A Sole Benefit Trust is an often neglected yet important type of Special Needs Trust that can be useful in planning for certain categories of individuals with disabilities. For example, a “Sole Benefit Trust” can be a useful solution for a disabled grantor who wishes to protect funds intended for a loved one with disabilities when the grantor has her own need to protect Medicaid or SSI eligibility. Which type of Sole Benefit Trust to use, however, depends upon the Medicaid and SSI status of the beneficiary. This article will help make that choice.
Taking a few minutes to follow the discussion presented in this article will open up a potentially powerful planning tool for situations in which a special needs trust might not otherwise be a workable option. Perhaps the best way to approach an understanding of Sole Benefit Trusts is to recognize that the federal scheme approaches Special Needs Trusts from two perspectives, that of the grantor, and that of the beneficiary. From the beneficiary’s perspective, when are trust assets available for Medicaid or SSI qualification purposes? From the grantor’s perspective, what types of trusts can be funded without incurring SSI or Medicaid transfer sanctions? Bear in mind, the grantor may not care about transfer sanctions because he has no intention of applying for any benefits. But if he might be applying for Medicaid within the next 5 years, he may care deeply.
To begin the analysis of Sole Benefits Trusts, it is important to remember that the term “Special Needs Trust” (SNT) is actually a general umbrella term that covers a number of distinct types of trusts established for beneficiaries with disabilities. The best known types are self-settled special needs trusts and community or “pooled” trusts. Also common are third party special needs trusts funded one or more third parties. As will be reviewed below, each has unique characteristics, but they share the common feature that from the beneficiary’s perspective the assets in those trusts are not countable for public benefits purposes.
The term “Sole Benefit Trust” (SBT) is best understood as a subcategory of SNT that from the Grantor’s perspective does not create a transfer sanction when funded. SBT, in the remainder of this article, refers to this subcategory of SNT.
A quick review of all types of SNTs will help set the stage for understanding SBTs.
A Self-settled SNT is a trust established by a parent, grandparent, court or guardian for the benefit of a person with disabilities under age 65. People use the term “self-settled” because these trusts are usually funded with property of the trust beneficiary. As will be discussed below, however, “self-settled” may be a misnomer because the trust can receive contributions from other donors. A trust of this type is also often referred to as a “D4A Trust” (after the subsection (d)(4)(A) of 42 U.S.C. 1396p, the federal statute authorizing the trust).
From the beneficiary’s perspective, of prime importance is that the assets in a trust of this type are not deemed available for benefit eligibility determinations. The trustee must apply the assets for the exclusive benefit of the beneficiary, but she has great discretion as to the amount and timing of distributions as long as they do not constitute one of a fairly short list of SSI-disqualifying types of distributions. These trusts also are sometimes known as “payback trusts” because upon the death of the beneficiary the trust must first reimburse Medicaid for benefits paid during the beneficiary’s life (to the extent assets are available) before other remainder beneficiaries may receive any distributions.
From the beneficiary’s perspective, Community trusts, also called “pooled trusts” or D4C Trusts (after subsection (d)(4)(C) of the authorizing statute) consist of multiple trust subaccounts for disabled beneficiaries and are established and maintained by nonprofit associations. These trust typically are used where the limited amount of the beneficiary’s funds so not justify the expense and complexity of establishing a stand alone D4A SNT. Upon the death of a beneficiary a community trust may, at state option, retain a significant portion of remaining subaccount assets to be applied to trust related purposes. Although at the time of passage of the federal law authorizing SNT’s it was believed that pooled trust accounts were an available option for disabled beneficiaries over age 65, there is currently considerable debate about this. A number of states, based on transmittals issued by the Centers for Medicare and Medicaid Services (CMS), now penalize transfers into pooled trust accounts made by beneficiaries over age 65. I refer to D4C Trusts and D4A Trusts collectively as D4 Trusts.
Third Party Trusts
A third party SNT is a trust established by an individual other than the beneficiary (or one of her surrogates) and funded with assets not owned by the beneficiary. A Third Party SNT is often a trust established by a parent or grandparent or other benefactor that simply contains language allowing great discretion to the trustee with respect to distributions and avoids any language mandating distributions that would disqualify the beneficiary from SSI or Medicaid. In fact, there may even be beneficiaries other than the beneficiary with disabilities.
From the beneficiary’s perspective, the assets are simply not available unless or until the trustee distributes to the beneficiary. The effectiveness of such a trust rests simply on the fact that trustee discretion precludes the assets from being deemed available to the beneficiary under SSI or Medicaid “availability” analysis.
