Whether your goal is to provide for a physically and/or mentally disabled loved one, or to prepare for the increased risk of dementia, Alzheimer’s disease, and other neurological disorders that accompany advanced age, disability is an important topic that should not be overlooked in your estate planning process.
Health Care Directives. An advance health care directive provides for surrogate decision-making authority in the event of incapacity. Such authority may range from normal health care decisions to discontinuation of life-sustaining medical treatment.
Durable Power of Attorney for Property Decisions. Another essential document in your estate plan is a “durable” power of attorney. This document delegates authority to a third-party to make decisions regarding a property owner’s assets and will survive the property owner’s incapacity. Many of the issues related to creating an effective health care directive apply to the durable power of attorney: Who will be the appropriate agent? What powers will the agent have? Will the power be immediately effective or springing (if permitted under applicable state law)? If it is to be springing, what will the conditions of implementation be, and how will the validity of the durable power of attorney be apparent to third parties? Great care must be taken on this last issue because the durable power of attorney is of little use if third parties will not accept it. If the condition is incapacity of the principal, some reliable third-party or parties must make that determination. State statutes should provide guidance.
But the inherent flexibility of the durable power of attorney is its main weakness, because an unscrupulous agent may start treating the assets as his or her own or similarly, use them ”for the good of the entire family.”
Several strategies exist to control such a situation:
- Choose the attorney-in-fact carefully and specifically delineate his or her powers.
- Consider the appointment of a co-agent who is not likely to be swayed by the other co-agent.
- Consider requiring the attorney-in-fact to submit monthly bank statements and quarterly brokerage statements to a trusted third-party for review.
Trusts. Another tool for property control and management is a trust. If the individual is disabled, a grantor trust and/or a special needs trust (discussed below) may be the best option. Clients planning for the risk of later disability should consider a revocable living trust. With this arrangement, the settlor/client places his or her assets into a trust that is revocable during the settlor’s lifetime but irrevocable at death. If, at some point, the settlor becomes incapacitated, a successor trustee can assume the duties of administering the trust according to its terms.
Guardianships. Finally, the most restrictive arrangement for surrogate decision-making regarding property – and sometimes health care – is a court-appointed guardian. Once appointed by the court, the guardian must comply with strict requirements outlined in the relevant state statutes.
Funding Sources. Though funding for the care of disabled individuals who lack adequate resources frequently comes from family members, other possible sources include long-term care insurance, litigation awards or settlements, and/or public assistance.
Long-term Care Insurance. Long-term care insurance is one option for individuals who anticipate possibly experiencing some form of disability in the future. The downsides of long-term care insurance are the expense and the possibility the client might not use it. On the other hand, some clients see long-term care insurance as a form of asset protection. Through various “partnership” programs, many states have amended their Medicaid programs to provide that the assets of the Medicaid recipient will be disregarded to the extent of the insurance benefit payments made under the long-term care policy.
Litigation Awards/Structured Settlements. At the conclusion of a personal injury action, the defendant may offer to pay the plaintiff with a structured settlement. These settlements function much like annuities by providing payments over a specified period – usually the life of the plaintiff but sometimes over a term of years. Structured settlement payments for damages (other than punitive damages) received for personal physical injuries or physical sickness are excluded from income (Internal Revenue Code Section 104(a)(2)), whereas investment earnings on any lump-sum payments for damages are not. However, tax consequences are only one factor to consider in deciding whether to accept a structured settlement or opt for a lump-sum payment that can be invested. If the client does choose some form of structured settlement and a special needs trust will be established, it is critical to ensure that the recipient of the income is the trust and not the individual.
Public Assistance/Special Needs Trusts. In some cases, a planner may wish to preserve the individual’s present or anticipated right to public assistance benefits, such as Medicaid or Supplemental Security Income (SSI). Though such programs are need based, they do not prohibit recipients from receiving supplemental income for non-essential items. A special needs trust is designed to allow the recipient to receive public benefits and have outside assets for non-essential items. Given the potential for abuse, many state and federal rules govern special needs trusts.
Special needs trusts can be established as either third-party or first-party (“self-settled”) trusts. First-party trusts are also known as “(d)(4)(A) trusts” because they are specifically treated under 42 USC Sec. 1396p(d)(4)(A). A number of restrictions apply, including a requirement that the trust contain an appropriate “payback” provision whereby, upon the Medicaid recipient’s death, the trust reimburses Medicaid for any Medicaid benefits received. In contrast, qualifying third-party trusts need not have a payback provision regarding state-provided Medicaid.
For both SSI and Medicaid purposes, extensive rules govern the nature of distributions from a special needs trust. The trustee may not make cash distributions to the beneficiary. Payment must be made directly to the vendor. Generally, permissible purchases include a car, non-essential utilities such as cable television, furniture and appliances, home maintenance, travel, education, entertainment, clothing, and anything that is not convertible to food or shelter. Additionally, all purchases must benefit only the disabled person, and the trustee must maintain records sufficient to satisfy the appropriate authorities that expenditures were made only for allowable items.
Numerous tax issues can arise in the formation of a special needs trust. Because trust income tax rates are much more compressed than individual income tax rates, the goal is often to draft the special needs trust so that trust income is taxed to the beneficiary but does not bar him or her from collecting public benefits. For this reason, advisors often set up special needs trusts to take advantage of the grantor trust rules contained in the IRC Sections 671 through 679.
Regarding the choice of trustee for a special needs trust, many of the same considerations for health care agents and powers of attorney are applicable. However, because special needs trusts involve a number of additional legal complexities, families may want to appoint a professional trustee.
Attorney Matz welcomes the opportunity to discuss these matters and assist you in estate planning. Click here to contact him.