Special Needs Trusts: How to keep your win from becoming your client’s loss

Avoiding great hardship for a client who receives certain public benefits requires careful planning

Kevin Urbatsch
2008 April

A plaintiff who is disabled and receiving needs-based public benefits requires special planning when he or she receives a settlement or judgment. Failing to plan can lead to great hardship for the client and may lead to a malpractice claim against the plaintiff’s attorney. Primarily, this planning is done by transferring the litigation recovery to a first party Special Needs Trust (SNT). This type of trust allows a person with a disability to use the litigation recovery for his or her future needs while preserving eligibility for needs-based public benefits.

First-party SNTs are statutorily created “safe harbor” trusts. Therefore, every first-party SNT must strictly comply with a myriad of federal, state, administrative and judicial rules and regulations defining them. Even small changes in a plaintiff’s fact pattern (e.g., plaintiff’s age, legal capacity or amount of recovery) can lead to a very different planning solution. Thus, it is imperative for the practitioner to understand the law in this area and how different factual situations will change the appropriate plan.

This article will discuss which clients with a disability must be planned for, the planning issues that arise for these clients, and the steps that need to be taken to assure that the client receives the full benefits of the litigation recovery.

Which client with a disability requires special planning?

Not every person with a disability requires an extensive plan. It is important to know that only certain public benefits require a plan to preserve benefits. Public benefits are divided into two main categories, (1) needs-based and (2) entitlement. It is easy to confuse what type of benefits a plaintiff may be receiving as they both are similarly named and are administered by the same agencies. Oftentimes, even the plaintiff will not know which benefits he or she is receiving.

Needs-based public benefits include Supplemental Security Income (SSI) and Medi-Cal (Medicaid in other states), while entitlement benefits include Social Security Disability Insurance (SSDI) and Medicare. Only recipients of SSI and Medi-Cal require planning. This is because for these programs an individual may only have a very limited income and $2,000 in his or her own name to be eligible.1 Assets held in a special needs trust are not counted as the public benefit recipient’s assets for eligibility purposes and thus preserve eligibility.

If the person with a disability receives only SSDI or Medicare, an SNT is not needed to preserve these benefits. These benefits are based on payment into the federal system by an employee. Anyone who becomes disabled under the program’s definition qualifies for SSDI and Medicare; the amount of assets held by the individual is immaterial.

However, even when preservation of public benefits is not of primary importance, it may still be prudent to prepare and fund an SNT. Medicare does not pay for all types of medical care. Sometimes, Medi-Cal will be needed right away or is expected in the future, so planning with an SNT should still be considered. Moreover, an SNT is a fully discretionary spendthrift trust. This means that assets are placed in other people’s hands to be managed. This can be of great comfort to the family of a person with a disability who may be susceptible to influence by others or may not be able to manage his or her own litigation recovery.

Planning to prevent the loss of needs-based public benefits

It is important that a litigation recovery not be received directly by a needs-based public benefits recipient; otherwise eligibility for SSI and Medi-Cal is lost. This can be devastating for the plaintiff. These programs are essential for the well being of most persons with disabilities because private health insurance is generally unavailable either because of their inability to work or because of preexisting conditions resulting from the disability. This leaves Medi-Cal as the only source of medical coverage for many persons with a disability. As a result of the lost SSI or Medi-Cal, all future medical payments for the plaintiff are paid from the litigation recovery. This generally means that the recovery is quickly spent on food, shelter and medical care until spent down below $2,000. The benefits recipient then returns to a welfare existence with no real opportunity to use the litigation recovery to improve his or her quality of life.

There are several planning opportunities available to a person with a disability in this situation. When planning for a person with a disability’s litigation recovery, there is often no one right answer. Sometimes two clients will have identical fact patterns and one will, for example, opt to purchase an exempt asset or opt to establish a first-party SNT. It is up to the practitioner to provide the available options and allow the decision-maker to decide which option best meets his or her needs.

First-Party Special Needs Trusts are “safe harbors”

A common planning mistake is transferring the litigation recovery to a non-qualifying first-party trust. Both the Medi-Cal and SSI programs disregard most first-party trusts, i.e., trusts that a public benefits recipient creates with his or her own assets. These welfare programs do not want their recipients to give away their own assets to remain qualified for public benefits, in trust or otherwise. Accordingly, an attempt by a benefits recipient to preserve his or her benefits by putting the assets into any first-party trust will not work. Either the transfer to the trust will be treated as a disqualifying gift transfer, or the assets, once transferred will still be counted as available – and disqualifying (See 42 U.S.C., §1396p(d)).

The primary way to preserve public benefits for a litigation recovery is to transfer it into a qualifying first- party SNT. There are two federal statutes that carve out these “safe harbor” trusts in use in California. The Medi-Cal program allows such trusts under the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993) (42 U.S.C., §1396p(d)(4)). The SSI program allows the same trusts under the Foster Care Independence Act of 1999 (FCIA) (42 U.S.C., §1382b), which incorporates the Medi-Cal safe harbor provisions of OBRA 1993 into SSI law.

