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.


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.

Related Posts

The #1 Problem in Powers of Attorney

The #1 Problem in Powers of Attorney

In the many powers of attorney I see in my line of work, one problem recurs over and over again. And it’s costing families tens of thousands, and even hundreds of thousands, of dollars in asset protection. The number one problem is inadequate gifting provisions. If...

Who has capacity to make a will?

Who has capacity to make a will?

Fundamental to the validity of any last will and testament is that the testator (person whose will it is, and who is signing the documents) had capacity at the time of execution. By statute, a testator in Pennsylvania must be “of sound mind” to make a will. (20 Pa....

Share This