THE ROLE OF SOLE BENEFIT TRUSTS IN SETTLEMENT PLANNING

 

By John J. Campbell, Esq., CELA, MSCC

 

 

Introduction

 

          Occasionally, a plaintiff settling a claim or suit will want to set aside funds from the settlement to provide for a disabled friend or family member, such as a child, grandchild or adult sibling.  At the same time, the plaintiff may need to preserve his or her own eligibility for Supplemental Security Income (SSI) or Medicaid.  The disabled friend or family member may also need to preserve eligibility for SSI or Medicaid benefits to cover his or her costs of care.

 

          Because of the federal laws regarding treatment of trusts and transfers of assets without fair consideration, the third party “Sole Benefit Trust” is a very effective tool in these situations.  Such a trust provides a means for a plaintiff to make a gift from settlement proceeds to assist a disabled friend or family member, while avoiding adverse effects on his or her own public benefit eligibility and that of the trust beneficiary.

 

Medicaid and SSI Rules on Trusts and Transfers

 

Trusts

 

          The Omnibus Budget Reconciliation Act of 1993 (OBRA ‘93), codified in the United States Code at 42 U.S.C. §1396p, contains provisions governing the treatment of trusts use in connection with achieving or maintaining Medicaid eligibility.    In December of 1999, the Foster Care Independence Act (FCIA) added new provisions regarding treatment of trusts for SSI eligibility purposes, almost identical to those under OBRA ‘93.  These provisions are contained in 42 U.S.C. §1382b(e).

 

          Both OBRA ‘93 and the FCIA generally disfavor trusts established by individuals with their own funds (often called “self-settled trusts”) and treat the corpus of these trusts as “available resources” to the individual.  Trusts are deemed to be established by the individual if the individual's assets form all or part of the corpus of the trust and if the trust is established by either the individual, his or her spouse, a third person with legal authority to act for the individual or the spouse (including a court or administrative body), or a third person acting at the direction or request of the individual or the spouse.   Trusts created in a will are exempt.

 

          Under OBRA ‘93 and the FCIA, the corpus of a revocable self-settled trust is considered an available resource.  In the case of an irrevocable self-settled trust, that portion of the corpus that could be distributed to or for the benefit of the individual or the individual’s spouse in any circumstance is also considered an available resource.  Further, distributions from the corpus of any of these trusts, other than to or for the benefit of the individual, will incur a transfer penalty, (as will foreclosure of the ability to make distributions from the corpus of these trusts to or for the benefit of the individual altogether). 

 

          The federal statutes under both OBRA ‘93 and the FICA provide exceptions to the disfavored treatment of self-settled trusts.  Certain self-settled trusts may be funded by the individual without incurring a transfer penalty and without the funds in the trusts being considered available resources.  Both the Medicaid and SSI statutes exempt the following two types of self-settled trusts:

 

                   1.       A “Supplemental Needs Trust” containing the assets of an individual under age 65 who is disabled (as defined in section 1382c(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 by the state; and  

 

                   2.       A “Pooled Trust” containing the assets of an individual who is disabled (as defined in section 1382c(a)(3) of the Social Security Act) that meets the following conditions: (i) The trust is established and managed by a non-profit association; (ii) 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; (iii) Accounts in the trust are established solely for the benefit of the individual by the individual, by the individual’s parent, grandparent, or legal guardian, or by a court; and (iv) To the extent that amounts remaining in the beneficiary's account upon the death of the beneficiary are not retained by the trust, the trust pays to the State from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the beneficiary by the state. (Transfers to fund a Pooled Trust account after the beneficiary reaches age 65 can incur a transfer penalty, but assets in the trust will not be considered an available resource.)

 

          The federal Medicaid statutes also exempt a trust established in a state for the benefit of an individual if the trust is composed only of pension, Social Security, and other income to the individual (and accumulated income in the trust), and the individual’s income exceeds the income cap ($1,737 per month in 2005), but does not exceed the average cost of nursing home care in the region in which the individual will be receiving nursing home care.  The State must 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 by the state.  Such a trust, usually referred to as an “Income Trust” or a “Miller Trust,” is only exempt for purposes of qualifying for Medicaid benefits for long term care, HCBS or under a Program for All-inclusive Care for the Elderly (PACE); and only in certain states.

