Income-Only Trust Upheld Notwithstanding Trustee Power to Purchase Annuity

The Massachusetts Court of Appeals recently ruled that the state Medicaid agency erred when it determined that the assets in an irrevocable income-only trust were countable because, in the agency's opinion, the trustee's ability to purchase an annuity with trust assets allowed the trustee to distribute trust principal to the beneficiary.  Heyn v. Director of the Office of Medicaid (Mass. App. Ct., No. 15-P-166, April 15, 2016).

Everlenna Roche transferred her home into an irrevocable income-only trust in 2003.  In 2011, Ms. Roche moved to a nursing home and began receiving Medicaid benefits.  Two years later, the Office of Medicaid terminated Ms. Roche's benefits after determining that the assets of the trust should be considered a countable resource.  Although the trust allowed the trustee to distribute only trust income, not principal, to Ms. Roche, the Office of Medicaid took the position that the trustee's ability to purchase an annuity with trust funds, in effect, allowed the trustee to distribute to Ms. Roche the principal used to purchase the annuity, rendering the trust countable.

Ms. Roche passed away and her estate appealed the Office of Medicaid's decision, but the appeal was rejected at an administrative level and upon review by the Superior Court.  On appeal to the Appeals Court, Ms. Roche's estate argued that state law prohibited the trustee from changing principal payments from the annuity into income and that the returned principal payments from the annuity were required to be retained in the trust. 

The court agreed with Ms. Roche's estate's claim that state law prohibits an allocation of principal to income that would circumvent the trust's prohibition on principal distributions.   The Court also went out of its way to reject two other alternative arguments even though the trial judge did not rely on them: (1) that the ability of the trustee to distribute principal to Ms. Roche’s children made the trust assets countable, and (2) that Ms. Roche’s power under the terms of the trust to direct a substitution of assets made the trust assets countable.  The Court determined that both arguments lacked support in law or logic, as neither would allow for distribution of principal to Ms. Roche which was the only relevant issue.

The Massachusetts Court of Appeals overturned the Office of Medicaid's decision.  The court wrote that:

"[o]ut 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 the trust, and is not available for distribution to the grantor under the governing provisions of the trust."

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