Supplemental Needs Trust Planning

Potential Adverse Tax Consequences when Trust is the Beneficiary of an IRA

Potential Adverse Tax Consequences when Trust is the Beneficiary of an IRA

A parent may want to require that assets be retained in a single trust for their children or separate trusts, one for each child.  While a trust for a child can be designated as a beneficiary of an IRA, special care must be taken to assure that the trust will be able to utilize the child’s life expectancy when determining required minimum distributions under the inherited IRA rules. 

A recent private letter ruling, PLR 201020138, discussed the consequences when a charity is named as a remainder beneficiary of a trust. Upon the death of the parent, assets were required to be retained in trust for the benefit of the children.  The Trustee had discretion to pay income and principal for the benefit of the children and to accumulate income not paid.  Upon the trust termination, the trustee was directed to distribute the balance to descendants of the children as well as charities.

A trust must have a “designated beneficiary” in order to take advantage of the inherited IRA rules.   If the trust has a “designated beneficiary”, the trustee will be permitted to take required minimum distributions over the actuarial age of the oldest trust beneficiary. 

Under the trust in question, there was no requirement that the IRA distributions be paid to the children.  Accordingly, the IRS rules require that the remainder beneficiaries be considered in determining whether the IRA has a “designated beneficiary.”   Code Section 401(a)(9)(E) defines a designated beneficiary  as any ”individual” as long as the individual is identifiable.  If a charity is named as a beneficiary, the IRA is treated as having no beneficiary even if individuals are also named as trust beneficiaries.  

In determining designated beneficiaries under a trust, the IRS does not look at “successor beneficiaries”, those who could become a successor to the interest on the beneficiary’s death, but this exception does not apply to “contingent beneficiaries.”

 In a trust that allows the Trustee to accumulate income and principal, the IRS states that the remainder beneficiaries must be considered “contingent beneficiaries, rather than successor beneficiaries for purposes of determining who is the designated beneficiary.  Since charities were contingent beneficiaries, the trust was deemed not to have a designated beneficiary as of the decedent’s date of death.  A court order reforming the trust was ineffective to correct this problem.  Accordingly, the trust was unable to use the more favorable measuring life for determining future required minimum distributions, (the actuarial age of the oldest trust beneficiary).  In this case, the Trustee was required to use the IRA owner’s remaining life expectancy at the time of death reduced by one each year for determining future required minimum distributions.   

 With the advent of the inherited IRA rules, it is incumbent upon clients to review their trusts to make sure that their beneficiaries will be able to take advantage of the tax favored treatment available the inherited IRA rules.

 This is particularly relevant in supplemental needs trust planning when the parents have significant IRA assets.   Some parents may want to benefit the non-profit agency that provided services to their child and desire to name that organization as the remainder beneficiary or among the remainder beneficiaries when the child with disabilities passes away.    In those cases, perhaps a different strategy will need to be considered in order to preserve the better tax-favored treatment accorded to trusts that have a “designated beneficiary.” 

Supplemental Needs Trusts and Recoveries under the Federal Tort Claim Act

When settling an injury case for a client who has a disability, it is important to consider whether a proposed settlement should be transferred to an exempt trust pursuant to 42 U.S.C. 1396p (d)(4)(A) or (C) in order to protect the client’s eligibility for needs based government benefits, such as Medicaid or Supplemental Security Income (SSI).

Part of the analysis involves whether the exempt trust adds any value.  Recoveries for personal injuries under the Nursing Home Care Act, 210 ILCS 45/3-605, are exempt from the Medicaid lien and consequently an exempt trust may add no value.   A recovery under the Federal Tort Claims Act must also be treated differently.  Currently, the Federal Tort Claims Office is not permitting a Reversionary Trust to be drafted as an eligible exempt trust for SSI/Medicaid purposes.  The Reversionary Trust is designed to hold that part of the settlement related to future medical needs related to the injury.   Only the Federal Government can receive the balance in the Reversionary Trust at the death of the injured party.

In settling this type of claim, assuring proper allocation of other damages, such as pain and suffering, loss of consortium, be set aside as a separate award and not commingled in the Reversionary Trust Is critical.    The Supplemental Needs Trust Attorney can also aid in negotiating the terms of the Reversionary Trust beyond those contained in the government’s model trust form.

When is an Exempt Trust under 42 U.S.C.(d)(4)(A) or (C) Not the Right Choice or the Only Choice to Hold Proceeds from an Injury Settlement

Merely because the injured party meets the Social Security definition of disability, the attorney should not automatically assume the exempt trust under 42 U.S.C. (d)(4)(A) or (C) is the right approach. 

 Generally, a person with a disability cannot convert his non-exempt assets to non-countable assets for government benefits purposes by transferring them to a trust of which he or she retains a benefit.  The trusts referred to above, the (d)(4)(A) trust and the (d)(4)(C) pooled trust; however, create two recognized trust exceptions.  If assets, such as the expected proceeds from the settlement of a liability case, are placed in either of these two exempt trusts, the trust assets will not be counted, and indeed these trust assets can then be used to pay for those services or needs not otherwise paid for by government benefits.  In exchange for the trust assets not being counted, Medicaid is given a “lien” interest on the balance of the trust assets remaining at the death of the beneficiary before the balance is distributed to the remainder beneficiaries.