The requirements for the two trusts are:

•  A trust that contains the assets of an individual with a disability under age 65, established for his or her benefit by a parent, a grandparent, a legal guardian, or the court, if Medi-Cal will receive all amounts remaining in the trust on the beneficiary’s death up to the amount of Medi-Cal benefits paid (42 U.S.C., §1396p(d)(4)(A)). This trust is commonly called a (d)(4)(A) SNT, a litigation SNT (LSNT), or a payback trust.

•  A trust that contains the assets of an individual with a disability if (a) the trust is established and managed by a nonprofit association and maintains separate accounts of pooled assets; (b) the accounts are established by a parent, a grandparent, a legal guardian, the individual beneficiary, or the court; and (c) the state will, on the beneficiary’s death, receive all amounts remaining in the beneficiary’s account (not retained by the trust) up to the amount of Medi-Cal benefits paid (42 U.S.C. §1396p(d)(4)(C)). These trusts are commonly known as pooled trusts or (d)(4)(C) SNTs.

Consider Special Needs Trust alternatives

A first-party SNT is not the only option available to a public benefits recipient who receives a litigation recovery. Other planning options to a benefits recipient in this situation are:

•  Spending the litigation recovery on exempt assets (e.g., primary residence, one automobile) or other qualified expenditures (e.g., paying off existing debt) until assets are below $2,000. This makes sense when the litigation recovery is for a small amount.

•  Gifting or transferring which results in the loss of needs-based public benefits for a period of time. This is generally an unacceptable option.

•  Some combination of the above. This can include the purchase of an exempt asset and the establishment of a first-party SNT.

Generally, alternatives to first-party SNTs are considered only when the litigation recovery is for a modest amount of money. For example, if the recovery is $10,000, it may be prudent to use the money to buy an exempt asset that is not counted by SSI or Medi-Cal, such as an automobile. If the goal, however, is to preserve public benefits and allow for the future use of the litigation recovery, then the proceeds must be funded to a qualifying first-party SNT.

Using structured settlement as planning option

In physical personal injury cases involving substantial monetary damages, many cases settle with a structured settlement, i.e., annuity-funded, income-tax-favored periodic payments for the life of the plaintiff or for a period of years.2 The combination of a structured settlement and a first-party SNT can be part of an effective strategy to protect a person with a disability’s future needs. This type of settlement usually consists of an initial payment to the plaintiff that covers the attorney fees and costs. In the context of SNTs, it may also include any preexisting Medi-Cal litigation lien held by the state against the plaintiff. The settlement agreement then provides for a lump-sum payment for the plaintiff and a separate structured settlement annuity for payments, continuing over an agreed-on period of time or contingent on a predetermined factor: e.g., the plaintiff’s continued survival. The lump-sum amount and ongoing payments are irrevocably assigned to the plaintiff’s SNT.

Sensible planning for a litigation recovery requires a realistic overview of the person with a disability’s future needs, but all too often, plaintiff’s trial attorneys are convinced to use too much of the settlement’s cash to fund the structure and to not leave enough cash outside the structure to properly care for the SNT beneficiary’s future needs. This is typically done with little or no thought as to the consequences to the person with a disability. For example, oftentimes a person with a disability will wish to purchase a home or car with settlement proceeds. However, the plaintiff is unable to do this because too much of the cash is being used to fund the structure and not enough is left outside the structure. Prudent planning would take into account the inflexibility of over-structuring a settlement.

Summary

A plaintiff who receives a litigation recovery should be advised of his or her ability to preserve needs-based public benefits and preserve the use of the litigation recovery. It is important that a qualified special needs planning attorney assist in designing, establishing, and administering a first-party SNT for a plaintiff with a disability. All too often, the litigation recovery is not properly planned for and the person with a disability gains little or no benefit from the recovery. Next Month: Establishing a Special Needs Trust.

Kevin Urbatsch Kevin Urbatsch

Bio as of July 2012:

Kevin Urbatsch is a settlement planning attorney in San Francisco, California. He is a Certified Specialist in Estate Planning, Probate, and Trust law and practices exclusively in the estate planning field with an expertise in planning for minors and persons with disabilities on receipt of settlement funds. He is the author of several books on special needs planning and a frequent lecturer on Qualified Settlement Funds, Medicare Set-Aside Accounts, and Special Needs Trusts. Contact him at Kevin@Urbatsch.com or visit the Web site: www.MyersUrbatsch.com.

http://www.MyersUrbatsch.com

Endnote

1 20 C.F.R., §416.1205(c), 22 Cal. Code Regs., §§50419–50420.

2 See IRC §104(a)(1) (workers compensation); IRC §104(a)(2) (personal physical injury); and Rev Rul 79–220, 1979–2 Cum Bull 74 (the seminal ruling in the field of structured settlements).

 

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