Take-Away: Medicaid self-settled qualifying trusts often lead to common law asset protection principles. While lawyers and courts are familiar with those principles, and the limits on those principles, e.g. the property rights associated with the donee of a limited power of appointment, Medicaid administrators have little or no familiarity, thus leading to some strange reasons for the denial of Medicaid benefits.

Background: We are somewhat familiar with special needs trusts for disabled beneficiaries used to preserve the beneficiary’s eligibility to receive governmental benefits. However, we are less familiar with irrevocable trusts that are created to enable the settlor of the trust to become eligible to receive Medicaid benefits. Over the years many individuals have attempted to ‘push the envelope’ with regard to the creation and funding an irrevocable trust with the goal of still qualifying for Medicaid benefits. A short sampling of some reported cases indicates what trust provisions need to be avoided if an individual seeks to create and fund an irrevocable trust for his or her own benefit and continue to remain eligible to receive Medicaid benefits. These cases provide a helpful reminder of when trusts are unable to serve as effective asset protection devices under historic common law principles, which in turn, often guide federal court decisions..

General Power of Appointment- United States v. Ritter: When an individual transfers property in trust for himself for life and reserves a general power of appointment to change the beneficiaries, the interest subject to such retained power, even if the power is not exercised, along with the settlor’s retained life interest, can both be subjected to the payment of the claims of creditors of such individual and claims against his estate to whatever extent other available property is insufficient for that purpose. Such a retained power will also cause the trust’s assets to be included in the settlor’s taxable estate. United States v. Ritter, 558 F.2d 1165, 1167 (4th Ci.r) (1977.)

Spendthrift Provision: The decedent created a ‘spendthrift’ trust for his own benefit and he also retained a general power of appointment over the trust’s remainder. The decedent’s estate was denied creditor protection to the trust’s assets and thus was considered to be an ‘available asset.’ The court stated: “In all trusts there must be a cestui que trust, and it is manifest from the deed that the decedent was to have the sole beneficial use of the property conveyed, certainly during his life, with power to dispose of what remained at his death by will.” Petty v. Moores Brook Sanitarium, 110 Virginia. 815 (1910.)

Discretionary Income-Only: The settlor created an irrevocable trust for his own benefit. The trust was a discretionary income-only trust. No principal distributions to the settlor-beneficiary were allowed by the express terms of the trust. The court held that a creditor of the settlor could reach the trust assets for satisfaction of a claim up to the maximum amount that the trustee could pay to the settlor-beneficiary or apply for the settlor-beneficiary’s benefit. Accordingly, with some limit as to the amount available, the trust assets were ‘available’ to the settlor to satisfy creditor claims. Ware v. Gulda, 117 N.E.2d 137 (1954.)

‘Could Reach Maximum’ Amount: In a Tax Court case, the settlor created a trust for herself where the trustee held discretionary power to distribute income-only to the settlor-beneficiary. No principal distributions to the settlor-beneficiary were allowed under the express terms of the trust. The Tax Court, relying on the Restatement (Second) of Trusts, held that the settlor-beneficiary’s creditors could reach the maximum amount which, under the terms of the trust, could be paid indirectly to the settlor. “The rule we apply is found in Restatement: Trusts (Second) Section 156(2): ‘Where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum amount which the trustee under the terms of the trust could pay to him or apply for his benefit’.” Paolozzi v. Commissioner, 23 Tax Court 182 (1954.)

Access to Principal: The nursing home resident appealed the denial of her Medicaid application following an administrative determination that the principal of the trust that she had established was an ‘available resource’ for the purpose of calculating her Medicaid eligibility. The trial court reversed the administrative decision. The Court of Appeals held that because the trust instrument did not provide the trustee with the authority or discretion to distribute trust principal to the settlor, the principal of the trust was not an ‘available resource.’ 733 A.2d 756, 775,(Connecticut Supreme Court, (1999.)

Limited Power of Appointment: Six elderly nursing home residence in New York created irrevocable, income-only, trusts. Medicaid benefits were denied because these trusts contained provisions where the settlors retained a limited power of appointment over the trust corpus. The New York Medicaid Agency (the Agency) held that a limited power of appointment made the trust assets an ‘available resource’ for purposes of determining Medicaid eligibility. In response, the resident-beneficiaries then filed a federal class action against the county and state in which they alleged that consideration of the trust assets as an ‘available resource’ for Medicaid eligibility is unlawful because there are no circumstances under which they could be paid the trust assets. The Agency responded that the resident-beneficiaries also retained the power to change beneficiaries of the trust who might be amenable to revoking an otherwise irrevocable trust. The federal District Court certified the class action and granted the resident-beneficiaries motion for summary judgment. “They allegedly are potential beneficiaries of self-settled trusts that contain limited powers of appointment; this exceeds the limits of federal law. Absent evidence of bad faith or fraud, the decision of whether or not to provide Medicaid benefits should not be based upon the remote possibility of collusion.” Verdow v. Sutkowy, 209 F.R.D. 309 (2016.)

