New Rules for Special Needs Trusts: Spending Guidelines
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As many estate planners and attorney s dealing with trust administrations will know, special needs trusts are valuable tools to ensure a disabled beneficiary is able to enjoy a gift or inheritance intended for them, while at the same time maintaining their qualification for public benefits. Special needs trusts are a relatively common tool estate planners use when a beneficiary receives public benefits, the eligibility for which is contingent upon the value of the assets owned by that beneficiary.
While the establishment of a special needs trust is a relatively simple procedure, what is less straightforward — and a potential special needs trust pitfall — is what expenditures are allowable under applicable law. Luckily, recent case law has established clearer special needs trust distribution guidelines for trustees to follow in making such expenditures, which will enable them to ensure that a beneficiary can enjoy the benefit of the assets in their trust, while simultaneously maintaining their eligibility for the public benefits that they may rely upon to live.
What Is a Special Needs Trust?
A special needs trust is a specific type of trust set up to shelter a disabled person’s assets in such a way that the assets do not detracting from impact the disabled person’s ability to qualify for need-based public assistance, typically Supplemental Security Income (SSI) or Medi-Cal.
These types of needs-based public assistance programs generally consider the aggregate value of the assets that a disabled person has on hand, in determining whether that person qualifies for the benefit.
Special Needs Trust Pitfalls
When need-based public assistance programs consider the value of assets that a disabled person has on hand to determine their eligibility, it can pose a problem for the disabled person — particularly if they are the intended recipient of a substantial gift or inheritance, but also rely on needs-based public assistance to maintain their standard of care and support.
In such a scenario, the disabled person is given the difficult choice of deciding whether to forgo their needs-based public assistance to receive the gift or inheritance intended for them, or forgo the gift or inheritance in order to keep their public benefits.
This problem is compounded by the fact that in many cases, the gift or inheritance will be exhausted by the beneficiary at an accelerated rate as the disabled beneficiary will be forced to use these assets to cover costs that were previously covered by the public benefits they had received, resulting in them again being placed on needs-based public assistance once the gift or inheritance inevitably runs out.
Congress, recognizing the inherently unfair ask of making disabled persons choose between receiving an inheritance or maintaining their need-based public assistance, created a carveout allowing disabled persons under 65 to keep their need-based public benefits so long as the assets intended for them have been maintained in a special needs trust.
You may be wondering: How does a special needs trust work? Special needs trusts work like any other trust, except that they can only be established by the disabled person, one of their family members or the court. Additionally, federal law requires that any amount remaining in the special needs trust at the death of the beneficiary, be reimbursed to the state for the payment of any healthcare benefits paid by the state for the benefit of the disabled beneficiary during their lifetime. California enacted similar statutes through Probate Code sections 3602-3606,governing the establishment and administration of special needs trusts in this state.
Thus, although special needs trusts operate similarly to any other type of trust, their establishment and administration are subject to special rules as defined by specific federal and state laws.
McGee v. Department of Health Care Services: Confusion Surrounding Special Needs Trust Spending Rules Results in Erroneous Ruling
In establishing the special needs trust carveout, Congress explicitly stated that the intent was, “to preserve public assistance benefits for the [disabled] trust beneficiary while, simultaneously, providing for the beneficiary’s ‘special needs’ that are not met by public assistance.”
Despite Congress’s apparent well-meaning intentions, the use of the term “special needs” has resulted in confusion as to the purpose and administration of said trusts. This confusion was paramount in guiding the trial court’s erroneous ruling in McGee v. Department of Health Care Services, (2023) 91 Cal.App.5th 1161.
What Can a Special Needs Trust Not Pay For? — Trial Court Disallows Any Expense Not Related to the Beneficiary’s “Special Needs”
In McGee, the petitioner/appellant was the trustee of a special needs trust established for the benefit of his disabled family member. After filing an accounting with the court, the trustee was surcharged by the court for violating special needs trust spending rules. Specifically, the court disallowed approximately $13,000 in trust fund distributions to pay for food for the beneficiary and her caregivers.
The court reasoned that for such expenditures to be allowed, the food must be required by prescription or a set of defined parameters, and also that food for non-beneficiaries was not a valid expenditure. The court also disallowed approximately $39,000 in disbursements made for the care of the beneficiary’s pets, again stating that such an expenditure was not related to the beneficiary’s disability. Other expenditures were also at issue, including payments for interest on credit cards, donations, taxes, jewelry, clothing and gifts.
