BY Dawn Doebler, MBA, CPA, CFP®, CDFA®, Senior Wealth Advisor
Here are 5 common reasons for establishing a special needs trust that applies to your family member with a disability.
In my last article, I outlined the benefits of ABLE accounts. For many families, ABLE accounts sufficiently meet their desire to provide assets for special needs family members. In higher net worth families, ABLE accounts are the first step in structuring a long-term financial plan for someone living with a disability. Oftentimes, the next step is to create a Special Needs Trust structure to hold current assets or receive funds a disabled beneficiary may receive in the future.
A special needs trust (also known as a supplemental needs trust) is designed to hold and protect financial assets for the benefit of a disabled beneficiary. The trust is a legal structure used to collect and manage the assets and may receive contributions from a variety of sources, including assets gifted from family members during their lifetime. A special needs trust is frequently established to receive assets from a legal settlement, especially if the recipient is a minor. Other special needs trusts are established via an estate plan when parents or other family members want to provide assets or life insurance proceeds at their own death as an inheritance for someone with special needs.
While many high net worth families are aware of special needs trusts, I find they’re often unsure whether their situation warrants establishing this type of trust. If you’re uncertain, it may be helpful to consult with an attorney to review your specific situation. Before taking that step, you may want to see if any of these five common reasons for establishing a special needs trust apply to your family.
1. Earmarking assets for support during your life or at your death
In general, trust structures are intended to provide a legal way to title and hold assets to be used to support one or more beneficiaries. Special needs trusts are similar and are used to benefit someone who has physical or mental disabilities. A special needs trust can be used to provide for a variety of needs and the initial trust language specifies the donor’s intended use of the funds.
For example, one of my former clients had a daughter living in a group home. He had substantial net worth and wanted to structure a way to provide her more comfortable living conditions including upgraded furnishings for her room. By providing for her through a special needs trust, he felt more confident that his daughter could live more comfortably while maintaining the necessary group living arrangement.
2. Putting a trustee in place
One of the primary benefits of a trust structure is the ability to appoint a trustee to manage investment decisions and oversee the distribution of assets. If you have a beneficiary who is unable to manage finances independently, the trustee fills an important role of watching over the assets and administrating spending decisions. The trustee is also required to ensure that assets are used according to the initial intentions.
Selecting a trustee can be difficult and it’s not always the best idea to select an older sibling or other family member as trustee. In this situation, getting the advice of an attorney can be helpful to determine who may be the most prepared to carry out all the duties expected of a trustee. In addition to designating an initial trustee, you’ll also want to name a successor trustee in case your first choice is unable to serve.
3. Maintaining a disabled person’s government aid
Sometimes, well-meaning family members make the mistake of naming a disabled family member as a beneficiary in their will. Doing so could actually disadvantage a disabled person by disrupting support they receive from government programs. By leaving assets to them outright, if those assets exceed $2,000 in value, the inheritance could cause the disabled person to lose government assistance programs. A range of government programs have income restrictions including Supplemental Security Income (SSI), Medicaid and other services such as job training and subsidized housing. When you consider that disabled individuals may have limited ability to earn money from other sources, disrupting any source of stable income to them may put them at risk.
To protect the beneficiary, grantors can direct intended inheritance or life insurance benefits to a special needs trust. In doing so, you can provide for spending that may improve a beneficiary’s quality of life without jeopardizing government monthly income or other services that may be their main (or only) ongoing source of support.
4. Protecting assets from creditors or providing assets in divorce
Not everyone with a disability qualifies for SSI or other government programs. However, you may still want to use a special needs trust structure for their protection. Like most trusts, a special needs trust can be effective in protecting assets if your beneficiary were ever sued or if they go through a divorce.
In the case of divorce, a special needs trust may be required as part of the divorce agreement. The first reason this may occur is so that the trust can be used to receive court ordered child support that benefits a disabled child. The use of the trust is important to shield child support payments from being considered when determining whether the child qualifies for government aid. The second reason couples may include a special needs trust in the divorce settlement is to use it to accumulate assets earmarked for future use of a disabled child. Additionally, during a divorce, life insurance coverages are often revised, and you should consider putting a special needs trust in place if any life insurance policies list a disabled person (minor or adult) as a beneficiary.
5. Preserving family wealth
The reason to establish a special needs trust is similar to reasons for using other types of trusts. Whenever you have a spendthrift beneficiary, a trust structure is helpful to create a way to provide assets while limiting their use. A special needs trust also helps ensure that wealth is allocated properly.
For example, many parents worry about providing for a special needs child who may outlive them. They also may worry about uneven distribution of their wealth which could upset other children who stand to be beneficiaries. Parents could direct that any remaining funds in the trust at the disabled beneficiary’s death be distributed to their other children. Although some types of special needs trusts (see below) allow the state a claim to assets at the death of a beneficiary, having a trust structure preserves the grantor’s right to direct final beneficiaries which may include other children, relatives or a charity.
Implementing a special needs trust
If any of the above situations apply to your family, you may want to consider establishing a special needs trust during your lifetime. Or, you may want to change your estate plan to establish the trust upon your death. While in theory you could write a special needs trust document on your own, that’s not advisable. Rules differ from state to state and you’ll want to find an estate attorney to consult on the specifics required in the document, as well as to discuss who might be an appropriate trustee for the trust.
Another important consideration is how to fund a special needs trust. In general, there are three main types of special needs trusts and the source of funding dictates the type of trust and the rules that apply. The first type of special needs trust is a first-party special needs trust which is used when the assets contributed belong to the beneficiary. This may be the case if the special needs individual receives an inheritance or a legal settlement. When that occurs, the beneficiary is considered to be the owner of the assets. If these assets are paid into a special needs trust, then they are excluded from government aid calculations. The offset to the ability to maintain government aid even with substantial wealth in a special needs trust is that when the beneficiary dies, assets remaining in the trust can be claimed by the government to reimburse them for medical and other costs paid through government programs.
If assets funding the trust come from someone other than the beneficiary, then you have a third-party special needs trust. One of the advantages here is that family members can contribute a variety of assets, including a home or even complicated investment assets. A third-party trust allows a beneficiary to still qualify for government aid. The main benefit here is that, since the funding assets belong to someone else, there is no government reach back at the beneficiary’s death. As a result, the family can direct the successor beneficiary and keep the wealth in the family or use it to benefit a desired charity.
The third type of special needs trust, a pooled trust, is designed for those who have more modest assets or for families who do not have someone who can act as a trustee. Pooled special needs trusts are administrated by a non-profit organization that gathers trust assets from multiple special needs beneficiaries. While each person has their own account, the funds are administered together to lower cost and simplify administration. Like a first-party trust, pooled special needs trusts have the government reimbursement requirement. Pooled trusts also include a provision that some of the remaining assets are passed on to the non-profit organization as payback for management of the trust.
Anyone can establish a special needs trust and most families will want to do so under the direction of an attorney in order to properly handle the related tax and estate planning details. You may also want to seek assistance to ensure the person with disabilities would continue to receive government aid. While the planning may be more complicated, a special needs trust can also be used to provide for elderly adults in need of Medicaid paid long-term care. Special needs trusts have a variety of important uses and can be an effective planning tool for families who want to ensure a person with disabilities is taken care of in the future.