Asked and Answered:
WHY DOES MY FAMILY NEED A SPECIAL NEEDS TRUST?
You want your child with a disability to live a safe, happy, and meaningful life.
Few families have the wealth to assure a lifetime of care for a child with a disability. It is likely that your child will need assistance from government benefits. The big four are Supplemental Security Income (SSI), Social Security Disability Insurance (SSDI), Medicaid, and Medicare.
Your child with a disability may live many years after you die. The money you provide for your child after you die will be your child’s safety net. You need to protect that money in order to protect your child’s future.
It is even more essential that you protect your child’s eligibility for government benefits. For that reason, you should never leave money directly to your child when you die.
Assuming the trust is drafted in accordance with federal and state law, the money in the trust therefore will not be counted as a resource of your child for determining eligibility for SSI or Medicaid. The state will not seize the assets in the trust for cost-of-care claims after your child dies. The special needs trust also protects the inheritance from your child's private creditors such as a credit card company.
In short, the third-party special needs trust provides for the supplemental needs of your child with a disability, preserves the child’s eligibility for government benefits like SSI and Medicaid, and allows any remainder assets to pass on to other heirs or a charity after your child dies.
The third-party special needs trust is a discretionary trust, meaning it will be up to the discretion of the trustee when to buy something for the beneficiary and how much to spend. The beneficiary, your child with a disability, has no control over the money in the trust.
The special needs trust is usually just one piece of your estate planning puzzle. When you work with an attorney to draft your estate plan, you often have other important documents such as a will, living trust, power of attorney for healthcare, power of attorney for property, and so forth. Your will or your living trust will state what percentage of your estate should go to the special needs trust after you die. During your lifetime, the trust can “catch” gifts, bequests, and other assets intended for the benefit of your child.
Few families have the wealth to assure a lifetime of care for a child with a disability. It is likely that your child will need assistance from government benefits. The big four are Supplemental Security Income (SSI), Social Security Disability Insurance (SSDI), Medicaid, and Medicare.
Your child with a disability may live many years after you die. The money you provide for your child after you die will be your child’s safety net. You need to protect that money in order to protect your child’s future.
It is even more essential that you protect your child’s eligibility for government benefits. For that reason, you should never leave money directly to your child when you die.
Assuming the trust is drafted in accordance with federal and state law, the money in the trust therefore will not be counted as a resource of your child for determining eligibility for SSI or Medicaid. The state will not seize the assets in the trust for cost-of-care claims after your child dies. The special needs trust also protects the inheritance from your child's private creditors such as a credit card company.
In short, the third-party special needs trust provides for the supplemental needs of your child with a disability, preserves the child’s eligibility for government benefits like SSI and Medicaid, and allows any remainder assets to pass on to other heirs or a charity after your child dies.
The third-party special needs trust is a discretionary trust, meaning it will be up to the discretion of the trustee when to buy something for the beneficiary and how much to spend. The beneficiary, your child with a disability, has no control over the money in the trust.
The special needs trust is usually just one piece of your estate planning puzzle. When you work with an attorney to draft your estate plan, you often have other important documents such as a will, living trust, power of attorney for healthcare, power of attorney for property, and so forth. Your will or your living trust will state what percentage of your estate should go to the special needs trust after you die. During your lifetime, the trust can “catch” gifts, bequests, and other assets intended for the benefit of your child.
WHAT HAPPENS IF MY CHILD INHERITS MONEY DIRECTLY?
Three problems occur if you leave money directly to your child:
1. Your child may not be able to manage the money.
2. The inheritance will disqualify your child from receiving means-tested benefits like SSI or Medicaid.
3. The inheritance is subject to cost-of-care claims by the state and vulnerable to possible private creditor claims.
1. Your child may not be able to manage the money.
2. The inheritance will disqualify your child from receiving means-tested benefits like SSI or Medicaid.
3. The inheritance is subject to cost-of-care claims by the state and vulnerable to possible private creditor claims.
HOW COULD MONEY BE GIVEN DIRECTLY TO MY CHILD AFTER I DIE?
If you make one of the following mistakes, your child will inherit money directly:
1. If you die without a will, the laws of descent and distribution in your state will write a will for you, and a portion of your estate will be distributed to your child with a disability regardless of consequences.
2. If you name your child with a disability as a beneficiary on your life insurance, retirement plan, IRA, or an annuity. For example, you might routinely name your spouse as primary beneficiary and your children as secondary beneficiaries of your employment benefits.
