Unlike Special Needs Trusts (SNTs) and Pooled Trusts (PTs), Settlement Preservation Trusts (SPTs) are not specifically described or authorized in Federal law. Except for being self-funded like SNTs and PTs are, this means that SPTs are completely different vehicles and are used for different reasons. Because SPTs are not used to protect SSI and Medicaid benefits, it also means they are not required to comply with a set of rigid Federal requirements.
Since SPTs are not subject to the rigid Federal requirements of SSI and Medicaid, they hold significant protection and management potential. As we will see below, SPTs can provide protection against exploitation and spendthrift tendencies while providing flexibility and liquidity at the same time. Being controlled primarily by State law allows for a high degree of customization, and with proper forethought, SPTs are able to meet an extremely wide range of needs and circumstances.
Protecting the Beneficiary’s Interests
With the word, ‘Preservation’, imbedded in the middle of ‘Settlement Preservation Trust’, it should be stating the obvious to say that a SPT protects a beneficiary’s interests first and foremost by preserving settlement proceeds. While there are several aspects to how SPTs can preserve settlement proceeds, they all fall under the more general heading of avoiding wasteful disposition. Wasteful disposition can happen for several different reasons, but no matter what the reason, SPTs can offer protection.
Perhaps the least egregious form of wasteful disposition comes from the trust beneficiary’s own spendthrift tendencies. Not all beneficiaries exhibit spendthrift tendencies, but it is not uncommon for settlement proceeds to be spent quickly within a relatively short time. This can sometimes be understandable because personal injury victims often get behind on normal household bills and incur debt if they experience periods of unemployment while waiting for cases to settle. They may also have ongoing medical needs because of the accident. Unfortunately, however, there are also a significant number of claimants who are simply unexperienced with large sums of money. These claimants tend to spend their settlements quickly because they have no real sense of how long their money will last.
Another form of wasteful disposition is undue influence, which can run the gamut of being subtle to being flagrant. It generally begins with someone taking advantage of the natural impulse we all share of wanting to help the people who are close to us. However, whether it is helping relieve a family member’s debt, investing in a family member’s business, buying a house for everyone to live in, or allowing the family’s “investment expert” to manage the funds, the claimant all too often feels the need to accommodate everyone and winds up with nothing to show from the settlement except unmet needs.
At its worst, undue influence becomes outright exploitation. Especially susceptible to exploitation are adults with mental or physical disabilities, adults with dependency problems, older adults who are frail or have memory problems, and minor children. The abusers can be friends, family members, neighbors, paid care providers, professionals, or even people who specifically target and exploit vulnerable people. While abusers can be subject to criminal prosecution, the better alternative is obviously to avoid situations where exploitation can occur.
Whether settlement proceeds will be jeopardized by spendthrift tendencies, undue influence, or exploitation, a professionally managed SPT can prevent wasteful disposition and protect a beneficiary’s interests. This can be accomplished with various strategies such as pre-determined distribution schedules and disciplined management. For example, a disciplined management team is not going to be swayed by a claimant’s friends and family members who present get rich quick schemes or opportunities that are too good to be true. Strategies such as pre-determined distribution schedules can ensure that a beneficiary’s most important needs are identified early and then provided for on a consistent basis.
Enhancing the Settlement
Not only can SPTs preserve settlements, but their flexibility can also greatly enhance settlements. For example, the paragraph above mentioned pre-determined distribution schedules. A pre-determined distribution schedule would be an agreed upon schedule of distributions that would be made from the SPT. This would be similar to a structured settlement payout where a claimant chooses from among several proposed payment streams, all of which vary according to how much will be paid and for how long it will be paid. However, unlike structured settlements, the distribution schedule for a SPT can be highly flexible.
Instead of making fixed periodic payments to a claimant as a structured settlement does, a SPT distribution schedule can make direct payments to vendors and service providers. For example, in cases where it is important to ensure that a settlement secures decent housing for a claimant, a SPT can be setup to make mortgage payments directly to the lender. Direct payments can also be made directly from the SPT for utilities and other important expenses. A distribution schedule can also provide for some mix of direct payments to vendors and cash distributions to the trust beneficiary or even all cash distributions to the beneficiary. The real point is that a distribution schedule can be truly customized to meet a claimant’s needs, within the confines of what is financially feasible, no matter what those needs may be.
In addition to customizing distributions to meet a claimant’s specific circumstances, it is also possible to change distribution schedules over time as the trust beneficiary’s circumstances change. Being able to make changes too easily would defeat the basic purpose of a SPT, but the SPT document can set out certain conditions that would trigger a reevaluation of the beneficiary’s needs. Based on this reevaluation, the trustee and trust beneficiary can agree to a corresponding change in the distribution schedule. By deciding on such terms in advance, a high degree of stability and adaptability is introduced that works for the benefit of the beneficiary while also fostering a harmonious relationship with the trustee. Conceptually, this is the equivalent of having the ability to change structured settlement payments, which is not possible with a structured settlement.
SPTs also enhance settlements because a SPT cannot be factored as a structured settlement can be. Factoring a structured settlement is a financial transaction that consists of selling the right to receive future payments for a discounted lump sum. Although the claimant receives a lump sum, the amount they receive is reduced to the present value of the future payments. This means that the claimant’s settlement is reduced even more at a time when they obviously need cash. By contrast, SPTs cannot be factored because they are irrevocable spendthrift trusts. Moreover, the beneficiary of a SPT is less likely to even think of factoring because the flexibility of a SPT allows for a better match with their needs and comes with the potential to revise the distribution schedule.