 

          Another important exception is for trusts that are not self-settled trusts at all, but rather are created and funded solely with property not belonging to the beneficiary or the beneficiary’s spouse.   These trusts, often called “Third Party Supplemental Needs Trusts,” are permitted and will not be considered an available resource to the beneficiary for purposes of determining the beneficiary’s eligibility for Medicaid or SSI.

 

          A Third Party Supplemental Needs Trust must meet the following conditions to be considered exempt as a resource of the beneficiary:

 

                   1.       The beneficiary must have no authority to compel distributions from the trust or to exercise any powers of ownership over assets in the trust;

 

                   2.       The assets in the trust must be used only for the beneficiary’s supplemental needs and not for support – otherwise, payments from the trust for support will be treated as income to the beneficiary;

 

                   3.       The trust may only have one lifetime beneficiary;

 

                   4.       The trust must be irrevocable; and

 

                   5.       the trust must be created and funded fully by a third party, i.e. the trust must never accept funds that are property of the beneficiary or the beneficiary’s spouse.

 

Transfers Without Fair Consideration

 

          Medicaid and SSI both impose an ineligibility period for an individual who disposes of assets for less than fair consideration to achieve or maintain Medicaid or SSI eligibility at any time during the “look-back” period.  The look-back period is generally the 36 month period prior to the application for Medicaid for outright transfers (60 months for certain transfers into or out of a trust); or 36 the month period prior to the filing of an SSI application, whether for outright transfers or transfers into or out of a trust.  The term “assets” includes all income and resources of the individual.

 

          Upon the filing of an application for benefits, Medicaid and SSI will determine if an applicant transferred assets without fair consideration within the applicable look-back period prior to filing his or her application.  If a transfer without fair consideration was made during the look-back period, a period of ineligibility will be imposed.

 

          Under Medicaid law, the penalty period is calculated by dividing the uncompensated value of the transfer by the average monthly cost of nursing home care for an individual in the state in which the individual lives; and the penalty period can be of indefinite duration.  To calculate the penalty period for any transfers of resources under the SSI statutes, the total, uncompensated value of all transfers made during the look back period is divided by the maximum SSI benefit plus any corresponding state payment. 

 

          The average monthly costs of nursing home care for an individual in every state will substantially exceed the maximum SSI benefit.  Thus, many transfers without fair consideration will result in a longer penalty period under SSI law than that which would be calculated under state Medicaid regulations.  However, the SSI transfer provisions, unlike the Medicaid transfer provisions, state that no penalty period can exceed 36 months.

 

          Certain types of transfers will not incur a penalty period for either SSI or Medicaid.  Among those exempt types of transfers are:

 

                   1.       Transfers of assets . . . to a trust established solely for the benefit of the recipient’s child who is blind or permanently and totally disabled; and

 

                   2.       Transfers of assets to a trust established solely for the benefit of an individual under 65 years of age who is disabled.

 

          Medicaid also exempts the transfer of assets to a trust established solely for the benefit the recipient's child who is under age 21.  Thus, a person who wishes to qualify for Medicaid or SSI may be able to fund trusts for the sole benefit of his or her child under age 21, his or her blind or permanently and totally disabled child, or any disabled individual under age 65, all without the imposition of a penalty period.   

 

Sole Benefit Trusts

 

          Generally, a “Sole Benefit Trust” is a special type of Third Party Trust.  It is exempt from the strict treatment of self-settled trusts and will not be counted as an available resource to the trust beneficiary for purposes of determining his or her Medicaid and SSI eligibility, so long as it is set up as a Third Party Supplemental Needs Trust.  Further, the third party funding a Sole Benefit Trust may do so without incurring a transfer penalty for purposes of his or her own eligibility for Medicaid and SSI if the trust complies with the Medicaid and SSI transfer exceptions mentioned above.  Thus, a Sole Benefit Trust can provide great flexibility in settlement planning.

