First Party and Third Party Trusts

A. Introduction
Because two of the most common benefit programs available to persons with disabilities, SSI and Medicaid, are means-tested programs, it is important to consider the financial impact on a beneficiary of assets owned, acquired or inherited by such a beneficiary.  Before 1985, some individuals attempted to set up discretionary trusts using their own funds without losing their eligibility for public benefit programs.  These attempts rarely met with success.  Courts held that assets held in self-settled discretionary trusts were available to the settlors and their creditors, including the state that provided the benefits these people were trying to protect.  See, e.g., Vanderbilt Credit Corp. v. Chase Manhattan Bank, 473 N.Y.S. 2d 242 (A.D. 1984).  In 1985, federal legislation declared such self-settled discretionary trusts to be against public policy.  The Consolidated Omnibus Budget Reconciliation Act of 1985 (“COBRA”) provided no creditor protection to these trusts and the principal and income were deemed to be available to the settlors of such trusts.  However, after COBRA, practitioners developed self-settled non- discretionary trusts that did protect the trust assets from being deemed available to the settlors. Only the distributions that were mandated by the trust could be considered by the state agencies. The result of this development was that a settlor could establish an irrevocable trust and receive income from the trust.  As long as the income from the trust was less than the income limits on public benefits, the principal of the trust and its undistributed income were not considered available to the settlor and therefore, to the state.  Settlors could thus protect the principal of the trust for their ultimate beneficiaries and provide an inheritance for their families.Following the 1985 Act, Congress perceived that such self-settled trusts were abusing the Medicaid program.  To correct that perception, in 1993 Congress included in the Omnibus Budget Reconciliation Act of 1993 (“OBRA-93”) a new definition of trusts that disqualified their beneficiaries from public benefits.However, the redefinition contained in OBRA-93 also included criteria for creating trusts that do not disqualify disabled beneficiaries from receiving public benefits.  See Section 1917(d) of the Social Security Act, 42 U.S.C. § 1396p(d).  Such trusts have to be lawful under the laws of the state in which they are created and also have to comply with state Medicaid regulations and federal agency interpretations of federal law found in the State Medicaid Manual.  These OBRA-93 trusts are frequently called Special Needs Trusts or Supplemental Needs Trusts.  They will be referred to interchangeably in this section as SNTs.  There are two primary types of self-settled SNTs.  They are often referred to as (d)(4)(A) and (d)(4)(C) trusts for the statutory sections that authorize them (42 U.S.C. § 1396p).  A (d)(4)(A) trust must contain a provision to repay Medicaid at the death of the beneficiary for the cost of services it paid for the beneficiary’s benefit during his or her lifetime.  A (d)(4)(C) trust is often referred to as a pooled trust.  Further discussions of these two types of trusts are in sections E and F, below.  Self-settled trusts are very different than third party trusts, which will be discussed in section F.  The primary distinction is that third party trusts do not contain assets of the beneficiary. 

