Douglas A. Turner, P.C.

Coming soon to a state near you is the demise of the third party special needs trust. Here is why and what to do about it.

Third Party Special Needs Trust (SNT)

A third party special needs trust (”SNT”) is somewhat of a term of art. The most common example of an SNT is a trust created for a special needs child. The SNT is designed to hold assets for the benefit of the special needs child without disqualifying the special needs child from government financial and medical assistance. It is called a “third party” trust because the assets contributed to the trust are not assets of the special needs child. The assets belong to a third party who has no obligation to give the assets to the special needs child.

Many SNTs contain very specific, restrictive language regarding distributions for the benefit of the special needs child. However, a purely discretionary third party trust qualifies as an SNT.

Beneficiaries of a purely discretionary trust have no right to distributions from the trust. The person in charge of the trust (the “trustee”) has absolute control to either make or not make distributions. While this may seem harsh, some level of influence can be exerted over the trustee through informal means and the ability to remove the trustee.

Historically, a purely discretionary trust will not disqualify a trust beneficiary from public assistance. The trust beneficiary has no legal right to demand a distribution. Without that legal right, the trust assets are not considered when a trust beneficiary applies for public assistance.

Three independent trends in the law pose a substantial risk to SNTs. Those trends are:

1. changes in a treatise known as the Restatement of Trusts,
2. the enactment of the Uniform Trust Code, and
3. the tightening of Medicaid eligibility rules.

In the United States, laws come from two basic sources – courts and statutes. Law developed by the courts is called case law or the common law. Law enacted by the state or federal government is called statutory law. Often, the two types of law work in unison. The common law is used to fill in gaps in the statutory law. However, when there is a conflict between state statutes and state common law, the state statute controls.

The common law has developed over several hundred years with the help of treatises. In the area of trust law, the controlling treatise is the Restatement of Trusts. Currently, the Second Restatement of Trusts is the treatise used by most state court judges. However, there is now a Third Restatement of Trusts, and it appears to give beneficiaries and certain creditors rights in a purely discretionary trust. By giving the beneficiary and creditors rights in the trust assets, the trust assets may be considered when applying for public assistance.

Uniform Trust Code (UTC)

The Uniform Trust Code (the “UTC”) is an attempt to create a uniform body of statutory trust law from one state to the next. Just like the Third Restatement of Trusts, the UTC appears to give beneficiaries and certain creditors rights in purely discretionary trusts. There have been several attempts to enact the UTC in Colorado.

Lastly, states are tightening eligibility rules for public assistance and attempting to control what trustees of SNTs can and cannot do with trust assets. All three factors working together create a dim outlook for third party special needs trusts in Colorado.

What to do About the Death of the Special Needs Trust in Colorado

So, what can a person do? First, consider changing any Colorado SNT with restrictive language to a purely discretionary trust. The existence of the restrictive language may give trust beneficiaries and creditors some rights to distributions.

Consider adding terms to the SNT to allow the SNT to leave Colorado and change the law under which the SNT is interpreted. This is commonly called a flee clause.

Consider creating the trust in another state or country. Some states and many foreign countries actively promote the strength of their trust laws and allow the creation of blind trusts. This can be a little pricey, but in the long run, it may be the only way to ensure a purely discretionary trust is not subject to unfavorable trends in Colorado law.

Last but not least, a person can do nothing. The above is merely my opinion based upon my experience. Many respected, legal scholars would disagree with me. However, I have looked into my version of a crystal ball. I see a bleak future for purely discretionary trusts in Colorado. It is time to plan for changes in Colorado law that may severely impact the viability of any Colorado asset protection trust including third party special needs trusts.

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