In making its ruling to surcharge the trustee, the trial court effectively stated that these were not valid expenditures from a special needs trust since they “[fell] outside the very limited purpose of being utilized for the beneficiary’s special needs[.]”
What Expenses Can Be Paid From a Special Needs Trust? — Appeals Court Expands Special Needs Trust Distribution Guidelines
The trustee appealed the trial court’s ruling, stating the court applied too narrow a definition of special needs, as defined both in the trust itself and applicable law, in making its finding. The appeals court agreed. Upon review, the appeals court looked at both the definition of special needs in the trust and in the federal statutes.
The trust instrument itself included a very broad definition of special needs. Specifically, the trust defined special needs as “the requisites for maintaining the Beneficiary’s good health, safety, and welfare when, in the discretion of the Trustee, such requisites are not being provided by any public agency, office, or department of the State of California, or of any other state, or of the United States of America.
The funds of the trust may be used as an emergency or backup fund secondary to public resources. Special Needs include without limitation special equipment, programs of training, education and habilitation, travel needs, and recreation, which are related to and made reasonably necessary by this Beneficiary’s disabilities. This is not a trust for the support of the Beneficiary.”
The appeals court also noted that the trust instrument itself gave the trustee broad discretion to make distributions from the trust “to or for the benefit of the Beneficiary during her lifetime, such sums and at such times as the Trustee, in [their] discretion, determines appropriate and reasonably necessary for the Beneficiary’s Special Needs.”
The appellate court continued: “In making distributions to the Beneficiary for her Special Needs, the Trustee shall take into consideration the applicable resource and income limitations of the public assistance programs for which the Beneficiary is eligible, and the duties of any persons legally obligated to support the Beneficiary.”
Thus, not only did the trust in Mcgee include a broad definition of special needs, but it also gave the trustee broad discretion to make distributions in support of the beneficiary’s special needs.
Appeals Court Substantially Broadens Meaning of “Special Needs”
After looking at the broad definition of special needs described in the trust instrument and the broad discretion granted to the trustee in making distributions from the trust, the appeals court next looked to the purpose of the federal statutes establishing special needs trusts in the first place.
Though an explicit definition of special needs trusts is not included in the applicable statutes, the appeals court considered numerous other definitions for special needs, specifically noting:
“The term ‘special needs’ suggests a category of needs that is narrow or somehow limited in scope. However, just the opposite is true. The term ‘special needs’ is distinguished from ‘basic needs,’ that is, needs for food, shelter, and medical care, which public benefits like SSI and Medi-Cal are intended to cover. ‘Special needs’ then encompasses the very broad range of everything else a human being needs in order to live, thrive, and realize his or her potential in life.”
The appeals court also noted that the Social Security Administration itself did not consider whether distributions from special needs trusts were related to the particular disability of the beneficiary. Thus, the appeals court ruled that the trial court erred in requiring there to be a nexus between the disability of the beneficiary and the expenditures from their special needs trust, as such a nexus was not required by the terms of the trust or any other law.
Takeaway: The Term “Special Needs” Refers to the Purpose of the Trust, Not the Beneficiary’s Disability
In effect, McGee makes clear that special needs trusts can be used to provide a vast array of care and support to a disabled beneficiary, which need not be tied to the beneficiary’s particular disability. This is true so long as the trust instrument itself provides broad definitions of special needs and grants the trustee broad authority to make distributions in furtherance of these special needs. Estate planning attorneys should be mindful of these specific requirements when drafting new special needs trusts.
The term “special needs” itself appears to have driven the trial court’s erroneous ruling in McGee. For estate planners establishing special needs trusts and attorneys representing trustees of special needs trusts, it is important to understand that the term “special needs” in this context is a reference to the particular purpose of the trust and not a reference to the disabled trust beneficiary.
The confusion appears to stem from the seemingly unfortunate usage of the term “special needs,” as people with disabilities are colloquially referred to as having special needs. This term, however, is outdated and in the process of being phased out through advocacy for the disabled.
Still, the term “special needs trust” persists,1, one can see why the trial court in McGee reasoned that expenditures from special needs trust must be tied to the specific beneficiary’s disability.
That said, it is important for practitioners to understand this distinction not only so that clients can be properly advised in establishing and administering a special needs trust, but also out of respect for the integrity of the disabled beneficiary.