Special needs trusts (SNTs) require proper funding so that certain assets are allocated to the trust. The trustee can then distribute these assets to benefit your disabled loved one.
Before funding can happen, you must choose the type of trust that best suits the situation for your special needs child or adult. Retaining a special needs attorney is critical to carefully select a first- or third-party SNT based on maximizing available government program benefits and assessing future tax implications.
Establishing the Trust as a Legal Entity
In some instances, the first step to funding a special needs trust is establishing a taxpayer ID number from the IRS. Once set up, the trust is irrevocable. An exception to the EIN requirement is establishing a living trust and will, which becomes irrevocable upon the trust creator’s death requiring an EIN later. This nine-digit Employer Identification Number (EIN) acts like a social security number for the trust so that the IRS can identify the trust as a separate legal entity.
Funding the Trust
Funding options for a special needs trust are unique to each family situation. Money from a personal injury settlement can fund a first-party SNT trust (if you are under 65 years old), and any inheritance the beneficiary receives directly. However, upon the death of the disabled individual, these trusts have pay-back provisions for Medicaid.
A third-party special needs trust is written either during the creator’s lifetime (inter vivos) or as a testamentary trust accessed upon the creator’s death. An inter vivos trust allows other family members or friends to contribute to the trust before the trust creator’s death. Typically, third-party SNT funding includes inheritances, family savings, and other financial gifts, which can be invested in stocks or bonds for growth and to hedge against inflation. The trust can be self-sustaining with the proper investment decisions.
A family creating a special needs third-party trust may also consider funding through:
Insurance – There are several products to consider before making your choice.
- Survivorship or second-to-die life insurance policies can be a good funding choice as they tend to have less expensive premiums; however, they will not pay out until the second member of a couple dies. Domestic partners may also purchase coverage as you do not have to be legally married to buy a policy. Problems may occur if the remaining spouse or partner does not have enough cash flow to cover the family’s ongoing expenses from other sources. A survivorship insurance policy requires a close look at your retirement planning and other income sources, as well as funding a special needs trust.
- Term life insurance is often another relatively inexpensive funding choice for a special needs trust. Term life insurance policies guarantee payouts during a specified period and typically cost less. You can renew these policies upon their expiration date, assuming you are not subject to significant health changes. Renewing term life insurance often means higher premiums as you age and if you encounter notable health changes.
- Whole life insurance will cover your entire life span. The premiums you pay collect in an investment account that the insurance company invests to grow value. These premium costs are fixed.
- Variable life insurance will also provide lifelong coverage; however, the policy cash value will fluctuate along with financial markets.
Real Estate – For a person with special needs, a family home may represent stability and routine, and living in that residence may be an important goal for continuity. Yet leaving the house in the name of your special needs loved one is often a big mistake as it affects means-tested government benefits. However, real estate in a third-party SNT will avert the Medicaid lien of a first-party trust upon their death and transfer to other beneficiaries instead.
If the special needs individual needs to move and sell the home, the sale proceeds will remain in the trust. If moving is not contingent upon selling the home, the SNT trustee can convert the property to a rental, producing income for the trust. In either case, it is important to have adequate trust funds to maintain a family home in the SNT.
Retirement Plans – Funding an SNT through retirement plans is complex. Without careful financial management, all the funds distributed to the trust’s beneficiary may be taxed during the transfer year. This situation may result in eligibility disqualification for government benefits and unnecessarily high taxes.
An exception is designating military survivor benefits to a special needs trust recently adopted through the Disabled Military Child Protection Act federal legislation. But, if your special needs trust receives funding from non-military retirement accounts, the SNT format should be an “accumulation trust,” which spaces out required minimum distributions. Additionally, any remainder beneficiaries (those entitled to remaining funds upon the death of the primary beneficiary) should ideally be younger than the primary beneficiary to avoid unintended distribution requirements.
Retirement accounts can negatively affect the intent of a special needs trust. Instead, many special needs attorneys or disability lawyers encourage draw downs on the retirement account to purchase life insurance for the SNT or leave their retirement funds to other heirs.
Getting Professional Advice
All funding options for a special needs trust require complicated decision-making. Before creating and funding an SNT, families should consult an attorney specializing in financial planning and special needs law. Understanding tax regulations, insurance options, and benefits laws are crucial to creating a trust that addresses the family’s goals for the future security of their loved one. Proactive planning with a special needs attorney can protect your loved one’s government benefits and provide additional assets through a properly funded special needs trust.
Please contact our Phoenix office at 480-699-3145 today and schedule an appointment to discuss how we can help you with your legal questions.