You may know that a special needs trust generally pays for the supplemental needs of the disabled, in order to preserve access to means-tested public benefits.

But what are those supplemental needs?

Commonly paid items

Below is a list of items that are often paid for by special needs trust.

Education – tuition, tutors, books, supplies

Computer, printer, internet, technological support

Home care, if not paid by another program

Phone or mobile phone, voice and/or data plan

Entertainment

Cable TV

Clothing (wasn’t always allowed to be paid for, but has been since 2005)

Medical supplies and equipment, such as wheelchairs, hearing aids, etc.

Eyeglasses

Vacations, including tickets or other travel charges, hotel

Companionship

Exercise and physical therapy equipment

Furniture

Health insurance premiums

Life insurance premiums

Household supplies and cleaning products

Tools used for home repair and maintenance

Dental costs

 House and vehicle

Two items that raise more complicated questions are the purchase of a house and a vehicle. Both may be beneficial and even necessary, and can often be purchased with funds from the trust. However, keep in mind that the purchase of such items raises complex questions of title and ownership, upkeep, insurance, and contribution by other family members.

Important caveats

Keep in mind that this list is not comprehensive. There any number of other items that will not reduce benefits and could be paid for by a special needs trust.

Check the terms of the trust. Even if an item is on this list, make sure the trust document itself allows the expenditure.

The general rule is that a special needs trust pays for items other than food and shelter. Such items could be paid for, but the purchase raises the issue of “in kind support and maintenance,” also referred to as ISM, which can reduce benefits. There may be reasons why the trust should make ISM payments, but that is a complicated topic for another blog post.

Check the rules of your local jurisdiction. Some states have rules that are more restrictive than others.

And of course, it’s best to seek competent professional advice before making distributions from a special needs trust. (Corporate trustees such as banks, trust companies, and nonprofits that are approved for handling special needs trusts, often serve as trustees of special needs trusts, rather than a family member or friend, because of the legal complexity.)

A “self settled” special needs trust is a particular type of special needs trust (SNT). In this post I’ll explain what it is, and when and how it is used. (For an explanation of SNTs in general, read this prior post.)

First, some terminology. A self settled SNT is also called a “first party” SNT or a “payback” trust or a “(d)(4)(A) trust” after the U.S. Code section (42 U.S.C. § 1396p(d)(4)(A)) that exempts it from being counted as a resource that would disqualify the beneficiary from certain types of public benefits (more on that shortly). The “beneficiary” is the person for whom the trust is created.

It’s called a first party or self settled trust because it is created using funds the beneficiary has or may soon receive. The two most common examples are lawsuits and inheritances.

Lawsuit. Sidney has permanent brain damage after a careless driver struck him in a crosswalk. He can no longer work and survives on his Supplemental Security Income (SSI) and has medical benefits through Medicaid. 

His lawyer reaches a settlement with the defending insurance company that will net Sidney about $400,000. If Sidney received the money outright, he would lose his monthly SSI payments and (perhaps more importantly) his Medicaid health coverage because both programs limit the amount of assets a person can own and still qualify for benefits.

But if the money funds a SNT for Sidney, he can keep his benefits. The SNT can then pay for other items that will help Sidney throughout his lifetime.

Inheritance. Tilly has had mental impairments since birth. Like Sidney, she is unable to work and gets by on SSI and Medicaid.

Her loving grandmother remembered Tilly in her will. Grandma recently died and Tilly stands to inherit $200,000. Though Grandma was well intentioned, she didn’t realize that it would throw Tilly off benefits to receive a $200,000 check.

A self settled SNT for Tilly provides the solution. By receiving distributions from the trust for the rest of her life, Tilly can benefit in many ways from Grandma’s generosity.

Payback requirement. Unlike some other types of SNTs, a self settled SNT must contain a “payback” provision. That is, the trust must provide that upon the death of the beneficiary, any funds remaining in the trust will pay back the state for whatever Medicaid costs the state paid on the beneficiary’s behalf.

In some cases, a payback requirement may make little difference. Take Tilly for example. If she is young enough, and has enough needs that can be met through the trust, its funds may be exhausted when she dies.

