Article on Supplemental Trusts

Consider the following scenario:

The year is 1990 and you are an eighty-year-old grandparent with a significant amount of wealth. In apprehension of your declining health, you decide to set up trusts for your children and grandchildren. Unfortunately, one of your grandsons is disabled, and wanting to ensure that the grandson is cared for, you set up a trust solely for him. The trust instructs the trustee to pay out the net income of the trust for the disabled grandson’s benefit during his lifetime. You pass away a year later and the trusts take effect. Before your death, the grandson was receiving government aid through Medicaid. Medicaid eligibility is based on a person’s income and ability to pay for medical care. Now, however, the proceeds of the trust are being counted as income for the grandson, thus making him ineligible for Medicaid. As a result, the burden of caring for this disabled grandson falls solely on the shoulders of the grandson’s parents, your son and daughter-in-law. Following your death, the Legislature in 1993 adopts a new type of trust called a supplemental needs trust. The supplemental needs trust allows a person to care for a disabled person by giving them income, but instead of supplanting governmental benefits, as a traditional trust would, the supplemental needs trust would supplement them. As a result, the proceeds of the trust would not count as the income of the disabled, allowing the disabled person to continue to be eligible for government funded programs. In this case, it would allow the grandson to continue to receive the income from the trust by supplementing the aid he was receiving from Medicaid. Would you, as the grandparent, want the trust to be modified by the courts to a supplemental needs trust?

The hypothetical above illustrates an issue the Surrogate Courts in New York have struggled with. The scenario illustrates a situation where a decedent has already executed a trust before the legislature enacted Estate Powers &Trusts Law (EPTL) §7-1.12, which authorized supplemental needs trusts. Here the trustee would like the trusts to be modified into a supplemental needs trust. A similar situation exists where the decedent creates a trust after the enactment of EPTL §7-1.12, but due to error, a regular trust is created and not a supplemental needs trust. Here the trustee would like the error to be reformed by converting the trust into a supplemental needs trust. Though the remedies sought are labeled differently, the New York courts have treated these situations the same, and in both scenarios the underlying issue is whether the courts are allowed to change these trusts into supplemental needs trusts.

Historically, New York courts have held that the general rule is that there is no reformation of testamentary instruments. The underlying policies behind the no-reformation rule stem from the fear that reformation of testamentary instruments would frustrate the intent of the testator’s testamentary plan and lead to excessive litigation. Yet some New York courts have reformed trusts into supplemental needs trusts when the testator’s intent is not frustrated, and the requirements of EPTL §7-1.12 for a valid supplemental needs trust are satisfied. The supplemental needs trust exception to the no reformation rule has been met with debate because some courts have refused to recognize it and have instead applied the traditional no-reformation rule.

This article will argue that although the New York courts should continue to enforce the traditional no-reformation of testamentary instruments rule, they should also recognize the supplemental needs trust exception. The New York courts should recognize this exception for three reasons. First, reformation should be permitted because caring for the disabled is an important public policy. Government assistance has changed in three important respects over the years. It has evolved from a gift into a right, it is no longer associated with a stigma, and it is viewed as an insurance benefit rather than a charity. These changes encourage reformation, which give the court the ability to reform a trust to allow a disabled beneficiary to take advantage of his right to government benefits for which he would otherwise be ineligible. Second, reformation should be permitted because it would allow the trustee to fulfill his duty of acting in the best interest of his ward. Acting in the best interest of the ward is essential to the role of the trustee, and reformation would allow the trustee to enable the disabled beneficiary to continue to receive government aid without exhausting the trust property. Third, reformation should be permitted because it is consistent with the doctrine of substituted judgment. The presumed intent of the disabled beneficiary would be to reform the trust so that he could be eligible for governmental benefits. Due to his disability, however, the beneficiary cannot request reformation. Under the substituted judgment doctrine, the court is able to “substitute its reasoned judgment for what the disabled individual would have decided if able, e.g., the presumed intent of the disabled person.” Thus, because the beneficiary would reform the trust if he were able to, the court should permit reformation. The court, however, should only apply the supplemental needs trust after considering the intent of the testator’s testamentary plan and determining that there was no fraud or unjust enrichment on the part of other beneficiaries. Additionally, the requirements of EPTL §7-1.12 must also be satisfied. These include: (1) the beneficiary of the trust suffers from a severe or chronic or persistent disability; (2) the trust evidences the intent that the assets be used to supplement, not supplant, government benefits; (3) the trust prohibits the trustee from using assets in any way that may jeopardize the beneficiary’s entitlement to government benefits or assistance; and, (4) the beneficiary does not have the power to assign, encumber, direct, distribute, or authorize distribution of trust assets. These factors and requirements will act as safeguards, ensuring that the testator’s intent is not frustrated and that excessive litigation does not arise. Thus, the policies of the no-reformation rule will not be ignored.

Part I of this article will give background information on trusts. This part will discuss the essential elements for a valid trust, and will then analyze the policies behind the no-reformation rule. This part will also discuss a key case in which the concept of supplemental needs trusts was first applied in New York and was eventually codified by EPTL §7-1.12, the section authorizing supplemental needs trusts. Part II of this article discusses key cases on the subject of supplemental needs trusts, the way courts have analyzed these situations, the courts trend in allowing the reformation of traditional trusts into supplemental needs trusts, and a case where the court denied reformation. Part III argues that the supplemental needs trust exception should be recognized by all New York courts, because of the important policy of caring for the disabled, the trustee’s duty to act in the best interest of their ward, and the doctrine of substituted judgment.