From the grantor’s perspective, Third Party SNTs offer the estate planning advantage that there is no payback provision; assets remaining on the death of the beneficiary may be distributed to other named beneficiaries. However, if a grantor is a potential applicant for SSI or Medicaid, unless the Third Party SNT complies with a statutory exception, funding the trust will incur transfer sanctions.
Transfer Sanction Exemptions and the Statutory Basis of Sole Benefit Trusts
The same section of the Social Security Act that authorizes D4 Trusts contains a subsection describing Medicaid transfer sanctions and exceptions to the transfer sanctions. Two of those exceptions apply to transfers to certain trusts benefiting either a grantor’s blind or disabled child of any age or another disabled individual under age 65. Each exception requires the trust to be “solely for the benefit of” the beneficiary and contains the parenthetical “including a trust described in subsection (d)(4) of this section.” Thus, by the literal language of the statute, the exceptions apply to transfers to trusts “solely for the benefit of” certain persons with disabilities, and included in those exemptions are transfers to D4 Trusts. In fact, this is the statutory basis for exempting from transfer sanctions the funding of D4 Trusts; the actual description of D4 Trusts under subsection (d)(4) merely says that from the beneficiary’s perspective the assets are not countable.
With respect to D4A Trusts the parenthetical “including” is significant because it indicates that notwithstanding the term “self-settled” generally applied to D4A Trusts, the statute clearly envisions the ability of individuals other than the beneficiary to make transfers to such trusts (which is contrary to the understanding of many practitioners and regulators). This is significant because the ability of an individual to fund a loved one’s D4A Trust, if handled correctly, can qualify the donor for Medicaid without disqualifying the beneficiary for Medicaid or SSI.
Payback or Actuarial Soundness?
As discussed above, the statutory exemption for transfers to certain trusts contemplates a broad category of trusts “solely for the benefit of” including D4 Trusts as a subcategory. The statute, however, does nothing to describe the meaning of “solely for the benefit of” in the context of non-D4 Trusts. In 1994, the Health Care Financing Administration (what CMS was then called) addressed the meaning of “solely for the benefit of” with the issuance of Transmittal 64 to the HCFA State Medicaid Manual. The State Medicaid Manual is to Medicaid what the POMS is to SSI; namely, the federal policy that implements the federal statute.
Due to less than clear drafting contained in Transmittal 64, there has been rather widespread confusion as to what is required under the Transmittal to have a valid Sole Benefit Trust. Careful analysis of the language of the Transmittal, however, resolves the issue. Section 3257 B.6 of this Transmittal lays out the general requirement that a trust, to be considered “for the sole benefit of” an individual, must require distributions “on a basis that is actuarially sound based on the life expectancy of the individual involved.” However, the immediately following paragraph begins: “An exception to this requirement exists for” D4 Trusts. The grammatical structure and language make it clear that a transfer by a grantor to a trust for a child or other “under age 65” person with disabilities is not a sanctionable transfer for the grantor if the trust either is a D4 trust, or a trust that contains an actuarially sound distribution standard.
What is “actuarial soundness”? Section 3258.9B. of Transmittal 64 describes “actuarial soundness” as a distribution standard that will insure complete distribution of the trust within the beneficiary’s anticipated life expectancy (as determined by tables in the transmittal). Most attorneys meet this requirement by drafting a requirement that trust distributions must be made at least annually in an amount not less than the trust assets divided by the beneficiary’s remaining life expectancy. Significantly, and as demonstrated by the example of actuarial soundness provided by HCFA at section 3258.9.B., the distributions may be made more rapidly. In other words, “actuarial soundness” provides a minimum distribution standard that may be exceeded; in fact, there are situations where the greatest benefit to the beneficiary will be obtained if distributions are made more frequently that annually and much more rapidly than over his lifetime.
From the beneficiary’s perspective, an actuarially sound SBT could be disastrous if the individual is on SSI or Medicaid because the trust assets will be deemed available to the individual to the extent the trustee is required to distribute, and will certainly be available to the beneficiary to the extent the trustee actually distributes. The strategic response to the dilemma is to establish a D4A Trust or a D4C Trust account (employing the usual methods for establishing such a trust) for the disabled beneficiary and then transfer the assets to the D4 Trust. The assets will not be deemed available to the individual, although the tradeoff is that the assets will be subject to the “payback” provisions. Nevertheless, in many cases this may be an acceptable tradeoff where a grantor needing to qualify for Medicaid who wishes to benefit a loved one with disabilities by establishing an SBT.
On the other hand, for a person with disabilities who is drawing Social Security disability income benefits (which are not needs based) an SBT based on actuarial soundness (with additional trustee distribution discretion) would be an excellent choice of strategy.