But if the amount were larger, or Tiller were older, or had few needs, a sizeable balance could remain when Tilly dies. Here’s where better planning on Grandma’s part could have helped. If Grandma’s will had said that Tilly’s $200,000 would go into a special needs trust, the law would have considered that a “third party” SNT. Unlike a first party trust, a third party trust does not require a payback provision. Grandma could have left the remainder upon Tilly’s death to her other grandchildren.   

Age requirement. Another requirement of a self settled SNT is that the beneficiary must be under age 65 when the trust is created. If a disabled plaintiff or heir is approaching age 65, act quickly.

If a potential beneficiary is 65 or older, a “pooled” SNT could be an alternative. In Pennsylvania, state law purports to limit all SNTs to those under age 65, but a federal court recently ruled that requirement invalid as applied to pooled trusts. (The state has appealed the ruling.)

Creation. Here is an interesting technicality that sometimes causes confusion. You would think that the beneficiary of a so-called “self settled” or “first party” would be able to create the trust himself. But you would be wrong. No, a parent, grandparent, legal guardian or court must create this type of trust. Often a court is already involved, handling the estate that creates the inheritance or the lawsuit brought by the beneficiary, and a lawyer asks the judge to authorize creation of the SNT. Oddly, no one seems to know the reason for this creation requirement. Maybe someday Congress will eliminate it since it has no apparent purpose and just causes extra work (and sometimes legal expense).

When Pennsylvania enacted a law in 2005 placing restrictions on the use of special needs trusts, many of us who practice in this field felt the restrictions went too far and violated federal law.

A federal judge recently issued the first ruling striking down some of those restrictions. (Lewis v. Alexander, 2011 U.S. Dist. LEXIS 95109, August 22, 2011.)

Pennsylvania has appealed.

Here is my take on the ruling.

Background

A special needs trust helps a person with disabilities by making funds available to pay for goods and services that will enhance quality of life. Such a trust can also preserve access to “means-tested” public benefits, such as Medicaid or Supplemental Security Income (SSI), that are available only to those who own very little in assets.

Federal law provides that some types of special needs trusts will not count as assets for purposes of determining eligibility for means-tested benefits programs, as long as those trusts meet certain requirements. One example is the “pooled” special needs trust.

In order to be non-countable as an asset for means-tested benefits programs (and therefore not interfere with eligibility) a pooled trust must meet these requirements under federal law:

(1) The trust is established and managed by a non-profit association.

(2) A separate account is maintained for each beneficiary of the trust, but, for purposes of investment and management of funds, the trust pools these accounts.

(3) Accounts in the trust are established solely for the benefit of individuals who are disabled. They must be established by the parent, grandparent, or legal guardian of such individuals, by such individuals, or by a court.

(4) To the extent that amounts remaining in a beneficiary’s account upon the death of the beneficiary are not retained by the trust, the trust must reimburse the state for any Medicaid payments made on the beneficiary’s behalf.

(Paraphrased from 42 U.S.C. § 1396p(d)(4)(C).)

After this federal law had been on the books for about 12 years, Pennsylvania in 2005 passed a law that added more requirements. The relevant parts read:

“(b) A special needs trust shall comply with all of the following:

(1) The beneficiary shall be an individual under the age of sixty-five who is disabled, as that term is defined in Title XVI of the Social Security Act.

(2) The beneficiary shall have special needs that will not be met without the trust.

(3) The trust shall provide:

(i) That all distributions from the trust must be for the sole benefit of the beneficiary. (ii) That any expenditure from the trust must have a reasonable relationship to the needs of the beneficiary.

(iii) That, upon the death of the beneficiary or upon the earlier termination of the trust, the department and any other state that provided medical assistance to the beneficiary must be reimbursed from the funds remaining in the trust up to an amount equal to the total medical assistance paid on behalf of the beneficiary before any other claimant is paid: Provided, however, That [sic] in the case of an account in a pooled trust, the trust shall provide that no more than fifty percent of the amount remaining in the beneficiary’s pooled trust account may be retained by the trust without any obligation to reimburse the [Department of Public Welfare].

(4) The department, upon review of the trust, must determine that the trust conforms to the requirements of Title XIX of the Social Security Act, this section, any other State law and any regulations or statements of policy adopted by the department to implement this section.

(c) If at any time it appears that any of the requirements of subsection (b) are not satisfied or the trustee refuses without good cause to make payments from the trust for the special needs of the beneficiary and, provided that the department or any other public agency in this Commonwealth has a claim against trust property, the department or other public agency may petition the court for an order terminating the trust.”

