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Potential Annuity Purchases by the Trustee Do Not Provide the Settlor of an Income-Only Irrevocable Trust with Access to Principal

May 22, 2014

As noted in prior posts, many irrevocable trusts in Massachusetts are now under wrongful attack during the MassHealth application process by the Office of Medicaid. One of the more specious arguments brought forth by the Office of Medicaid has been that the Trustee could purchase an annuity and thereby provide the Settlor of the trust with access to principal. Unfortunately, the memorandum of the Office of Medicaid that is typically filed at MassHealth fair hearings betrays a fundamental ignorance of basic annuity principles and trust law. When a payment is received from an annuity, the portion of the payment that represents a return of principal is nontaxable, and reasonable accounting principles require the trustee to allocate the return of principal to the corpus or principal of the trust.

Section 103(a)(4) of the Uniform Principal and Income Act, as adopted in Massachusetts as M.G.L. c.203D, s. 3(a)(4), states that, in allocating receipts and disbursements to or between principal and income, a trustee “shall add a receipt or charge a disbursement to principal if the terms of the trust … do not provide a rule for allocating the receipt or disbursement to or between principal and income.”  Thus, the legal presumption in Massachusetts is that any amount received by a trustee is not income, but rather principal. In the absence of explicit contrary powers in the trust, the trustee has no power to deviate from generally accepted practices of fiduciary accounting when determining what is income and what is principal. See Restatement (Third) of Trusts §233, comment p.

Under the Massachusetts Principal and Income Act, “[i]f a payment is characterized as interest or a dividend or a payment made in lieu of interest or a dividend, a trustee shall allocate it to income. The trustee shall allocate to principal the balance of the payment and any other payment received in the same accounting period that is not characterized as interest, a dividend, or an equivalent payment.” G.L. c. 203D, § 18(a). The Massachusetts Principal and Income Act also provides that “[a]n amount received as interest, whether determined at a fixed, variable or floating rate on an obligation to pay money to the trustee, including an amount received as consideration for prepayment of principal, shall be allocated to income without any provision for amortization of premium.” G.L. c. 203D, § 15(a). Thus, annuity distributions cannot be treated solely as income under Massachusetts law, where most of such payments are a return of principal.

The memorandum of the Office of Medicaid typically points to Massachusetts law and states that trustees are specifically given the power to invest in annuities, but the Office of Medicaid’s cite to M.G.L. c. 203, § 25A, is pointless, as it was repealed in 2008.  That trustee power, however, is irrelevant to the question of whether the trustee has the discretion to distribute principal to the applicant. The Office of Medicaid cites regulations in support of its position that all payments from annuities are “income,” but if the irrevocable trust does not make reference to those regulations, it is instead governed by its express terms, common law and statutory authority, including the Massachusetts Principal and Income Act.

The Office of Medicaid completely ignores the Massachusetts Principal and Income Act in its memorandum of “law.”  The Office of Medicaid may not unilaterally impose its own definition of “income” from another context and create unintended definitions of terms and phrases within an irrevocable trust. Allowing any state agency to do so would wreak havoc on well-established trust doctrine, upset settled legal expectations of settlors, trustees and beneficiaries, and be in violation of the Massachusetts Principal and Income Act.

2 Comments leave one →
  1. Rick DiMare permalink
    May 23, 2014 7:49 am

    Brian, thanks for posting these topics and opening them for discussion.

    I attended the MCLE Elder & Disability seminar last Wednesday and it was said that Massachusetts interpretations of principal and income should govern IIOTs, but this doesn’t sound right to me. It may be true if Medicaid was solely a state run program, but since it’s not, it seems to me that a strict federal definition of “income” would preempt any state’s interpretation of what is income vs. what is principal. Am I missing something?


  1. The Case of Heyn v. Director of the Office of Medicaid Brings Much of Medicaid Trust Law in Massachusetts Back to Reality | Massachusetts Estate Planning, Probate & Elder Law

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