B. SSI and Medicaid Requirements 
An individual may qualify for Medicaid directly or as a result of qualifying for Supplemental Security Income (“SSI”) through the Social Security Administration (“SSA”).  The Supplemental Security Income program was signed into law in 1972 by President Nixon to address gaps in federal benefit coverage for the aged, blind and disabled who had not been able to work a sufficient amount of time to qualify for benefits under the Social Security Act and who were poor.  Before the SSI program was enacted, only state welfare programs provided cash income to such beneficiaries.  In order to be eligible for SSI, an individual may have up to $2,000 in available resources and a couple may have up to $3,000.  In addition, a person or couple is allowed to have a homestead, without any limitation on value, household goods, a car, and each individual can have a burial fund with not more than $1,500 in it.The trust provisions of OBRA-93 also pertain to eligibility for SSI.  The Foster Care Independence Act of 1999 (“FCIA”) (P.L. 106-169) changed the SSI rules for trusts, effective January 1, 2000. 42 U.S.C. 1382b.  Section 205 of this law provides, generally, that trusts established with the assets of an individual (or spouse) will be considered a resource for SSI eligibility purposes. It addresses when earnings or additions to trusts will be considered income. The legislation also provides exceptions to the general rule of counting trusts as resources and income. The FCIA specifically exempts OBRA-93 special needs trusts and pooled trusts from being considered an available resource and provides that transfers to fund such trusts by an individual under age 65 will not incur a transfer penalty.  In many ways, the SSI rules for SNTs are more restrictive than the Medicaid rules.  The SSA will review SNTs for beneficiaries who are receiving both SSI and Medicaid, but only after the SNT is created.  The Social Security Administration’s Program Operations Manual System (“POMS”) is an exhaustive set of regulations dealing with many issues, among them, SNTs.  See, e.g., POMS SI 01120.200, SI 01120.201 and SI 01120.203 (January 2009).  The POMS may be found online at are critical elements required to establish a SNT under 42 U.S.C. § 1396p (d)(4)(A) that are contained in the following paragraph from the statute:A trust containing the assets of an individual under age 65 who is disabled (as defined in section 1614(a)(3) [of the Social Security Act]) and which is established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State plan under this title.The Social Security Administration has included additional criteria for approval in the POMS that are not apparent from the statutory language:Disability—There is no requirement that the disabled individual have been determined to be disabled before the trust was created.  That determination can be made when the trust is funded and submitted to SSA for approval.  POMS SI 01150.121.Sole benefit requirements—Until a few years ago, there were some SSA Regional Counsel who took the position that payment of taxes, trustee fees or other administrative expenses violated the requirement to repay Medicaid first.  Since the Medicaid repayment is only accomplished after the death of the beneficiary, it would be impossible to administer the trust.  The POMS were amended to clarify that the “sole benefit” requirement is not violated if certain administrative expenses are paid during the life of the beneficiary and certain others after death, but before repayment to Medicaid.  The prohibited and allowable expenses are found in POMS SI 01120.203.B.3.Doctrine of Worthier Title—Some of the SSA Regional Offices (including Boston, which includes Vermont) have published regional instructions to guide staff in evaluating trusts.  These instructions describe what is necessary to have an irrevocable trust under state law.  A recent change to the Boston Region POMS indicates that a Vermont trust mayprovide that assets will go to “the heirs of John Smith” or the “Estate of John Smith.”  See POMS (SI BOS01120.200.D.3).  This is a change from the prior practice of the SSA, which would disqualify a Vermont trust if the beneficiary’s heirs were contingent beneficiaries.  Note that the State as a creditor does not constitute a beneficiary.Funding by Competent Adult Beneficiary—Until the issuance of the new trust POMS by SSA in January, 2009, it was unclear whether an adult beneficiary of a Supplemental Needs Trust who had capacity could fund his or her own trust.  The new POMS make it clear that it is permissible for the person “whose actions created the trust” to seed it with a token amount, like $10.00, and have the adult beneficiary transfer his or her own assets to the trust.  SI 01120.203 B 1 f.  This clarification will make it easier to fund a trust and will eliminate the necessity of establishing a guardianship for an adult beneficiary with capacity. 

C. The (d)(4)(A)  Trust
One important thing to keep in mind is that a (d)(4)(A) Trust cannot be established for a person aged 65 or older.  This means the trust must be in place and funded before the beneficiary reaches his or her 65thbirthday.  While the trust can continue after the individual turns 65, additions to the trust cannot be made after that birthday without counting as income to the beneficiary.  In the case of a structured settlement annuity in place before the beneficiary reaches age 65, payments can continue to be made after the beneficiary turns 65.  Persons over age 64 may be able to use a pooled trust established by a non-profit association. See section F, below.  The other salient characteristic of a (d)(4)(A) Trust is that there is a mandatory payback to the State at the death of the beneficiary.  The amount to be paid back from trust assets is an amount equal to the total amount of medical assistance paid on behalf of the beneficiary under the State plan. 

D.  The (d)(4)(C) Trust
In a (d)(4)(C) Trust, the trust is established and maintained by a non-profit association.  A separate account is maintained for each beneficiary of the trust, but the trust pools these accounts to invest and manage the assets.  Accounts in the trust are established by a parent, grandparent, or legal guardian of such an individual, by the individual himself or herself, or by a court and must be solely for the benefit of the disabled individual.  If there are amounts left in the beneficiary’s account at his or her death, they may be retained by the non-profit sponsor.  If they are not retained, the trust pays the State back, much as in d)(4)(A) Trust situation.  The (d)(4)(C) Trust is very similar to the (d)(4)(A) Trust.  While there is no requirement that the beneficiary be under the age of 65 in the federal law, the Center for Medicare and Medicaid Services and many states now consider amounts put in a (d)(4)(C) Trust for someone over 64 to be a non-exempt transfer of resources.  The Vermont regulation,4473.1, formerly M 440.31, is unclear on this point, but DCF is interpreting the regulation to prohibit people over 64 from establishing (d)(4)(C) trusts.  Unlike (d)(4)(A) Trusts, the individual whose assets are being transferred to the trust may establish the trust himself or herself.  One pooled trust that is available to Vermont residents and has been approved (informally) by DCF is Enhanced Life Options, located in Bedford, NH.  See  Nina Hamberger is the Executive Director and is very helpful. 

