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Special Needs Trusts and Structured Settlements

Last month I offered some guidance on how to deal with Medicare “set-asides”. It was advisory in nature because the rules and actual protocols for how to handle this element of settlement planning have simply not yet been established. This month let’s talk about something much more definitive and beneficial: Special Needs Trusts (“SNTs” for short).

Why discuss SNTs at settlement? Simple: if the defendant’s liability is in question or insurance limits are low, a special needs trust can be an effective way to bridge the financial gap to create an acceptable settlement.

Special needs trusts are used to preserve government benefits for claimants who might otherwise be declared ineligible by the simple act of receiving their personal injury settlement. Since some vital programs – principally Medicaid - are “needs-based” as to the claimant’s assets and income, you have to be careful how you distribute settlement proceeds. You can’t simply hand them a check or even a guaranteed monthly income because doing so might result in the sudden termination of their benefits. 1

Federal law offers a solution: claimants are permitted to have settlement funds deposited directly into an irrevocable trust and still maintain their benefits, provided they agree to certain restrictions on how that money is spent.

The first restriction is that the funds cannot be used to pay for things that Medicaid already covers. SNTs are intended to supplement, and not supplant public benefits (indeed many are titled “Supplemental Needs Trusts” in deference to this first condition).2 The second condition is that any funds remaining in the trust upon death of the beneficiary must first be used to reimburse the state for Medicaid payments made during the interim. This feature is known as the “payback provision”.

All in all, it’s a pretty fair deal and can lead to a substantial improvement in quality of life for claimants. The SNT can pay for things that Medicaid doesn’t cover like wheelchair-accessible vehicles, certain kinds of specialized rehabilitation, and additional attendant care. It can even be used to pay for participation in cultural events, a vacation, or a home. Health care services are not the only thing a disabled person needs and a thoughtfully crafted SNT can make a big difference in their life.

USA Today said, “A special needs trust… can improve a disabled adult’s quality of life without endangering eligibility for government programs.”3 That pretty much sums it up.

If there is a downside to using SNTs it is that they are fully taxable at high trust rates. Some might also mention the additional cost of fees to pay the trustee, custodian and investment advisers but those are really unavoidable and, if done right, valuable. Trustees serve a critical role as “gatekeeper” of the funds. They exercise discretion regarding spending that is so vital to maximizing the long term value SNTs. As long as fees are examined and found “reasonable” for value received (and in relation to competing service providers) fees alone are not an issue. 4

The taxes, however, are problem and that’s one place where structures come in handy. Instead of putting all settlement funds directly into the SNT at settlement, you start with an initial corpus deposited into the trust then build a structure that pays into the fund. All funds allocated to the structure are then shielded from taxation. If you design the structure to pay the approximate amount of known annual needs, you avoid creating excess income inside the trust, and thus lessen the tax load further.

The other area where structures boost value is in transferring “longevity risk” away from the claimant via the guaranteed lifetime payments available through structures. In cases of serious injury or illness, annuity issuers will actually evaluate claimants on an basis, providing pricing discounts based on customized life expectancy estimates. Besides transferring the longevity risk away from the claimant, this specialized pricing can increase income by as much as 20% to 30% over standard life contracts.

When designing a structured settlement to complement an SNT, don’t forget that payback provision. It’s important that you consider including a commutation feature in the annuity payments so that a cash amount becomes immediately available upon death to help pay any amounts due to meet this obligation.

One final thing: never attempt to set up an SNT on your own. Special needs trusts are highly technical and require detailed knowledge of public benefits law and tax law. Don’t hire just any attorney either. Hire one who works in the special needs arena on a full time basis. The same goes for trustees and custodians: it’s tricky and technical – but worth it.
Do you have a case involving Medicaid and or Supplemental Security Income? Would you like to find a way to resolve that claim by using the most up-to-date settlement tools and techniques? Call Frank C. Kilcoyne, CSSC at 800-544-5533. I am here to help.

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1Depending on jurisdiction, amounts as low as $2,000 can cause problems.
2See “Brief Guide to Special Needs Trusts” from the experts at www.specialneedsalliance.com

3Block, Sandra: “Special Needs Trust Helps Disabled Child”, USA Today, August 29, 2000
4Assessing the “reasonableness” of fees is an affirmative duty under the prudent investor standard.