trust with assets (to lower his or her asset holdings below the Medicaid asset threshold) and may consistently fund the pooled trust with income that exceeds the Medicaid income threshold. The trust may use the disabled beneficiary’s account to pay for the beneficiary’s supplemental needs.

            Unlike the self-settled trust and the Miller trust, after the death of the disabled beneficiary, there is some flexibility in the pooled trust. The trust has two choices.

The first choice is to have the beneficiary’s account simply remain with the non-profit organization and be used as part of its general (non-profit) purpose. In that case, the state need not be reimbursed for the care provided to the beneficiaries. Alternatively, the trust may pay back the state for the care it provided to the beneficiary and the remainder may then be distributed to the heirs of the beneficiary.

In most states, there is no age restriction on who can fund a pooled trust. This is an important advantage over the self-settled supplemental needs trust. Of course, the downside to the pooled trust strategy is that the organization maintains control over the trust assets and must approve expenditures on behalf of the beneficiary.  With a supplemental needs trust it will be recalled, a family member or friend can be the trustee and thus control distributions to the disabled beneficiary.

Transfers to Supplemental Needs Trusts

             In addition to the important benefit of maintaining/preserving a disabled person’s eligibility for government assistance programs, supplemental needs trusts provide another important statutory advantage. Recall that gift transfers typically cause a five-year period of ineligibility to receive Medicaid assistance. A transfer to a qualified supplemental needs trust, on the other hand, does not result in a period of ineligibility for the donor.  If the disabled beneficiary of the trust is a spouse or child of the grantor, the disabled beneficiary may be of any age.  If the disabled beneficiary is someone else, the beneficiary must be younger than age 65.

            In addition to the other statutory requirements of a supplemental needs trust, to be eligible for this transfer exemption the trust must be for the “sole benefit” of the disabled beneficiary. This is true even if the transfer is made to a third-party supplemental needs trust.

            Since a supplemental needs trust to which such a transfer is made is generally a third-party supplemental needs trust, a “payback” provision is not required. However, the gift to the supplemental needs trust must be such that, based on sound actuarial data, it is reasonable to expect that the amount transferred will be spent over the course of the life of the disabled beneficiary.  Any gift over and above this amount will cause a period of ineligibility for Medicaid purposes.  The reason for this is simple. If the gift is large enough that it will not likely be spent during the lifetime of the beneficiary, the entire gift cannot reasonably be considered for the benefit of the disabled beneficiary.

            Unfortunately, this only works to avoid the transfer ineligibility period. If a person has consistent income exceeding the Medicaid income limitations, transferring the excess income to a supplemental needs trust for the benefit of a disabled child will not prevent it from being considered available to the recipient of the income.

            One last possible benefit of transferring assets to a supplemental needs trust is that some states will not “recover” assets paid by Medicaid after the recipient’s death if the assets are left to a supplemental needs trust for the benefit of a disabled beneficiary. Typically, if Medicaid pays for the care of a person who dies with assets, the state is required by law to seek recovery of the expenses that were laid out. However, at least one state, California, expressly states that it will not seek to recover such assets if they are left to a supplemental needs trust.