Fleming & Curti, P.L.C. - On Watermelons, Pomegranates and Special Needs Trusts

MARCH 17, 2008 VOLUME 15, NUMBER 38

On Watermelons, Pomegranates and Special Needs Trusts

Many of our clients (and readers of this newsletter) are confused by the term “Special Needs Trust.” The confusion is natural — there are several quite different kinds of trust arrangements that go by the same name, and we (lawyers) are at fault. Let us now see if we can clear up some of the muddle.

Planning for the financial future of children with special needs is a relatively new concept in the law. The first “special needs” trusts began to appear just a few short decades ago. In 1993 Congress made it possible for an individual to place assets into a trust and still qualify for public benefits; unfortunately, those of us practicing in the field didn’t immediately see the danger of confusion and the need for a different name for those trusts.

Today lawyers distinguish between “third-party” and “self-settled” special needs trusts. The two kinds of trusts are very different in structure, purpose and potential. Sadly, the literature often fails to distinguish between these very different types of trusts.

A “third-party” special needs trust is usually established by parents for the benefit of a child with special needs. There is no requirement that the trust be set up by a parent — it can be any interested person — but the central distinction from the second type of trust is the source of funds. If the person with disabilities never had any right to the funds, the trust can be considerably more generous in terms and structure.

A “self-settled” special needs trust is one established by the individual with disabilities — or by someone on his or her behalf. In fact, the individual can never truly establish the trust for himself or herself, as the law requires that a parent, grandparent, guardian or court be involved. The key to recognizing a self-settled special needs trust is the flip side of the third-party variation: if the money ever belonged to or could have been received by the beneficiary, the resulting trust is self-settled regardless of who actually signed the documents or made the transfers.

A self-settled special needs trust must include a provision returning trust assets to the state to repay Medicaid costs on the death of the beneficiary. A third-party trust need not have such a provision. A third-party trust can be much more generous in its terms, allowing the trustee to determine whether continued eligibility for Medicaid, Supplemental Security Income or other government programs is even important for the beneficiary. Self-settled trusts are usually not so flexible. In most states, most self-settled trusts are subject to regular court review and approval, and it is much more common to see professional trustees than family members. The opposite is usually true for third-party trusts, which are most often administered by family members without court supervision.

A good friend of ours, and a leading force in special needs planning for the whole country, is attorney Steve Dale of Walnut Creek, California. Steve makes the point as succinctly and illustratively as we have ever heard it made by comparing the two main types of special needs trust to fruit. The third-party special needs trust, says Steve, is like a watermelon: it is easy to get your arms around it, it is sweet and juicy (especially on a hot Arizona summer afternoon), and it is pure enjoyable delight. True, a watermelon has some seeds -- but they are easy to work around, and can even be swallowed without incident. True, a watermelon is not terribly nutritious, but it is nonetheless satisfying, and even provides essential trace minerals.

By contrast, the self-settled special needs trust resembles the pomegranate. It is smaller, hardened and yields its fruit only after some effort. When you finally get into the pomegranate, it is delightful and can be refreshing -- but it is also seedy and produces far less juicy sweetness than the watermelon. Still, the pomegranate is good -- just not as obviously or easily wonderful as its distant cousin.

The first time we ever heard Steve's fruit-based explanation, incidentally, it did not escape our notice that he was talking about our work here at Fleming & Curti in two different ways. Not only do we do a considerable amount of special needs trust work, and administer a fair number of self-settled special needs trusts, but we do so from our offices here on Granada Avenue in Tucson -- "granada" being Spanish for (you guessed it) pomegranate. [Ed. note: more than one reader pointed out that "granada" can also mean "grenade." We choose not to think of the explosive effect of some poorly managed special needs trusts.]

Although most of us who practice in this area talk about the two main types of special needs trusts, we often fail to discuss three other types of trusts that might fairly be called "special needs" instruments -- especially if our goal is to confuse the issues. Suffice it to say that for now, we are looking for good fruit-based metaphors to characterize so-called "Miller," "Sole Benefit" and Pooled trusts. More on that later. More seriously, we're working on how to distinguish between third-party and self-settled special needs trusts in a way that doesn't require botany at all.