Ignorance of the law is no excuse for parents

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In his article, author and estate planning attorney Paul Heckt, explains two kinds of legal trusts for persons with mental retardation or developmental disabilities - “supplemental needs trusts” and “special needs trusts” - and their role with regard to inheritance and Medicaid eligibility. Mr. Heckt is a long a long time VOR member who practices law in Minneapolis, MN. He has a daughter, Ann, with mild developmental disabilities and a sister, Janice, with severe developmental disabilities. His father is Mel Heckt, former VOR Board Member, who continues to practice law at age 84. Mel wrote the first supplemental needs trust in the State of Minnesota, and he served on the President’s Committee on Mental Retardation under Presidents Nixon and Ford.

Ignorance of the Law is No Excuse

When I was in law school, we were constantly reminded that “Ignorance of the Law” was not a defense to a criminal prosecution, or to a civil suit, for that matter. The same rule holds true for parents, grandparents and siblings of persons with special needs. In some cases, a well meaning grandparent remembers the child with special needs in his or her will, not realizing that any inheritance of over $2,000 will disqualify that child from receiving Supplemental Security Income (SSI) or that an inheritance of over $3,000 will disqualify that child from receiving Medical Assistance (MA). The same thing happens with parents who are not aware of the rules which control governmental benefit programs—their child is disqualified until they have spent down the entire inheritance until it is under the $2,000 or $3,000 limit. Clearly, this was not the intent of the parents or grandparents, but, through ignorance of the law, that is the unfortunate effect.

Some parents are aware of the rules and think they can circumvent the rules (and save on attorney’s fees) by disinheriting the child with special needs and leaving their share to a sibling or other relative to “hold” for the child with special needs. This approach is fraught with problems. If the money is in the sibling’s name, then guess who is going to go after it? That’s right, the sibling’s ex-spouse in a divorce action. The sibling can claim it was non-marital, but many courts will ignore that distinction based on a showing of “undue hardship” by the ex-spouse. Unfair? Absolutely. But it happens quite frequently. If the sibling is involved in a car accident and a judgment is filed against him or her, the bank account that was supposed to be used for the child with special needs can be seized without notice. The judgment creditor doesn’t care whether the money was for the sibling or for the child with special needs. To them, it is just money that they were owed and now they have it. If the sibling later develops a drinking or drug or gambling problem, guess what will happen to that money? After the parents are dead, they cannot control what happens to that inheritance…unless, of course, they are not “ignorant of the law” and have provided for their special needs child in a way that cannot be attacked by anyone—ex-spouses, creditors, or even state governments. I am talking, of course, about setting up a supplemental needs trust as part of the parents’ wills, or in a separate “standalone” trust combined with “pourover” wills (to pick up any assets that the parents forgot to put into the trust).

There are two kinds of trusts which involve persons with special needs, “supplemental needs trusts” and “special needs trusts.” Unfortunately, their labels bear no relationship to the type of trust they refer to, and the two terms are so confusingly similar that even lawyers get them mixed up from time to time. However, there are really just two main differences between them and once they are established, they operate very similarly. The two differences involve the funding source, on the one hand, and what happens to the money after the person with special needs dies, on the other hand.

“Supplemental Needs Trusts” are established by state law. While I cannot comment on other states’ statutes, as I am only licensed to practice law in Minnesota, most states do permit this type of trust. In my state, the enabling statute is Minn. Stat. §501B.89, Subd. 2.

Subparagraph (b) of that statute defines a supplemental needs trust as: “…a trust created for the benefit of a person with a disability and funded by someone other than the trust beneficiary, the beneficiary’s spouse, or anyone obligated to pay any sum for damages or any other purpose to or for the benefit of the trust beneficiary under the terms of a settlement agreement or judgment.” (Emphasis added).

In other words, a parent, a sibling, a grandparent or anyone except the person with the disability or their spouse can fund a supplemental needs trust.

The second key difference is what happens to the remaining funds in the trust when the trust beneficiary dies. With a supplemental needs trust, the money goes to whomever the grantors or creators of the trust (usually the parents) want the money to go to. In most cases, the grantors provide that whatever is left over be distributed to the trust beneficiary’s siblings or to a charitable organization, such as VOR, or perhaps a combination of the two.

A “special needs trust,” on the other hand, is funded by money which belongs to, or will belong to, the person with the special needs. For example, if your child is injured in an auto accident and suffers a traumatic brain injury requiring lifelong support, the settlement from the personal injury case can be placed into a special needs trust. Or, if the parents of a child with special needs failed to do proper estate planning and died without creating a supplemental needs trust, or died “intestate,” meaning without a will, then the state will expect that child to disclose the receipt of the inheritance and they will be disqualified from receiving benefits until the child with special needs has spent that money down to $2,000 or $3,000, as noted above. Instead of letting that happen, the family can set up a “special needs trust.”

The problem with special needs trusts is that when the person with the special needs dies, any money remaining in the trust must be repaid to the state to reimburse it for any medical assistance or various other governmental benefits that were provided to the person with the special needs. In practice, this usually means that there will not be anything left for the other siblings (or VOR). And it puts the trustee in the position of wanting to spend the money sooner rather than later, so that the state doesn’t take it all, but spending it sooner risks running out of money before the person with the disability passes away.

In summary, all parents and relatives of persons with special needs should make sure that their estate plans don’t inadvertently disqualify their special loved ones from receiving governmental benefits. If they don’t, their “ignorance of the law” will have very disastrous consequences.