 While I have referred to these two exempt trusts as (d)(4)(A) trusts or (d)(4)(C) pooled trusts, these exempt trusts are known by a variety of names, such as the OBRA payback trust, a first party trust, self-settled trust or a supplemental needs trust, which creates endless confusion.

 The special needs attorney should evaluate different strategies other than, or in addition to, an exempt trust. These other strategies might be categorized as follows:

 A.  Giving away or spending down the settlement;

B.  Planned allocations;

C.  Outright distribution of the settlement to the Plaintiff.

 One of the most significant reasons for considering alternate strategies involves the payback provision that must be included in an exempt trust.  Creating an exempt trust, whether a (d)(4)(A) or (d)(4)(C) pooled trust, could trigger a payback where one did not otherwise exist.  Under current law the state has no claim for reimbursement for medical assistance properly paid where the individual received the benefits when he or she was under the age of 55 and not receiving inpatient care in a nursing facility or an intermediate care facility for the mentally retarded (305 ILCS 5/5-13).

 If the Medicaid recipient is a young adult, the Medicaid estate claim becomes very important.  If you create a (d)(4)(A) or (d)(4)(C) pooled trust, you are expanding the right of Medicaid to recover for benefits paid before the beneficiary attained age 55. As currently interpreted by Illinois Medicaid, this includes Medicaid paid prior to the creation of the exempt trust.

 A. Giving Away or Spending Down the Settlement

 Assume a competent individual who is disabled, 25 years old and living in the community.  Such an individual could transfer assets to a trusted family member, incur no transfer penalty, and then re-enroll in Medicaid.   Of course, this strategy would have to be carefully considered if eligibility for SSI is at stake.  SSI now imposes transfer of asset penalties for transfers after January 1, 2000 unless such transfers are to an exempt trust.  42 U.S.C. Sec. 1382b(c)(1)(A)(iv) sets forth how the period of ineligibility for SSI will be determined for uncompensated transfers.  There is a three year cap on the penalty.  In some cases, it may be worth foregoing the monthly SSI payment and incurring the penalty depending on the amount of the settlement at issue.

Some cases will involve timing.  Perhaps a substantial settlement is expected, but the injured party has no immediate need for government benefits.  Suggesting other Medicaid planning strategies may be more advantageous to the client, such as asset transfers and waiting out the lookback period or transfers in combination with spending down on exempt assets.

 Depending on when and how Illinois implements the Deficit Reduction Act of 2005 (Pub. L. No. 109-171, “DRA”), if a competent Medicaid recipient was receiving institutionalized care, he could retain enough assets to pay for his care throughout the applicable penalty period, transfer the balance to a trusted family member, and at the end of the penalty period, reenroll in Medicaid.   As an alternative, the individual could consider retaining sufficient assets to pay for his care throughout the penalty period and take the balance and fund an Irrevocable Income Only Trust with the added creditor protection and tax benefits associated with that type of planning. 

 In a case where the expected settlement will be small, perhaps a strategy involving spending the settlement on exempt assets or using the pooled (d)(4)(C) exempt trust is the path to take.   Of course, for SSI and Medicaid, the receipt of the settlement is deemed “program income” in the month of receipt, but if not spent down on exempt assets in that month, the unspent settlement will be treated as excess countable assets the following month.  20 CFR 416.1207(d); WAG 10-05-00.  Any “spend down” strategy needs to be fully developed so that the spend down can occur within the month of receipt of the settlement so government benefits are not interrupted the next month.

 To make an informed decision, the net amount to the plaintiff as well as the plaintiff’s age and projected life expectancy must be known.  Depending on those factors and the size of the settlement, the possibility might exist that most of the exempt trust would be used for supplemental needs of the beneficiary, leaving little or nothing for Medicaid to recover.

 However, the cost of creating and maintaining either type of exempt trust may be excessive in comparison to the amount of the expected settlement or award.  In such cases, the individual with the disability wanting to preserve eligibility for Medicaid or SSI could purchase exempt assets, such as a home or car, pay off debts, including mortgages or credit cards, or prepay bills, and in certain cases, lifetime personal care contracts.

 When it is a minor who is the beneficiary, it is unlikely that a court would authorize a transfer of funds away from the child in lieu of funding an exempt trust, but the court should be apprised of options involving the purchase of exempt assets when the cost of creating and maintaining an exempt trust outweighs its benefits.

 B. Planned Allocations

Under the rules governing the exempt trusts, only the disabled individual can benefit from the trust, not his or her spouse or dependents.  Examining the possibility of allocating the settlement between the injured party and his or her parents, spouses or other loved ones, either as part of settlement (loss of consortium) or in paying back expenses advanced can be an option.