 

          A Sole Benefit Trust must meet all of the conditions applicable to Third Party Supplemental Needs Trusts to be exempt as a resource to the beneficiary.  However, a Sole Benefit Trust must also meet additional requirements. 

 

          For the trust to be considered for the “sole benefit of” the beneficiary, the trust must provide that the beneficiary is the only person who will benefit from funds in the trust, both at the present and at any time in the future.  Thus, the trust must provide that the assets in the trust will be spent or distributed in a manner that is “actuarially sound.”  In other words, the trust must provide that the assets will be distributed each year in an amount that is calculated to deplete the trust within the beneficiary’s remaining life expectancy.

 

          A Sole Benefit Trust does not have to meet the “actuarially sound” requirement if it is an exempt Supplemental Needs Trust or Pooled Trust under OBRA ‘93 and the FICA.  However, the Sole Benefit Trust would then lose its primary advantages over OBRA ‘93 and FICA exempt trusts: the Sole Benefit Trust does not need to be created by a court or a parent, grandparent or legal guardian of the beneficiary; and it is not required to contain a “state pay back” provision. 

 

          Thus, it is advisable to ensure that a Sole Benefit Trust be considered actuarially sound to take full advantage of the flexibility in planning that such a trust provides.  The simplest way to meet the actuarially sound requirement is for the trust to provide for a minimum annual amount to be expended from the trust for the sole benefit of the beneficiary, based on the beneficiary’s remaining life expectancy. 

 

          The trust can be funded with a lump sum or annuity.  However the trust must be fully funded before the beneficiary reaches age 21 (in the case of a minor child of the plaintiff who is not blind or permanently and totally disabled); or before the beneficiary reaches age 65 (in the case of any disabled beneficiary who is not a child of the plaintiff).  If the beneficiary is a blind or permanently and totally disabled child of the plaintiff, the trust funding can continue over the remaining life expectancy of that beneficiary, regardless of age. 

 

          Once created and funded, the trust must be administered as would any Third Party Supplemental Needs Trust to preserve the beneficiary’s eligibility for public benefits. 

         

          In the context of a settlement where the disabled plaintiff is concerned with providing for a blind or disabled child, a child under age 21 or another disabled person under age 65, a Sole Benefit Trust provides an almost ideal solution to maintaining Medicaid and SSI eligibility for both the beneficiary and the plaintiff.  However, the continued Medicaid or SSI eligibility of the plaintiff who acts as grantor of the trust does not depend upon the beneficiary’s public benefit eligibility. 

 

          According to both Medicaid and SSI law, the beneficiary need only be blind or permanently and totally disabled (or under age 21 for Medicaid only), (in the case of a child of the grantor), or disabled, (in the case of any other individual under age 65).  As a result, Sole Benefit Trusts can also be useful where the plaintiff wishes to preserve his or her own Medicaid and SSI eligibility, but the beneficiary does not.

 

          In situations where the beneficiary’s ability to qualify for Medicaid or SSI is not a concern, the Sole Benefit Trust can be administered to provide for the beneficiary’s general health, education, welfare, support, maintenance and comfort.  So long as the trust is created for the grantor’s blind, disabled or minor child, or for any other disabled individual under age 65, and the trust meets the “sole benefit” requirements, the grantor’s transfer of assets to fund the trust will not subject the grantor to a transfer penalty under Medicaid or SSI law.

 

          In situations where Medicaid and SSI eligibility for both the plaintiff and the beneficiary is a concern, neither the plaintiff, the beneficiary nor the spouse of the plaintiff or beneficiary may act as trustee.  Otherwise, the assets in the trust would be considered available resources and adversely affect their Medicaid and SSI eligibility.  However, where the Medicaid or SSI eligibility of the beneficiary is not an issue, the beneficiary or the beneficiary’s spouse could act as trustee without adversely affecting the plaintiff’s eligibility for public benefits. 