Right to Change Trustee or Beneficiary: The terms of the trust made it irrevocable. Mr. Spetz, the Medicaid applicant’s husband, reserved to himself the right to change the beneficiary of the trust. This right was limited, in that Mr. Spetz could not name himself, his spouse, the estates of himself or his spouse, or the creditors of those estates (the equivalent restrictions needed to create a limited power of appointment.) The New York Medicaid Agency (the Agency) claimed that Mr. Spetz’ retention of the right to change beneficiaries is equivalent to control over the corpus of the trust, and thus the trust must be considered in determining Mrs. Spetz’ eligibility to receive Medicaid benefits. The Agency also argued that the trust assets were ‘available’ to Mr. Spetz because he could control the trustees under the threat of appointing different trustees if they refused to comply. The Court held that although it was conceivable that Mr. Spetz could bring pressure on the trustees to make payments to, or for, Mrs. Spetz’ benefit, New York law provided that the availability of assets for Medicaid eligibility purposes depends upon the trustee’s actual authority under the specific terms of the trust agreement. Consequently, the court found that the trustees had no such authority. In the Matter of Irene Spetz, 190 Misc.2d 297, 737 N.Y.S.2d 524, LEXIS 29 (2002.)

Trustee and Beneficiary the Same: The court in Spetz also noted that “although the trustees and beneficiaries are currently the same people, that is not necessarily so under the terms of the trust..and in any event, their roles as trustees and beneficiaries must be considered as legally separate.”

Possibility of Collusion to Revoke: The Agency in Spetz also argued that under Uniform Trust Code Section 411, any trust can be terminated provided the beneficiaries consent in writing to the termination. Accordingly, the assets of the trust should be considered ‘available’ to the Medicaid applicant because her husband could seek the consent of the trust’s beneficiaries to terminate the trust, thus placing the corpus back in the settlor’s hands. Since Mr. Spetz also retained the power to change beneficiaries, he could possibly use his power to change beneficiaries in collusion with someone who is willing to terminate the trust. The court found that the speculative possibility of a termination of the trust pursuant to New York’s trust laws [comparable to MCL 700.7411] did not render the corpus of the trust ‘potentially available’ to the Spetz,’ as there was no evidence presented that the beneficiaries of the trust would consent to the trust’s revocation. “To hold otherwise would eviscerate the federal and state statutes providing, in detail, for the protection of assets through the use of irrevocable trusts, since every trust would be presumed to be revocable.”

Invasion of Principal Power: The trust permitted the Medicaid applicant to use and occupy the home. the home was thus considered an ‘available asset.’ In addition, the court concluded the trust’s principal was a ‘countable’ asset because the trust, despite some language restricting the settlor’s access to the principal, allowed the trustees to invade the trust’s principal and income when necessary to ensure the settlor-applicant’s’ ‘quality of life, comfort, and respond to her changing needs.’ Doherty v. Director of the Office of Medicaid, 908 N.E. 2d 390, Massachusetts Court of Appeals (2009.)

Right of Substitution: Spouses transferred title to their condo to an irrevocable trust, naming their children as trustees. The deed retained a life estate to the settlors. Six years later the husband moved to a nursing home and an application for Medicaid was filed on his behalf. Medicaid was denied because the trust held a ‘countable’ asset. The denial of Medicaid benefits was sustained by the court. “If a Medicaid applicant can use and occupy her home as a life tenant, then her home is ‘available.’” In effect, the court found that the provision in the deed that retained property rights for the settlors invalidated the trust which did not give them the right to use and occupy the condominium. The court looked at the provisions of the trust and found that the trustees could use income and principal to pay certain trust expenses,- taxes, insurance premiums, and a right of substitution. Due to the settlors’ retained right of substitution, the court held that the settlors “had access to both the trust principal and income.” In other words, in the view of those who administer the Medicaid program, the right to substitute assets of equal or greater value retained by the settlors (making it a grantor trust?) allows the settlors to ‘obtain principal’ from the trust, even though it is only by way of substitution.

Annuity Owned by Trust: The state Medicaid agency determined that the assets in an irrevocable income-only trust were ‘countable’ because the trustee possessed the ability to purchase an annuity with trust assets. The Agency reasoned that the trustee would then be allowed to distribute trust principal to the beneficiary. The court held the Agency’s analysis to be incorrect. “Out of each annuity payment, only the investment income portion would be available for distribution to the grantor from the trust; that portion of each payment representing a return of capital would be required by the trust instrument to be retained in the trust. The income portion available for distribution in such circumstances would be no different in character than interest earned on a certificate of deposit…In all events, the trust principal is preserved in trust, and is not available for distribution to the grantor under the governing provisions of the trust.” Heyn v. Director of the Office of Medicaid, 48 N.E.2d 480, Massachusetts Court of Appeals (2016.)

Conclusion: The common law principles of self-settled trusts, the concepts of limited powers of appointment, etc. are frequently encountered in reading court decisions where a trust either frustrates an application for Medicaid benefits, or other trust provisions are ignored when determining Medicaid eligibility. Asset protection concepts are sometimes cited by courts, and in other situations, they are ignored. The point is that trusts created to enable the settlor to later file for Medicaid benefits are often problematic and close attention will be given to the various trust provisions with the focus on whether any of the trust assets will be ‘available’ to the settlor who earlier created and funded the trust.