E.  The (c)(2)(B) Trust
In 1988, the Medicare Catastrophic Coverage Act added provisions that allowed an individual to transfer assets to certain individuals without penalty.  These included transfers to the individual’s spouse or to another for the sole benefit of the individual’s spouse, to a blind or disabled child or to a trust for the benefit of such a child.  42 U.S.C. § 1396p (c)(2)(B). In 1993, OBRA-93 added subsection (iv) to (c)(2)(B).  Subsection (iv) allowed a transfer to a trust established solely for the benefit of an individual under the age of 65 who is disabled (as defined in section 1382c(a)(3) of the Social Security Act).  The amendment included in subsection iv a (d)(4)(A) trust.The effect of this provision is to allow a third person to transfer assets to a trust for a disabled person without being penalized for the transfer.  Creating the trust will not disqualify the donor from receiving Medicaid benefits if he or she is otherwise eligible for them.  This can be very helpful for a person applying for long-term Medicaid benefits who has a family member or friend with disabilities.The trust must either be a (d)(4)(A) trust and provide for a payback to Medicaid after the death of the beneficiary  or must be for the sole benefit of the disabled individual and must provide for spending the funds on an actuarially sound basis determined by the life expectancy of the beneficiary.  Health Care Financing Administration (HCFA) Transmittal Letter 64, §3257.6.One question that arises is whether naming a remainder beneficiary violates the law.  This possibility would arise where the trust is not a (d)(4)(A) trust, but a (c)(2)(B) trust that is actuarially sound.  An examination of the State Medicaid Manual, Transmittal Letter 64, §3257.6, leads to the conclusion that the trust must contain a payback provision to Medicaid following the beneficiary’s death or provide for distributions that are actuarially sound based on the sole beneficiary’s life expectancy in order for a remainder beneficiary to be named without disqualifying the trust.  A recent exchange with the attorney for policy decisions at DCF confirmed the option for (c)(2)(b) trusts. 

F.  Third Party Trusts
A third party SNT is a special needs trust established by one person for the benefit of another and funded with assets that do not belong to the beneficiary.  The purpose of a third party SNT is to preserve public benefits for the beneficiary while using the trust funds to enhance the beneficiary’s lifestyle.  A key issue in creating a third party SNT is whether or not the funds in the trust are “available” to the beneficiary.  If the income from the trust is considered available to the beneficiary, he or she may be driven over the income limit for the applicable program.Relatives of disabled children have several options in considering estate planning for the child with disabilities.  They can disinherit the child, distribute assets directly to the disabled child, distribute assets to siblings or others with the understanding that the beneficiaries will use the inheritance for the benefit of the disabled child or distribute assets to a special needs trust.Disinheriting the child may be an option if the estate is small and there is not enough money to make a meaningful difference in the child’s life.  Leaving the disabled child an inheritance may result in the reduction or elimination of government benefits that are means-tested.  Medicaid, SSI or federally assisted housing may become unavailable.  Medicaid is especially important because it provides health coverage for the child.  If the child is a patient in a public institution and inherits money, the State may not only charge the child for his or her care, but seek to be repaid for past care.Leaving money or assets to a sibling or other relative with the understanding that it will be used for the benefit of the disabled child can be risky.  The assets are subject to misappropriation by the relative or loss to creditors or in a divorce.. The fourth option is to leave the inheritance to a special needs trust.  A properly drafted special needs trust allows individuals on means-tested programs to retain their benefits.  It also provides management of assets by a qualified trustee, instead of risking loss because of the disabled child’s lack of ability to manage money.  A special needs trust is designed so that the assets are not “available” to the disabled child.  The child cannot compel distribution and it is set up as a discretionary spendthrift trust.A special needs trust can be set up as an inter vivos trust.  An advantage of an inter vivos trust is to provide a vehicle for grandparents or other relatives to leave money for the person with disabilities.  If the parents are divorced, it provides an opportunity for each of them to leave money for their child without an inordinate amount of concern that the other parent will misappropriate the money, since if that parent is acting as trustee, he or she will have fiduciary obligations.A third party trust can be revocable or irrevocable from its inception, but will become irrevocable at the death of the grantor.  Having the trust be revocable will avoid the necessity of filing fiduciary income tax returns as long as the grantor is alive.The lawyer creating a third party SNT should take income, gift and estate tax issues into consideration.  Some income tax rules pertaining to third party SNTs are, first, that all transactions should be reported under the taxpayer ID for the trust, not the grantor’s or beneficiary’s social security number; second, the trust reports net income distributed to a beneficiary via a Schedule K-1; and, third, the beneficiary’s income tax returns will reflect income at lower individual tax rates.  Filing an income tax return for the beneficiary will not, in and of itself, impair benefit eligibility, but the SSA reviews IRS income tax data by Social Security Number, which can generate a notice to the beneficiary to explain the income reported; and the trustee must be able to show that income amounts were distributions made for extra and supplemental items.Federal Medicaid law only allows assets of a spouse to be put into an SNT for the other spouse’s benefit through a will, rather than an inter vivos trust.  A testamentary special needs trust may be subject to the surviving spouse’s rights to an elective share.  There is no law in Vermont stating that a testamentary special needs trust satisfies the state’s elective share law.  Therefore, if the surviving spouse is receiving Medicaid benefits, the State may require an election against the testamentary SNT.Special Needs Trusts are a vital tool for families with members who have disabilities.  The proper creation and administration of such trusts is complex, but essential to prevent disqualifying the beneficiary from important benefit programs.