An individual with special needs is someone who has a mental or physical disability that may affect their ability to care for themselves, obtain private medical insurance, pay for food and housing, and/or engage in substantial gainful work activity, among other things. These individuals often receive public benefits based on financial need, such as Supplemental Security Income (SSI), Medicaid through the Arizona Health Care Cost Containment System (AHCCCS) and/or Arizona Long Term Care System (ALTCS), or Housing and Urban Development (HUD) Section 8 housing assistance, and may be in danger of losing those benefits if they directly inherit money, receive gifts of money or property or receive a personal injury settlement.
It is important to review all asset beneficiary designations, such as financial accounts, pensions, and life insurance, to ensure that the individual with special needs does not directly inherit money that will leave them ineligible for much-needed benefits or expose the assets to spend down.
Social Security Disability Insurance (SSDI) payments and Medicare are not based on financial need, but individuals receiving these benefits may also be receiving Medicaid benefits or may need those benefits in the future.
Our firm provides options to ensure that gifts and inheritances can be made to the individual with special needs and settlement funds are protected, while maintaining the individual’s important public benefits.
A third-party special needs trust is one way to leave an inheritance for, or make a gift to, an individual with special needs. It is called a “third-party” trust because it is funded with the assets of someone other than the individual with special needs or their spouse. The person whose assets are funding the trust is called the “grantor” or “settlor.” The grantor gives the assets to a “trustee” to manage and use on behalf of the named beneficiary. In many cases, the grantor and the trustee are the same person. The assets assigned to the trust must be titled to the trust either through retitling the asset during the grantor’s lifetime or by making the trust the designated beneficiary of certain of the grantor’s assets. The grantor can provide for residual beneficiaries, who would get the remaining funds upon the death of the primary beneficiary or, if the beneficiary is competent, the grantor could give the beneficiary a limited power of appointment to allow the beneficiary to appoint in writing a person or class of persons who will receive the remaining funds upon the primary beneficiary’s death. A third-party trust can be a standalone trust, a sub-trust that is created under the terms of another trust upon the occurrence of a certain event (such as the death of a grantor), or it can be created under the grantor’s last will and testament.
The assets in a third-party special needs trust are not counted for SSI resource eligibility if the individual with special needs does not have the legal authority to revoke or terminate the trust or to direct the use of the trust assets for their own support and maintenance. However, any distributions made directly to the beneficiary and distributions made for the beneficiary’s food or shelter expenses are counted as income and may reduce the SSI payment (see Public Benefits Planning page).
Similarly, for ALTCS resource eligibility, if the trustee has discretion over whether, when, how, and to whom to make distributions from the trust, and the beneficiary is not also the trustee, the trust assets are not counted toward the beneficiary. For ALTCS income eligibility, distributions made directly to the beneficiary are counted; however, distributions made directly to vendors on behalf of the beneficiary, including for food or shelter, are not counted as income.
The HUD Section 8 eligibility criteria have recently changed. Section 8 eligibility was previously based solely on annual income, including income imputed from assets in excess of $5,000. Under the new rules, however, Section 8 now includes a resource limit of $100,000 and income is imputed to all assets in excess of $50,000. In cases in which a trust fund has been established and the trust is not revocable by, or under the control of, any member of the family or household, the value of the trust fund is not considered an asset of a family if the funds continue to be held in trust. Any income distributed from the trust fund is considered income in any calculations of annual family income, except in the case of medical expenses for a minor.
Under federal Medicaid law, a trust created by the spouse of an individual receiving or applying for Medicaid is treated as though the individual themselves created the trust, if the trust was created “other than by will.” Traditionally, in Arizona, such “testamentary trusts” (as with other testamentary trusts) were not counted for ALTCS purposes as long as there were no mandatory distributions and the trustee had discretion over how the funds were used. However, it appears that ALTCS has recently changed its policy on these trusts and may now be counting assets in a testamentary trust created by the spouse’s last will and testament, even when the trustee has full discretion over the funds. While we believe this policy is contrary to federal law and the change was made without due process, we would advise caution in using this planning technique until the new policy is clarified.
Under SSI rules, testamentary trusts created by the spouse are treated the same as other third-party trusts and are not counted for SSI resource eligibility if the individual with special needs does not have the legal authority to revoke or terminate the trust or to direct the use of the trust assets for their own support and maintenance. As with other third-party trusts, distributions directly to the beneficiary and distributions for food and shelter expenses are counted as income for SSI.
