Meeting Special Needs With Trusts

April 24, 2013

Trust, but verify. You can actually do both simultaneously to help meet the future financial needs of your special needs dependent. How? By setting up a special needs trust. Properly structured and funded, a special needs trust can help assure financial security and stability for a dependent who may not be able to manage his or her own affairs effectively. It can also help ensure efficient use of resources for serving that person’s needs in the future. Many people are familiar with the uses of trusts in estate planning. They are common vehicles for tax management, meeting philanthropic objectives and maintaining the long-term integrity of property holdings and investment portfolios. Trusts can serve many of these same objectives when you draw up a financial plan for a family member with special needs. But they can do much more. Special Needs Trusts Have a Prime Directive

The overarching concept that distinguishes most special needs trusts from other trust applications is that they are intended to provide financial support that is, above all, “supplementary.” That is, in order to protect the trust beneficiary’s access to important resources such as Medicaid, a special needs trust must be structured to provide only supplemental and extra care to that beneficiary. This means that special needs trust proceeds should be used only for things that programs such as Medicaid would not ordinarily provide to a person with special needs. For example, a special needs trust could finance many educational and cultural undertakings that enrich the life of the beneficiary but do not provide essential lifeline support. A special needs trust could also finance advanced adaptive equipment and property modifications that might go well beyond baseline standards of accessibility, and it could finance a broad range of recreational activities. Keep in mind that a typical special needs trust also has to be managed so that it funds only permissible benefits for the designated beneficiary, that it does so directly and that it does not give the beneficiary any direct access to or control over cash payments. Otherwise, the trust proceeds and its assets could be counted as resources for determining benefit eligibility. The trustee must be someone other than the beneficiary. He or she must consistently act to ensure that correct protocols are observed and that only compliant expenses are funded from the trust. Meeting these requirements calls for carefully drawn trust language and an especially attentive trustee. The legal principles underlying special needs trusts are spelled out in seasoned statutes that have changed little over the decades. But standards of care and administrative policies affecting individuals with special needs are more fluid, and in some cases, can change frequently. People charged with overseeing special needs trusts should be well versed in the legal fundamentals and well informed about current trends and developments. After all, the consequences of administrative transgressions are most likely to be borne by the special needs beneficiary himself or herself—publicly financed benefits can be curtailed or eliminated and trust assets can be redirected away from their originally intended purposes if the trust were to make impermissible disbursements. The Basics of Special Needs Trusts at a Glance Primary strategic objectives of special needs trusts include:

Assuring that adequate financial resources will be available for the beneficiary’s special needs.
Conserving the beneficiary’s assets in an efficient manner.
Protecting assets intended for meeting special needs from potential misapplication or misuse.
Establishing enforceable preferences for the ultimate disposition of any assets that remain after the trust is no longer needed.
Complying with applicable rules and regulations for special needs assistance programs.

Important funding sources for special needs trusts include:

Securities and income-producing assets you own.
Assets or property belonging to the individual with special needs.
Life insurance and annuities.
Cash bequests or gifts.
Child support payments.
Proceeds from legal settlements.

Principal Types of Special Needs Trusts While trust law may be complex and some of its terminology arcane, the most common forms of special needs trusts can be assigned to one of two general categories: self-funded trusts and third-party trusts. The type of trust you use should generally be governed by the sources of trust funding and your ultimate objectives for the trust. Keep in mind that each type of trust may have different implications for control, inheritance, Medicaid eligibility and other important factors. Also note that there are niche trust types for certain applications that fall outside these primary categories. An Overview of Self-Funded Trusts The term “self-funded” is used when the source of the funding is the special needs person himself or herself. Actual financing for these trusts typically comes from gifts, insurance proceeds and tort settlements credited directly to the beneficiary. However, since individuals cannot generally create trusts for which they are the primary beneficiaries, the actual creator of a self-funded special needs trust is a third party who has explicit legal authorization to act on behalf of the beneficiary—generally, a parent, grandparent, guardian or other court-authorized agent. Self-funded special needs trusts can be set up so that they are generally not counted immediately as resources for benefit determination. Assets in these trusts may remain excluded from future benefit determinations as long as the trust continues to meet the standards for providing only supplemental and extra care and the special needs beneficiary is the sole beneficiary of the trust. But when the beneficiary of a self-settled trust has received publicly funded support from programs such as Medicaid, the funding agency generally has the right to reclaim funds it paid out from trust assets when the beneficiary dies. Only after all such claims are satisfied could any remaining trust assets generally pass into the beneficiary’s estate. An Overview of Third-Party Trusts The key feature of third-party trusts is that they are financed by assets that do not belong to the beneficiary and the beneficiary has no control over either asset management or trust disbursement. Assets within properly constructed third-party special needs trusts play no role in benefit determination and cannot be reclaimed for Medicaid or Supplemental Security Income (SSI) reimbursement. However, the special needs beneficiary must still be the sole trust beneficiary and disbursements from the trust must still meet the supplemental needs tests. Otherwise, the trust’s payments will be considered as resources, potentially leading to benefit exclusion. Third-party trusts can typically be terminated when predetermined conditions are satisfied. Remaining assets could be distributed at that time according to whatever termination plan was specified in the trust documents. For example, assets remaining when the special needs beneficiary no longer requires trust support can be distributed to siblings, charities or other trusts as designated in the trust creation documents. Keep in mind that the tax consequences of various third-party special needs trust scenarios for you, your estate and your heirs are complex. They call for careful planning and expert guidance. Niche Trust Applications The trust arrangements outlined so far are those used by and for individuals and families. They are typically used to finance the general spectrum of special needs. You may also wish to consider trusts designed solely for extended care and those which may benefit a designated philanthropy in addition to your intended special needs beneficiary. The trust created to finance extended care is commonly known as a “Miller” trust, named for the court case that established the trust’s ground rules. The Miller trust is intended to finance the difference between Medicaid-financed long-term nursing home care and any desired level of more specialized care. It is used in those states that impose income limits on Medicaid long-term care eligibility. Assets in the trust are not counted in the eligibility calculation, and disbursements are allowed to enhance the care opportunities. However, as with the self-settled trusts discussed earlier, assets in Miller trusts are subject to claims for eventual reimbursement to Medicaid when the beneficiary dies. The special needs trust format that can also benefit a designated philanthropy is known as a Nonprofit Pooled Income Special Needs Trust. In these arrangements, any assets that might remain after benefits are paid and Medicaid reimbursement requests are satisfied would pass to the sponsoring agency. As you can see, trusts can address many special needs financing and legacy needs, but they must be constructed and operated according to strict rules. Let me help you identify the trust opportunities most suited to your needs and resources. If you’d like to learn more, please contact Angel Chavez, CIMA®, 415-984-6008. Morgan Stanley Smith Barney LLC, its affiliates and Financial Advisors do not provide tax or legal advice. This material was not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties that may be imposed on the taxpayer. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. Article by McGraw Hill and provided courtesy of Morgan Stanley Financial Advisor. The author(s) are not employees of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). The opinions expressed by the authors are solely their own and do not necessarily reflect those of MSSB. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned. Morgan Stanley Financial Advisor(s) engaged SVLatino to feature this article. Angel Chavez may only transact business in states where he is registered or excluded or exempted from registration http://www.morganstanleyfa.com/elcaminogroup/ Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Angel Chavez, CIMA® is not registered or excluded or exempt from registration. Investments and services offered through Morgan Stanley Smith Barney LLC, member SIPC. CRC 647991 [04/13]