[An article originally published in the Straight Word, March 2016.]
By Thomas D. Begley, Jr., CELA
A Self-Settled Special Needs Trust is funded with the assets of the individual trust beneficiary. These trusts usually involve funds received as a result of a personal injury, inheritance, alimony, or child support. Under federal law, 1 a SelfSettled Special Needs Trust may be established by a parent, grandparent, guardian or court. In cases involving an adult with capacity court involvement is often unnecessary, so it is convenient to have the trust established by a parent or grandparent. In some states, such as New Jersey, it is possible to establish a “dry trust.” This means that the trust is established but not funded until a later date. In other states, a trust is not established until it is funded with at least a nominal amount of money. These are called “seed trusts.” In a strange but significant case,2 the parents of Stephany Draper sought to establish a selfsettled special needs trust for a personal injury settlement that Stephany was receiving. Under the federal statute, a parent of the trust beneficiary is permitted to establish a self-settled special needs trust but the individual is not. Stephany was a competent adult who had executed a power of attorney appointing her parents as agents. The trust was funded by the personal injury settlement. It should be noted that Stephany’s parents did not use the power of attorney to establish the trust. The Social Security Administration (SSA) held the trust to be invalid. There could be no question but that Stephany is the type of person whom Congress intended to benefit from a self-settled special needs trust. What went wrong?
Generally, under traditional trust rules, a trust does not come into existence until it is first funded. The person who first funds the trust is considered the person who established the trust. However, some states, such as New Jersey, permit the establishment of a “dry” or “empty” trust, while other states require that a trust be seeded to be valid. These are called “seed trusts.”
When the parents established the trust, they made no reference to acting as agents under the power of attorney for Stephany. If they had been acting as agents, they would be acting on Stephany’s behalf and the trust would be invalid, because it would have been established by an individual. What the parents did not do was either recite its status as a dry trust and cite the statutory authority, or treat it as a seed trust and fund it with the parents’ money (i.e., $10). It is not entirely clear that treating the trust as a dry trust would have satisfied SSA. Had the parents paid the $10 into the trust, it is likely SSA would have recognized the trust as a valid trust. It should be noted that at the Hearing before the Administrative Law Judge, the Drapers did not rely on the fact that South Dakota permitted dry trusts.
In the appeal to the Federal District Court, counsel for the plaintiffs further confused the issue by stating that the trust is created by the funder and that the trust was funded by the parents using a power of attorney from Stephany. Under traditional trust doctrine, the person who first funds the trust is the establishor. The problem with plaintiff’s counsel’s argument is that if Stephany’s parents usecl a Power of Attorney from Stephany to fund Stephany’s trust, this would mean that Stephany funded the trust ancf was, therefore, the establisher. The Trial Judge noted that the amount of money placed in the trust was the exact amount of the personal injury settlement. This supported the argument of SSA that since Stephany’s money funded the trust, Stephany was the establisher of the trust and, thus, the trust was invalid. The court never determined whether South Dakota was a dry trust state or a seed trust state. The court found that Stephany’s trust was never an empty trust.
It was funded with Stephany’s money and, therefore, she was the establishor.
The Drapers could have avoided the problem had they funded the trust with $10 of their own money. They may also have avoided the problem if they had recited reliance on the South Dakota trust statute declaring that South Dakota recognizes dry trusts.
In the appeal to the 8111 Circuit, the issue was first funding. Unfortunately, the 8111 Circuit upheld the District Court with the result that Stephany’s trust was determined to be invalid, because it was established by Stephany. Essentially, the court held that the person who first funds the trust is the establishor of the trust.
So where does Draper leave us? At a recent conference at Stetson Law School, Ken Brown and Eric Skidmore, from the Social Security Administration (SSA), indicated that SSA is now taking the position that whoever first funds the trust is the establishor of the trust regardless of whether state law authorizes dry trusts. SSA trust reviewers are looking at trusts to determine if a parent deposited $10 or more of the parent’s money. One way to do this is to send Social Security a trust with a $10 bill attached. A better way would be to open a trust bank account with $10 and deposit that $10 before the personal injury settlement is deposited. It is always best practice in selecting a trustee for a First-Party or Third-Party Special Needs Trust to use a corporate fiduciary rather than an individual. The rules for administering these trusts are extremely complex. SSI and Medicaid rules change constantly, and individuals do not have the time or the expertise to keep up with these changes. Improper administration of a Special Needs Trust will cause SSI and/or Medicaid to declare the trust to be invalid. Failure to open a trust bank account with $10 and deposit that first and then deposit the personal injury settlement, may result in the trust being held to be invalid. This is one more technicality.
Although this raises another issue. If a Special Needs Trust is funded with the assets of a third party, it is a Third-Party Special Needs Trust. If a Special Needs Trust is funded with the assets of the beneficiary of the trust, it is a First-Party or Self-Settled Special Needs Trust. What Social Security is now requiring is a hybrid. The trust would be first funded with the assets of a third party (i.e., the parents) and then funded with the assets of the trust beneficiary; however, the trust would be considered a Self-Settled Special Needs Trust.