Before funding the exempt trust, consider allocating some of the settlement for paying loans to family members who helped out financially during the pending lawsuit; for support for the spouse and dependent children, for paying for past attendant care, for advanced payment of nurse’s training for a parent who will care for a disabled child, or for the purchase of a home or improvements to the home owned jointly with the spouse or with the parents.  This is particularly important since a house purchased by the trustee of an exempt trust will be subject to payback.

C. Outright Distribution of the Settlement to the Plaintiff

If the settlement will be substantial, perhaps the injured party will be able to self-fund his living expenses and medical care. While an exempt trust may not be necessary, issues of asset management may still be present, and offering suggestions for non-exempt trust management and selection of trustee can still be important.

If the injured plaintiff will have a shortened life expectancy, one must balance the benefit of paying for private care against the repayment for Medicaid assistance.   Consider the age of the plaintiff and evaluate the impact of payback.  Perhaps there are sufficient assets to cover private care in lieu of enlarging the scope of the payment beyond the lien paid at the time of settlement.   There may be some value in foregoing public benefits, yet partially funding an exempt trust as a hedge against future needs and future changes in the law.

In addition, the Medicaid benefits may pale against the federal estate tax costs incurred in larger settlements.  Of course, as this article is being written, there is no federal estate tax cost, but as the current law in effect provides, unless Congress takes action in 2010, the federal estate tax reemerges in 2011 with only a $1,000,000 exemption.  Lifetime giving could mitigate federal estate tax exposure, but no one other than the disabled beneficiary can benefit from the exempt trust during his or her lifetime. 

In a very large settlement where estate taxes may be a concern, planning to pay for the estate tax is critical.    Consider having the exempt trust purchase life insurance on the beneficiary as a strategy to cover the payment, especially where there is a house owned by the trust that the family expects or hopes to continue living in after the death of the beneficiary.  

If a structured annuity is being used to fund some or all of the settlement, it will be important to consider the present value of the settlement and its potential impact on the federal estate tax.  In some cases, confirming that the structure has a “commutation feature” will be critical.

 As mentioned at the outset, whether to create an exempt trust involves understanding the type of government benefits which are currently provided to the client or likely to be important in the future.  If the injured party is receiving Medicare and/or private health insurance and Social Security Disability Insurance (SSDI), these programs are not financially means tested so an exempt trust may not add any value.  In addition, the injured party may be receiving certain government benefits that have higher asset or income limits or no asset limits.

To recap, the supplemental needs trust attorney can assist in evaluating whether the exempt trust is an option, and if so, is it the right option.  The role the supplemental needs trust attorney will be in analyzing the appropriateness of the exempt trust in comparison or in conjunction with one or more of the strategies discussed above.

Health Reform for Americans with Disabilities

On March 23, 2010 President Obama signed the Patient Protection and Affordable Care Act into law, as amended by the Health Care and Education Reconciliation Act of 2010 (“Health Care Reform”).  Here are some highlights of the Health Care Reform legislation intended to provide greater access to health insurance coverage for individuals with disabilities. 

  • Health Care Reform legislation provides for a new, voluntary self-insured program to help families pay for community based supportive services if a family member develops a disability.   The Community Living Assistance Services and Support program (CLASS Act) is not intended to replace private long term care insurance or Medicaid, but is meant to provide a supplemental monthly cash payment to help defray the cost of non-medical services, such as home health care, assistive technology, or adult day care.

    Working adults will be able to make voluntary premium contributions either directly or through payroll deductions.  Your employer will automatically enroll you in the program, unless you opt out.  To be eligible for benefits, an adult would need to pay premiums for at least five years and have been employed during three of those five year.

    The CLASS program is effective on January 1, 2011, but payout of CLASS benefits will not take effect until 2017, leaving many people with disabilities and seniors without affordable options to finance long-term care in the short run.

  • Creates more options for the States to provide Medicaid funded home and community based services to enable more people with disabilities to access long-term services in a setting they choose. 
  • Makes improvements to the Medicaid Home and Community Based Services Option. 
  • For 2010, prohibits insurance companies from denying coverage to children based on pre-existing conditions.  Next year, insurance companies will be prohibited from denying coverage or charging more to an individual based on medical history. 
  • Provides access to health insurance through Exchanges to those without job-related coverage and premium tax credits to those who cannot afford coverage.
Proposed Changes to SSI Asset Test

On March 24, 2010 the SSI Savers Act of 2010 (H.R. 4937) was introduced to reform the asset test in the Supplemental Security Income (SSI) program.  SSI provides monthly cash payments to people with disabilities, among others.  Currently, to be eligible for SSI, the applicant must have assets of $2,000 or less ($3,000 or less for a couple).  SSI counts all resources available to the applicant, including retirement accounts, such as 401(k)s and IRAs.   H.R. 4937 is intended to provide savings incentives in SSI in a number of ways, among them, by raising the asset limit to $5,000 for an individual and $7,500 for a couple and excluding retirement savings for non-institutionalized individuals under age 65.

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