Liquidity and Tax Issues
Liquidity is often described as the ability to convert an asset to cash easily and quickly, with little or no loss in value. The term is also used sometimes to describe investments that can be bought or sold easily like blue chip stock. While using the term in this manner may accurately describe the ease of conversion, it does not necessarily take into account the fluctuating value of securities. No matter how the term is used, however, SPTs provide a high degree of liquidity compared to other settlement options. Of course, the extent to which liquidity is a consideration will always depend on the needs and objectives of the claimant.
Historically, liquidity has been an important factor to consider for estate tax purposes. Estate tax is the federal transfer tax owed to the Federal government after allowing for the exemption amount. Also referred to as the ‘death tax’, both aisles of Congress have made estate tax a political football in recent years. The uncertainty created by this political climate has made it difficult to plan for estate tax, but it has not affected the need for such planning. Because estate tax must be paid within 9 months of death, it is critical for a taxable estate to have sufficient liquid funds so the tax can be paid timely without incurring costly penalties and interest.
Much of the uncertainty surrounding estate tax was resolved when the American Taxpayer Relief Act of 2012 (the Act) became effective in January of 2013. The Act made the 2012 lifetime exemption amount of $5,000,000.00 permanent with an annual increase indexed to inflation. With a lifetime exclusion of $5,340,000 in 2014, Federal estate tax is expected to be a non-issue for 99.5% of all American households. However, while this would seem to make liquidity less of a factor, it is still important to recognize that approximately 30% of the States impose their own estate or inheritance tax. Although the exemption amount varies State by State, the issue of State taxation is significant enough to make liquidity an ongoing planning concern.
Since SPTs provide a liquid settlement option, any estate tax owed to the Federal or State government can be paid in a timely manner without risking penalties or interest. It can also be possible to have additional funds available at death by using a SPT in conjunction with life insurance, which is a traditional estate tax planning technique. Structured settlements can also provide liquidity with a commutation rider, but it is not automatic. A commutation rider is an additional document that becomes part of the annuity contract, and it must be requested as part of the settlement negotiation at the time a claimant agrees to a structured settlement.
An Alternative to Guardianship
Under the laws of all States, guardianship is considered the most intrusive form of protecting the property of vulnerable adults and minor children. With adults in particular, a guardianship requires a court to enter a formal order finding that the individual lacks capacity to exercise his or her rights. The order is entered after a petition is filed to determine someone’s capacity, and all parties are represented by legal counsel. A legal guardian is appointed who is required to file annual reports and accountings for as long as the guardianship continues.
In contrast to a guardianship, a SPT can be a less restrictive alternative. Using the individual’s property to fund a professionally administered SPT can alleviate the need for a guardianship. In turn, this can reduce costs and avoid many of the difficulties that typically come with a guardianship. In addition, the funds in a SPT can often be used for the individual’s benefit more directly and without delay.
Minor children who receive settlements or other property such as inheritances need a guardianship established in many cases because the laws of all States limit how much a parent can receive on behalf of their children. If a minor child is going to receive property in excess of these State statutory amounts, a guardianship of the property must be established to safeguard the minor’s funds. In such circumstances, parents continue to be the natural guardians of their child, and the parents’ ability to make all other decisions is unaffected.
Another factor that concerns parents is the fact that all of the funds subject to the guardianship are typically available as soon as the minor child reaches the age of majority. Since it is the rare parent who thinks it is a good idea for their child to receive a large sum of money on their 18th birthday, a SPT can also provide longer term protection and sound management through a pre-determined distribution schedule. Funds can be earmarked for education and other important expenses in this pre-determined schedule that ensure the funds are distributed over time in a sensible and controlled manner.
Limited Medicaid Protection
While SPTs cannot protect SSI and Medicaid generally, they can protect certain types of Medicaid under the right circumstances. You may recall from our Special Needs Trust page that Federal law requires someone who wants to establish a SNT to have a disability. As explained briefly on our Special Needs Trust page, Medicaid has two major divisions among its many programs: non-SSI related Medicaid and SSI related Medicaid.
Because the SSI related Medicaid programs are grounded on the SSI rules, which require disability, eligibility for SSI related Medicaid will generally satisfy the disability requirement for most Medicaid beneficiaries who want to establish a SNT. By contrast, someone who is eligible for non-SSI related Medicaid cannot establish a SNT because they fail one of the essential requirements for a SNT, which is to have a disability.
However, the Medicaid regulations of most States do not count trusts as an available resource for someone who receives non-SSI related Medicaid if the trust is not available to meet the needs of the individual or family. Therefore, a SPT can protect the non-SSI related Medicaid benefits for someone if the terms of the SPT do not make the funds available. This only works under the right circumstances, such as protecting the funds of a minor child until the child reaches the age of majority. Because SPTs are flexible, the funds can be unavailable while the child needs to maintain eligibility for non-SSI related Medicaid with a provision that makes the funds available when the child becomes an adult. At that point, the SPT distribution schedule can provide for a lump sum payout or a series of payouts that can include cash or direct distributions for expenses like education.