OCTOBER 10, 2016 VOLUME 23 NUMBER 38
Let’s say that your mother wants to leave an inheritance for your son (let’s call him Daniel), but that Daniel is a minor. How can she arrange his inheritance? By putting it in trust, of course. Pretty commonly, Daniel’s trust might continue until he is 21, or 25, or some other age that your mother might choose. After that, the money can go to him outright. In the meantime, you, or your mother’s accountant or lawyer, or a family member with good financial skills, can manage Daniel’s money for him.
There’s nothing very remarkable about that setup, but one common development can change the story dramatically. What if, before he reaches the age for distribution from the trust, Daniel becomes disabled — or receives a diagnosis that you just didn’t expect when you wrote the trust?
If your mother is still living, of course, she can change the trust provisions to create a “special needs” trust for Daniel. But if she were to die before the family learned that Daniel needed a different type of trust, things could get much more complicated.
If no steps are taken before Daniel turns 25 (or whatever age the trust set), then the trustee will have no choice to turn the money over to him. That will almost certainly mean that he loses some or all of public benefits he receives because of his disability — and he may not be able to manage the money anyway. That could be a bad result.
One response might be for you, as Daniel’s parent and/or guardian, to create a new special needs trust for him after he turns 25. That might require court action, and will result in a pretty tightly-controlled trust document (because the rules are fairly restrictive). This kind of trust is usually called a “self-settled” special needs trust, even though Daniel might not actually be involved in its creation at all. This kind of trust also has to provide that, when Daniel dies later, the state’s Medicaid program will be entitled to make a claim against the trust’s remaining assets — before they pass to Daniel’s other family members.
Another excellent choice in Arizona might be for Daniel’s trustee to “decant” his trust. This notion borrows its name from decanting of wine — the trustee would simply pour (as it were) the trust’s assets from the existing trust container into a new, more appropriate (and special needs) container. But there is some uncertainty about whether that new trust container would have to be a “self-settled” trust — and include the restrictive provisions and payback clause.
It was not in Arizona and does not apply Arizona law, but a recent New York appellate court decision addressed this very question. Daniel’s trustee asked the New York courts for permission to decant his trust to a new special needs trust — but without the payback provision. The trustees gave notice to the state Medicaid agency, and its representatives appeared and objected. Because Daniel would be absolutely entitled to receive the trust balance when he reached the age in the original trust document, they reasoned, the money was really his, and the trust would need to be of the self-settled variety.
Not so, argued the trustee. The money would not be Daniel’s until he reached the age set out in the trust — and in the meantime, state law permitted the trustee’s to move the trust into a new trust, governed by a new document. That meant that no payback provision was required.
The New York Surrogate’s Court (what we would call the probate court in Arizona) agreed with the trustees and allowed creation of a new trust with no payback provision. The Medicaid agency appealed, but unsuccessfully. According to the appellate court, Daniel’s trustee was correct — the new, decanted trust was not a self-settled special needs trust, since Daniel did not have the right to receive the property at the time the new trust was created. Matter of Kroll v. New York State Department of Health, October 5, 2016.
This may seem like a small thing, but the ramifications are actually quite large. If the New York precedent holds up in other states, it will open a terrific opportunity for management of trusts when circumstances have changed (as they so often do). It might be applicable not only when beneficiaries like Daniel reach the age of distribution; it might also apply when a trust contains unfortunate language, or management considerations change.
Will this be the law in Arizona? It is hard to be certain, but each case (and this one is the first) reaching a similar conclusion will add impetus to what we can hope will be a developing trend.