3. You have a standard will that distributes some portion of your estate equally among your children, including the child with a disability. Or perhaps money for that child goes into an ordinary trust that will make an outright distribution when the child reaches a certain age.
WHO ARE THE PARTICIPANTS IN A SPECIAL NEEDS TRUST?
The grantor (or trustor or settlor) is the person who creates the trust. That would be you.
The beneficiary is your child with a disability. That child does not own or control assets in the trust, but receives the benefits of the trust.
The trustee manages the assets in the trust, under the terms and conditions of the trust document. If you are married, you and your spouse are usually the initial co-trustees. If you are single, then typically you will be the sole trustee.
You will name a sequence of successor trustees to take over after your death or in the event of your own incapacity. Your choices here are critically important and represent your deep literal “trust” in those whom you choose.
You will also name remainder beneficiaries, the individuals or organizations that will receive the remaining assets of the trust after your child with a disability dies.
The beneficiary is your child with a disability. That child does not own or control assets in the trust, but receives the benefits of the trust.
The trustee manages the assets in the trust, under the terms and conditions of the trust document. If you are married, you and your spouse are usually the initial co-trustees. If you are single, then typically you will be the sole trustee.
You will name a sequence of successor trustees to take over after your death or in the event of your own incapacity. Your choices here are critically important and represent your deep literal “trust” in those whom you choose.
You will also name remainder beneficiaries, the individuals or organizations that will receive the remaining assets of the trust after your child with a disability dies.
SHOULD THE SPECIAL NEEDS TRUST BE A LIVING TRUST?
Your attorney can draft a living special needs trust that becomes effective the moment you sign it, or your attorney can draft a special needs sub-trust that is placed inside your will or inside your living trust. The special needs sub-trust becomes operative only after you die and is funded from your trust estate. Either approach is legal, but I have a preference.
When I am working with parents who have a child with special needs, I usually draft an unfunded living special needs trust. Mom and Dad are the trustees. They do not have to fund the special needs trust during their lifetimes, because a portion of their estate will fund the trust after they die. Also, I build language into the parents’ trust that states that if the parents become incapacitated, the trustee can act for them to fund the special needs trust.
Here are the advantages of the living special needs trust:
• During your lifetimes, you can contribute to a checking account or an investment account in the name of the trust. Relatives and friends can also make monetary gifts to the trust that can be deposited into those accounts for your child with a disability. These gifts effectively fund the trust when deposited. These deposits will not effect your child’s eligibility for Supplemental Security Income (SSI) or Medicaid.
• Grandparents and other relatives can name the special needs trust as a beneficiary of their own wills or trusts. They couldn’t do this with a sub-trust because the sub-trust is not yet in existence.
• It’s easier to name the trust as a beneficiary of your life insurance, retirement plan, or an IRA than naming a sub-trust under your will or living trust. You can name a sub-trust as a beneficiary but it is wordier and particularly difficult for online beneficiary forms.
WHERE IS THE TRUST?
Many people think the trust has to be at one particular bank or financial institution. Not true.
I think the easiest way to think about it is for me to ask you “Where is your money?”
You might have a checking or savings account, an investment account, a home equity account, an IRA, or another retirement account. And how do we know you own it? Your name is on the account, right?
It’s the same with a special needs trust: You can open up an account, a checking or investment account, in the name of the trust at most financial institutions. Or, as trustee, you could buy a condominium and the deed would say that you, as trustee of the trust, is the owner.
You, as trustee, can move the trust accounts to another financial institution or even to another state as convenience and circumstances require.
I think the easiest way to think about it is for me to ask you “Where is your money?”
You might have a checking or savings account, an investment account, a home equity account, an IRA, or another retirement account. And how do we know you own it? Your name is on the account, right?
It’s the same with a special needs trust: You can open up an account, a checking or investment account, in the name of the trust at most financial institutions. Or, as trustee, you could buy a condominium and the deed would say that you, as trustee of the trust, is the owner.
You, as trustee, can move the trust accounts to another financial institution or even to another state as convenience and circumstances require.
SHOULD WE USE AN ABLE ACCOUNT IN FINANCIAL PLANNING FOR OUR CHILD INSTEAD OF A SPECIAL NEEDS TRUST?