Enabling Federal Legislation

The enabling federal legislation permitting “special needs trusts” is United States Code, title 42, section 1396p(c)(2)(B)(iv) or 1396p(d), as amended by section 13611(b) of the Omnibus Budget Reconciliation Act of 1993, Public Law 103-66, commonly known as “OBRA 1993”. This was codified in Minnesota by Minn. Stat. §501B.89, Subd. 3. Most states have similar laws.

In both cases, the trusts are permitted because their fundamental purpose is to “supplement, not supplant” benefits provided by governmental agencies. The theory is that the state cannot force parents to leave money to their child with a disability, and if they leave the money to the other siblings, the state can’t get their hands on it any way. Similarly, there would be no incentive for an injured person to sue to recover damages if all of the money that he or she recovered had to be paid to the state. So instead of putting all of that money at risk, the states permit the parents or guardians to put the money into a supplemental needs trust or a special needs trust, as the case may be.

The primary purpose of both trusts is to provide for the reasonable living expenses and other basic needs of a person with a disability when benefits from publicly funded benefit programs are not sufficient to provide adequately for those needs. For example, the government will not pay for my developmentally disabled daughter to go to a Minnesota Twins baseball game or a Minnesota Gopher hockey game, both of which she loves to attend. They won’t pay for her to go on a vacation or an amusement park or to go out to dinner or a movie. They won’t pay for my developmentally disabled sister to go to Baker’s Square for a piece of French Silk Pie and a coke, or buy her a Rock ‘n Roll CD’s at Best Buy. In other words, if it is fun, the government won’t pay for it.

I am not suggesting that the government should pay for these types of expenses. The federal government and most state governments are broke enough as it is. Fortunately, through the efforts of state and national organizations like VOR and the ARC’s, the government has passed statutes and rules that let us as parents and family members set aside money to provide for those quality of life enhancements without such money causing the loss of governmental benefits for our loved ones with special needs.

One problem I encounter quite frequently is that the lawyers who most people go to for their estate planning needs are not always experienced in drafting supplemental or special needs trusts. This causes problems because the statutes and rules governing these trusts are very specific. For example, both a supplemental needs trust and a special needs trust must contain provisions which prohibit disbursements that would have the effect of replacing, reducing, or substituting for publicly funded benefits otherwise available to the beneficiary or rendering the beneficiary ineligible for publicly funded benefits. (The government generally provides for housing, medical and food.) So the trustee should not use trust funds for these purposes, although there are some creative ways to “enhance” government provided benefits without replacing them. The point is that if these restrictions are not included in the trust document, then the trust will not qualify for an exemption and those funds will be considered by Medical Assistance as “available assets,” which must be spent down before the person with special needs can qualify or re-qualify for benefits.

One way to avoid this problem is by asking the lawyer, before you hire him or her, how many supplemental or special needs trusts they drafted in the past year, and what percent of their time is spent on disability law. The better approach is to check with friends who have children with special needs to see what attorney they used, and if they liked the work. Or you can call your local association for whatever disability your loved one has and ask for the names of lawyers who practice in that area. The associations usually don’t want to “endorse” anyone in particular, but they will usually share the names of lawyers who they know practice in that area. The number of lawyers who practice in this area is rather small, unfortunately. (In Minnesota, we have 25,000 lawyers, 9,000 of whom practice in Hennepin County, where I practice. Yet there are less than 10 lawyers that I would feel comfortable enough referring parents of persons with special needs to for estate planning if I could not handle their case. It isn’t a particularly profitable area of law, so unless the lawyer has a sibling or child with a disability (I have both), they often do not have much interest or experience in this area.)

Another area of difference between supplemental needs trusts and special needs trusts is when they must be created. The special needs trust has to be created before the person with special needs receives the money from the insurance settlement or the inheritance. With a supplemental needs trust, the trust can be established after the second spouse dies by including the trust in the parents’ wills. These are called “testamentary” trusts. The advantage is that they cost less and don’t have to be funded until after the parents both pass away. The disadvantage is that they cannot be funded until both parents pass away. What happens if the parents run out of money because of nursing home costs? A trust with no money in it is of no benefit. Moreover, if the trust is not set up during the parents’ lifetimes, then there is nothing to receive inheritances from grandparents or siblings or other friends who wish to leave a special bequest to the person with special needs.

The other option is to set up an “inter vivos” or “living” trust for the child with special needs. It costs more, but it has several advantages. First, the trust will be operating and the trustee, usually an adult sibling or close family member, can see how it is supposed to be run. For example, the trustee will learn from the parents and their attorney what kinds of expenditures are permitted and what kinds are not, what types of tax returns are required, if any, and what kids of records need to be kept. Second, the parents can see how well their chosen trustee is performing and make a change if they are not working out. Third, the trust will most likely be “grandfathered in” if the state changes the law in the future and no longer permits supplemental needs trusts. And fourth, grandparents and other relatives can direct gifts from their own wills to the trustee of the inter vivos trust, which they cannot do if the parents are using a testamentary trust.

From a tax and leverage point of view, the best way to fund an inter vivos supplemental needs trust is with a life insurance policy on the parent. If there are two parents, a second to die policy can be used to save cost and fund the trust at the second death. The insurance policy builds up tax free and the proceeds are also tax free. Plus, the money is available in year one, if the parent dies, which would not be the case if the parent tries to fund the trust a little bit at a time, over say, twenty years.

If the parents are not insurable, the second best choice would be an annuity, again because it builds up tax deferred. There would be a tax when the annuitant passed away, which is why we prefer life insurance, but not everyone can obtain life insurance. The younger the person is when they buy it, the less expensive it is to fund.