 62 Pa. Stat. Ann. § 1414.

 What’s wrong with the state law?

Many elder and disabilities law practitioners objected that Pennsylvania had no right to impose restrictions on the use of special needs trusts that were more stringent than federal law. And these more stringent restrictions could make a significant difference to disabled beneficiaries, pooled trusts, and others.

For example, the requirements that the “beneficiary shall have special needs that will not be met without the trust” and that “any expenditure from the trust must have a reasonable relationship to the needs of the beneficiary” could be interpreted as severely restricting what goes into a special needs trust and what could be spent from it.

Suppose a car accident cost 25-year-old Jane the use of her legs. She can no longer work at her former job as a waitress and instead lives on her SSI income. Medicaid pays for her health care. If Jane later recovers $500,000 from a lawsuit against a negligent driver, federal law allows her to set up a special needs trust that will preserve her public benefits while still paying for things that might improve her quality of life: physical therapy, a new wheelchair, a computer, college training to learn new job skills, and so on.

Will Pennsylvania argue that the trust is improper because she already receives medical care and subsistence income and therefore has no “special needs that will not be met without the trust?” Will the state dispute the amount put into the trust? If a trust is set up, will the state argue that the physical therapy and wheelchair have a “reasonable relationship” to her special needs but the computer and college training do not?

You can see how Pennsylvania’s additional requirements create doubt about whether a trust can be established, how much can be used to fund it, and what expenditures might be proper.

Another federal law mandates that although states help to administer and regulate the Medicaid program, a state may not impose requirements that are more restrictive than federal guidelines. Many legal practitioners believe the 2005 Pennsylvania law violated this “no-more-restrictive” mandate.  

Class action lawsuit

Plaintiffs holding pooled trust accounts, and organizations who served as trustees, filed suit as a class action to challenge the 2005 Pennsylvania law as it applied to pooled special needs trusts.

On August 22, 2011, a federal judge in Philadelphia ruled that the state of Pennsylvania, having elected to participate in the Medicaid program, was prohibited from adopting Medicaid eligibility rules that are more restrictive than federal guidelines. The court struck down a number of provisions of Pennsylvania’s 2005 law (at least as they applied to pooled special needs trusts) for being more restrictive than federal law.

Special needs requirement. The court found that federal law requires only that a person be disabled in order to establish a pooled special needs trust account. But the challenged state law adds an extra requirement that “the beneficiary shall have special needs that will not be met without the trust.” This requirement, the court said, would “render ineligible disabled persons who would be eligible [for Medicaid benefits] under federal law.” The provision therefore conflicted impermissibly with federal law, according to the court.

Age requirement. Pennsylvania’s law limits the availability of pooled trust accounts to persons younger than 65, the court found, while federal law does not. Therefore, this provision violated federal law, the court said.

“Reasonable relationship” requirement. The court found that federal law allows funds in special needs trusts to “be used broadly for purposes beyond the treatment of specific disabilities.” Pennsylvania’s requirement that distributions “must have a reasonable relationship to the needs of the beneficiary” would narrow the permissible use of funds to “items, products or services … [that] assist in and are related to the treatment of the beneficiary’s disability.” Again, the court ruled, the Pennsylvania statute could not be enforced because it was more restrictive than federal law.

Fifty-percent payback provision. The court interpreted federal law as allowing a pooled trust to retain up to 100% of the remainder in a pooled trust account upon the death of a beneficiary. Pennsylvania’s rule that a pooled trust could retain only 50% was therefore more restrictive than federal law, the court ruled, and once again, unenforceable.

Trust termination. The court also ruled that the state could not enforce against pooled trusts its provision that the state has the power to seek a court order terminating a trust that does not comply with the provisions of its (now largely invalidated) 2005 law.

Some provisions do not conflict with federal law and could be enforced, according to the court. The court found no conflict in Pennsylvania’s requirement that “all distributions from the trust must be for the sole benefit of the beneficiary.”

What happens next

For the moment, Pennsylvania may not enforce the provisions of its 2005 law that the court found violated federal law, at least as to pooled special needs trusts. Pennsylvania has appealed the ruling, however, so final resolution lies ahead.

In the meantime, what does the ruling mean to special needs trusts that are not pooled? To the extent other courts find the ruling persuasive in its reasoning, it could mean Pennsylvania cannot enforce certain provisions of the 2005 law as applied to other types of special needs trusts besides pooled trusts.