Similar to the College Savings plan (or 529 account), An Achieving a Better Life Experience (ABLE) account (or 529A account) is a tax-advantaged account that an individual can use to save funds for disability-related expenses. The beneficiary of the account must be blind or disabled by a condition that began before the individual’s 26th birthday. Social Security does not count the assets in the ABLE account as a resource of the individual if the balance is $100,000 or less. After the death of the designated beneficiary and payment of any outstanding disability expenses, funds remaining in the ABLE account are used to reimburse the state(s) for certain Medicaid benefits that the designated beneficiary received.
Any person can contribute to an ABLE account. (“Person,” as defined by the Internal Revenue Code, can also include a trust.) However, the IRS limits the total annual contributions that any ABLE account can receive from all sources to the amount of the per-donee gift-tax exclusion in effect for a given calendar year. In 2018, for example, that limit is $15,000.
Here’s an example: Let's say your daughter is working at a supermarket for $400 per month. Your child wants to save $4,000 to pay for orthodontic care. The problem is your child cannot own more than $2,000 in her name and still remain eligible for Supplemental Security Income. What do you do? Your child can transfer money into an ABLE account and that money will not count toward the $2,000 resource requirement for SSI and Medicaid.
The ABLE account is useful in other ways: If the child inherits a small inheritance under $15,000 it can be transferred into an ABLE account to preserve eligibility for SSI or Medicaid. Most importantly, the ABLE account empowers the person with a disability to manage his or her own money without losing SSI or Medicaid.
An ABLE account can be a very useful element in your estate plan for your child, but it is not, repeat not, a substitute for a third-party supplemental needs trust. Here’s why:
• Here’s the biggest concern: Upon the death of your child, the state may file a claim against any remaining money in the account for cost-of-care or Medicaid waiver services during your child’s lifetime. That means, the state can seize money that you (the parent) contributes to the ABLE account.
• When assets in the account total $100,000, Social Security suspends your child’s SSI benefits. However, your child can continue to receive Medicaid up to the state limit that varies from state to state.
• You can only contribute cash to an ABLE account. Unlike a special needs trust, the ABLE account cannot hold title to real estate.
• There is a limit on how much money you can deposit into an ABLE Account per year (for 2018, $15,000).
• Compared to a special needs trust, you have less ability to control and direct the investments in the ABLE account,
• There are restrictions on how the money can be spent and various reporting requirements,
• There is no trustee or custodian. Unless you are the guardian for your child, your child has control and access to the money which may be empowering with a modest amount of money but imprudent with larger amounts,
• If you are the guardian for your child, in some states you will need court approval to place the cash in the ABLE account and some counties require an annual surety bond,
• Only individuals whose disability was established before age 26 can set up an ABLE account.
It should be clear, even in this brief overview, that in comparison to an ABLE account, the third-party supplemental trust offers more capacity, flexibility, protection, and (via the trustee) more control. If your child with a disability works, has an income, and is able to manage his or her earnings, or you want to empower your child to manage money that will not count as a resource for SSI eligibility, by all means use an ABLE account. However, for ensuring the long-term security for that child, preserving the assets in the trust after your child dies, and having a trustee to manage the assets, trust your own estate to a third-party supplemental needs trust.
WHO PAYS TAXES ON TRUST INCOME?
The taxation of special needs trusts depends on many factors. However, if you are a parent and you have created a third-party supplemental needs trust for your child, the trust will likely be deemed a "Grantor" trust pursuant to IRS regulations. Income from the trust will be taxed to you while you are living.
Bear in mind that in your lifetime, the trust will likely be unfunded or casually funded (by incidental gifts and bequests given on your child’s behalf). The tax burden for you, in most cases, will not be significant.
After your death, when the trust becomes fully funded by proceeds from your estate, your successor trustee will be responsible for filing an income tax return for the trust. In general, a trust deducts income distributed to the beneficiary and the beneficiary pays income tax on the taxable amount of distributions. Tax law governing trusts is not a subject for amateurs, and your trustee will be grateful that your trust document authorizes the trustee to obtain the services of professionals and specialists as necessary.
Bear in mind that in your lifetime, the trust will likely be unfunded or casually funded (by incidental gifts and bequests given on your child’s behalf). The tax burden for you, in most cases, will not be significant.
After your death, when the trust becomes fully funded by proceeds from your estate, your successor trustee will be responsible for filing an income tax return for the trust. In general, a trust deducts income distributed to the beneficiary and the beneficiary pays income tax on the taxable amount of distributions. Tax law governing trusts is not a subject for amateurs, and your trustee will be grateful that your trust document authorizes the trustee to obtain the services of professionals and specialists as necessary.