 

          Since the plaintiff will be funding a trust whose sole beneficiary is another person, the funding of the trust can have gift tax implications.  If the beneficiary’s Medicaid and SSI eligibility must be preserved, the plaintiff will not be able to use his or her annual gift exclusion for the first $11,000 per year of trust funding because the beneficiary will not be perceived as receiving an immediate benefit.  This is primarily due to the restrictions on the beneficiary’s ability to control trust assets or compel distributions. 

 

          However, if the trust is created for a beneficiary who either does not need or cannot otherwise qualify for Medicaid or SSI, this problem can be avoided because the trust does not have to be a Supplemental Needs Trust.  The trust can provide the beneficiary with the ability to compel limited distributions or even to act as his or her own trustee.  Thus, an immediate benefit will be realized by the beneficiary from trust funding, allowing the plaintiff to shelter the first $11,000 each year in funding from counting towards his or her lifetime gift tax exclusion.

 

          If the trust is to be funded with an amount in excess of the plaintiff’s $1,000,000 lifetime gift tax exclusion, the excess amount will be subject to federal gift tax.  If the plaintiff’s entire lifetime gift tax exclusion is not still intact because it has been partially exhausted by earlier gifts in excess of annual exclusion amounts, the threshold amount for gift tax liability at the time the trust is funded will be lower.

 

          A fairly simple way to avoid the imposition of gift taxes immediately upon the funding of the trust is to have the trust include a testamentary power of appointment belonging to the plaintiff who funds and creates the trust.  A testamentary power of appointment is simply a power within the trust itself that permits the plaintiff to determine in his or her will who will receive any trust assets remaining upon the death of the beneficiary.  To be safe, the power of appointment should be limited so as to prevent the plaintiff from exercising the power to grant a benefit to someone other than the beneficiary.   

 

          The testamentary power of appointment will allow the plaintiff to retain sufficient ownership control over the trust assets for the trust to be considered a “grantor trust” under the Internal Revenue Code.  As a result, the funding of the trust will not be considered a completed gift until the plaintiff dies or the trust is terminated, whichever occurs first. 

 

          By creating the Sole Benefit Trust to qualify as a grantor trust, the plaintiff can at least defer any gift taxes until a later time.  An additional advantage to a grantor trust is that income earned by the trust can be taxed at the grantor’s income tax rate, rather than the higher income tax rates applicable to trusts.

 

          However, it is a far better idea to limit the funding of the Sole Benefit Trust to an amount which will not be subject to gift taxes at all.  Otherwise, even a deferral of gift tax liability could be problematic, (e.g., if the plaintiff or the plaintiff’s estate no longer has sufficient assets to pay the gift tax when it becomes due).  

 

Conclusion

 

          In the context of most settlements involving a seriously disabled plaintiff, planning for the continued eligibility of the plaintiff for financial needs based public benefits, such as Medicaid and SSI, assumes that the plaintiff will want to preserve the maximum amount of settlement proceeds to supplement his or her own care needs.  However, the plaintiff may also wish to dedicate a portion of the settlement to the care needs of a disabled friend or family member.  Often that disabled friend or family member will need to maintain eligibility for Medicaid or SSI as well.

 

          A Sole Benefit Trust, funded by the plaintiff from his or her settlement proceeds, provides an extremely flexible tool for use in settlements involving these unique concerns.  The plaintiff can provide funding for the trust from his or her own assets without incurring a Medicaid or SSI transfer penalty; and the beneficiary, if needed, can continue to qualify for Medicaid and SSI without the assets in the trust being deemed an available resource.

 

          The sole beneficiary of the trust can only be a child of the plaintiff who is blind or permanently and totally disabled (or under age 21, if the plaintiff only needs to qualify for Medicaid); or any other disabled person under age 65.  The trust must not benefit anyone other than the beneficiary, either currently or at any time in the future, and must be “actuarially sound.” 

 

          The trust must be carefully drafted to contain any necessary provisions tailored to the beneficiary’s needs.  The arrangements for funding the trust from settlement proceeds must also comply with any age limitations in the Medicaid and SSI transfer exceptions.  Finally, the plaintiff should consider possible gift tax consequences before funding the trust with a large amount in excess of his or her remaining lifetime gift tax exclusion.