People with disabilities often have particular needs for services and supports, beyond the basic necessities of life. One way for family and friends to support people with disabilities is to set up a trust to help provide funding for those needs, or to pay for things that will improve quality of life.

A special needs trust holds funds used to benefit a person with disabilities (called a “beneficiary”). It is governed by a trust document that specifies how those funds can be used. A trustee is named to manage the trust and make distributions to help the beneficiary.

Protecting access to public benefits

Special needs trusts often have provisions to ensure that the beneficiary will not lose public benefits.

That’s because some public benefits programs benefitting the disabled, such as Medicaid or Supplemental Security Income (SSI), have restrictions on how much a recipient can own, or receive in income. (These are called means-tested programs.)

Grandma may think she’s helping her Suzie, her autistic granddaughter, with a handsome inheritance, but the inheritance could cause Suzie to lose her medical benefits because she would have too much money. Suzie may have to spend down her inheritance to pay for medical care that was previously covered, and then go back on benefits with her inheritance exhausted.        

If a special needs trust is set up the right way, Suzie can often keep her benefits and the trust can pay for a variety of supports and service that will improve Suzie’s quality of life for years to come.

Types of trusts

Trusts for the benefit of those with special needs come in different varieties. Most, however, fall into one of three categories.

First party trusts. (Also called “self settled” or “payback” trusts.) This type of trust is created when a person uses his or her own funds, or funds earmarked to go to that person, to establish a special needs trust.

For example, Joe was injured in a severe accident and is now a paraplegic. Joe may later receive an inheritance or a payout from a personal injury lawsuit. Joe may want to establish a special needs trust to avoid losing public benefits he receives now, or might receive in the future.

Keep in mind that a first party special needs trust for Joe can be established only if Joe is under age 65 at the time.

These trusts are sometimes called “payback” trusts because they must contain a provision that when the beneficiary dies, any amount remaining in the trust must go to pay back the state for the value of any public benefits the beneficiary received. If anything remains after that payback, it can go to other beneficiaries, such as family members.

Sometimes you will hear people call first party trusts “(d)(4)(A)” trusts, referring to 42 U.S.C. §1396p(d)(4)(A), which was part of the Omnibus Budget Reconciliation Act of 1993, or “OBRA ‘93.” That federal law exempts certain trusts from being considered the property of the beneficiary for public benefits purposes.

Third party trusts. When the funding for a special needs trust comes from someone besides the beneficiary, that’s called a third party trust.

The typical situation is for a parent, grandparent, or other relative to give the money for the trust. The person establishing the trust may do so while alive, or at death with a provision in his or her will.

Unlike a first party trust, a third party trust does not need to be a payback trust. Instead, any amount remaining when the beneficiary dies can go to others, perhaps the beneficiary’s brothers and sisters, with no requirement to pay back the state for public benefit costs.   

Also unlike first party trusts, the beneficiary can be any age – even over 65 – when the trust is established.

Pooled trusts. A special needs trust can also be established as a “pooled” trust with an approved nonprofit association. Funds in this type of trust are pooled together with other special needs trusts for investment purposes, but a separate account is maintained for each beneficiary.

Funds to establish a pooled trust account can come either from the beneficiary or from a third party.

A pooled trust is often used when the amount of the trust is relatively small. Administrative fees for trust management can be lower due to efficiencies and shared costs, and the cost of establishing an account in a pooled trust are often minimal.

Nonprofits operating pooled trusts are permitted to retain funds of deceased beneficiaries to assist other persons with disabilities, but not all of them do. When a beneficiary dies, funds remaining in that beneficiary’s account go to pay back the state for any Medicaid benefits the beneficiary received, unless the trust retains those funds.

The legal shorthand for a pooled trust is a “(d)(4)(C)” trust, referring to 42 U.S.C. §1396p(d)(4)(C).

Which is the right one?

Whether to establish a special needs trust, and is so what type, can be a complicated decision, often taking into account such considerations as the amount of money involved, the source of the funds, the beneficiary’s age, type of disability, type of benefits (if any) the beneficiary receives now or could receive in the future, and a number of other factors. Objectives vary from client to client.

For this reasons, it’s best to consult an experienced professional in your jurisdiction before establishing a special needs trust.