If the individual with special needs receives a personal injury settlement, inheritance or gift, the individual may be able utilize a first-party special needs trust to maintain their eligibility for certain public benefits. It is called a “first-party” trust because it is the individual’s own assets that are used to fund the trust. Federal Medicaid law under 42 U.S.C § 1396p(d)(4)(A), a special needs trust may be created for an individual with a disability who is under age 65 by the individual themselves, if competent, the individual’s parent, the individual’s grandparent, or the court. As with the third-party special needs trusts, the individual with special needs cannot act as their own trustee.
One major difference between third-party and first-party special needs trusts (aside from the obvious difference in the funding source) is that first-party special needs trusts are required to contain a provision that the state Medicaid agency will receive all amounts remaining in the trust upon the death of the individual up to an amount equal to the total medical assistance the state paid on the individual’s behalf. For this reason, a third-party trust is preferable if you want to leave an inheritance to an individual with special needs.
Under federal law, all distributions from a first-party special needs trust must be “for the benefit of the beneficiary.” In addition, Arizona law restricts how the first-party trust funds can be used. Only disbursements listed under A.R.S. § 36-2934.01 are allowable, including:
- legal and professional fees related to the administration of the trust, such as tax preparation, annual accountings, investment fees, legal advice for the trustee, etc.
- health insurance premiums, including dental and vision insurance
- medically necessary medical expenses
- expenses to make the home accessible to the person
- purchase of a specially equipped vehicle (but the vehicle must be titled to the trust or the trust must hold a lien on the vehicle for the amount the trust provided)
- guardianship or conservatorship fees
- entertainment and hobby expenses
- travel expenses for a companion if necessary to enable the beneficiary to travel for nonmedical reasons
- income taxes of the trust or beneficiary when an actual tax liability is established
- clothing and personal items for the beneficiary
- living expenses for food and shelter (if the trust purchases a home for the beneficiary, the property must be titled to the trust; for this reason, we generally recommend that the home be purchased prior to funding the trust, if possible)
- “other expenses that are individually approved by the director” of AHCCCS
For SSI purposes, the trust must be irrevocable. For ALTCS, the trust can be revocable or irrevocable, but if the trust is revocable, it must contain language that the payback provision is triggered when the trust is revoked or terminated. For both SSI and ALTCS, distributions made directly to the beneficiary as well as distributions for food and shelter are counted as income to the trust beneficiary. This is another reason a third-party trust is preferable if you want to leave an inheritance for an individual with special needs: for a third-party trust, ALTCS does not count distributions made to vendors on behalf of the beneficiary towards the income limit.
If a first-party trust is made irrevocable, it is likely that HUD would treat the trust as a transfer without fair compensation, resulting in the trust income being imputed to the beneficiary for two years, even if it is not distributed. Depending on the size of the trust, this may merely increase the rental obligation by a few dollars or may make the tenant ineligible.
If the individual became disabled prior to age 26, an ABLE account is another planning tool available to them and their family. The Achieving a Better Life Experience (ABLE) Act of 2014 added Internal Revenue Code (IRC) § 529A to allow individuals whose disabilities manifested prior to age 26 to create and fund an account under a qualified ABLE program to pay disability-related expenses. ABLE accounts provide tax advantages comparable to 529 college savings plans.
Although ABLE accounts are required to have a payback provision similar to those required for first-party special needs trusts, a huge benefit over the first-party special needs trust is that distributions from an ABLE account for food and shelter are not counted as income for SSI or any means-tested public benefits program, including ALTCS, unless those distributions are retained by the beneficiary beyond the month of receipt. Additionally, unlike special needs trusts, the ABLE account beneficiary can manage their own ABLE funds, which provides an added measure of independence for the beneficiary.
Unlike special needs trusts, however, there is a limit on the amount that can be contributed to an ABLE account. Anyone can contribute to the beneficiary’s ABLE account, but total contributions from all sources cannot exceed the annual gift tax exclusion amount within any calendar year, currently $14,000 per year. Additionally, all ABLE funds in excess of $100,000 are counted toward the SSI resource limit, but will suspend rather than terminate the beneficiary’s SSI eligibility if the ABLE account is the sole reason for exceeding the resource limit. The account balance is fully excluded for ALTCS purposes.
Due to the current regulatory freeze, HUD has not yet issued a rule regarding how ABLE accounts will be treated, but has issued interim guidance to the public housing authorities indicating that the law excludes ABLE funds from the HUD eligibility determination.
Due to the funding limitation and disability onset age requirement, ABLE accounts do not work for everyone, but are a great planning tool for those who qualify and can be used in conjunction with special needs trusts.