Key Takeaways
- Special needs trusts help financially support children with disabilities or other types of health needs.
- Many types of assets can be used to fund a special needs trust.
- Selecting the right trustee is a key decision for families using special needs trusts. Issues involving land acquisition (and other hurdles) can be challenging.
Special needs trusts are a tool that can help address the financial issues facing families with a child who has a disability. These trusts are often used by parents seeking to help ensure their child will be taken care of after they’re gone. Some parents also set up these trusts while still alive to help supplement the regular—and potentially astronomical—costs that accompany caring for a child with a disability.
Special needs trusts are becoming increasingly well known and common, in our experience. One reason is that there’s rising awareness of disabilities in general, thanks to advances in medicine and the ability to diagnose them. These days, it’s likely that you have a family member with a disability or know someone whose child has one. Also, rising life expectancies mean people with disabilities are living longer and therefore may need financial help for longer than did past generations.
While special needs trusts can offer important support for families, they can be complex and challenging to navigate. Big decisions need to be made about which type of trust to use, how to best fund the trust, who the trustee should be and a wide range of other issues, potentially.
With that in mind, here’s a closer look at some important do’s and don’ts to consider when it comes to special needs trusts.
Types of special needs trusts
Special needs trusts are designed to hold and safeguard assets to benefit a child. These trusts can be set up with terms and language for how and when the money should be used, although many specific terms must be met for the trust to be deemed acceptable. And as with many other types of trusts, a special needs trust can potentially protect assets if the child is sued or becomes divorced at some point.
Though special needs trusts vary, they typically cover issues such as:
- The purpose of the trust
- The ways in which money can—or can’t—be used to support the child
- The name and responsibilities of the trustee as well as any successor or co-trustees
- How the trust can be funded
- How any income earned off the trust is to be managed
- Beneficiaries who should receive funds in the trust if the child dies.
In general, there are two main types of special needs trusts that most families with assets to invest tend to consider:
- A first-party trust is set up when the assets contributed to the trust belong to the beneficiary—that is, your disabled child or grandchild. This can happen if the child inherits wealth or gets money from a legal settlement. The beneficiary is considered to be the owner of the assets in this scenario. The good news is that when those assets are put into a special needs trust, they’re excluded from aid calculations determining eligibility for government benefits (such as Supplemental Security Income). The bad news: When the beneficiary dies, the government can claim assets still in the trust to reimburse it for any assistance payments it made to the child over their life.
- A third-party trust is used when the funding assets come from parents, grandparents or anyone other than the beneficiary (who in this case would not be considered the owner of the assets). A third-party trust also allows a beneficiary to retain government assistance they might receive—but because the assets contributed belong to someone else, the government won’t seek to collect remaining assets when the beneficiary dies. The upshot: A third-party trust can give you more flexibility to transfer remaining wealth to another beneficiary (such as another child or a charity).
Important: Don’t assume you are too wealthy to qualify for government benefits (or that the child is). The rules can vary from state to state, making it possible you’ll be eligible for some amount of financial assistance.
Of course, you might not know with certainty whether the child will ultimately need a trust at all—for example, if the disability is one that may recede or diminish in severity over time. It may be possible to create a standard trust that includes a provision for converting to a special needs trust if certain events occur or criteria are met.
Funding a special needs trust
In general, you’ll find there’s some flexibility when it comes to getting assets into a special needs trust you set up. You can transfer assets into the trust either during your lifetime or at death, for example, and you can set it up as a revocable trust—which enables you to reclaim those assets down the road if necessary.
What’s more, there are numerous ways to fund the trust. For example:
- Life insurance, payable after the parents’ deaths
- Savings and investments, including cash and retirement accounts
- Gifts, assistance and inheritances from friends and family members
- Property, such as the family home or vacation house
That said, there are some funding moves that can be more beneficial than others. If you transfer a traditional retirement account such as an IRA or a 401(k) to a special needs trust while you’re alive, the amount you transfer will be treated by the IRS as a withdrawal from that account—meaning you’ll owe taxes.
In contrast, life insurance can potentially make more sense as a funding source in some cases. One option is a second-to-die policy. Both members of a couple are covered, and the policy pays out a benefit to the child after the second spouse dies. This way, the parents can supplement their child’s needs during life, then fund the trust using the life insurance policy after their deaths.
Selecting a trustee for a special needs trust
A special needs trust also needs a trustee to administer the trust. It’s the trustee’s job to distribute cash to the beneficiary (the child with the disability) in line with the trust rules and to generally act in the best interest of the beneficiary. That means following government benefit rules and requirements, managing tax obligations, and performing other duties, depending on the complexities of the trust.
Choosing a trustee is generally important with any trust, but it can be particularly crucial when the beneficiary is a minor or adult who may be especially dependent on financial assistance. For that reason, special needs trust trustees often are the beneficiary’s parents. Siblings or other close relatives can also be named as trustees.
That said, family members aren’t required to take on this role—and often don’t want to, given the number of responsibilities it can entail and the importance of those duties. Trustees can also be professionals or companies that specialize in special needs trusts. Or there can be a co-trustee relationship, in which the trustee role is shared by a professional and the parents/ relatives. That way, the parents can communicate the specific needs of the child and the professional trustee can handle the trust’s logistics.
Advice:
Name a successor trustee who can take over to manage the trust if the trustee becomes unable to fulfill the duties.
Help the helpers
One often-recommended step when establishing a special needs trust is to include a written letter of intent spelling out in detail any instructions you want to communicate to the trustee or others who will be involved in caring for your child, either today or in the future.
A letter of intent isn’t a formal legal document that’s binding. Instead, it’s meant to convey to another caregiver or guardian your key insights about a child and how to best care for them. Armed with clear information about the child’s needs, preferences, behavioral triggers and the like, other caregivers can get up to speed quickly—and potentially avoid challenging or even dangerous situations with the child.
Consider including the following information in a letter of intent to “help the helpers” give your child the type of care they got from you:
- Summary information. A short overview of your child’s life thus far, as well as your big-picture thoughts and hopes about your child’s future.
- Daily routine. Document your child’s typical schedule, preferred activities and any triggers that disrupt their ability to stay on course during an average day. For example, some kids can become agitated if daily events or tasks don’t follow a particular order—and caregivers should know that. Likewise, some children have strong issues with certain aromas, fabrics and so on.
- Diet. List favorite foods and, if necessary, how they should be prepared or cooked. Also highlight any food that your child is allergic to or dislikes.
- Health information. You need potential caregivers to know the child’s medical history, allergies, medical professionals (and the schedule/goals of their sessions with those professionals) and prescriptions.
Conclusion
Special needs trusts can be powerful allies in the lives of so many people—from children with disabilities and their parents to other family members and the people who ultimately may be looking out for the children’s best interests.
VFO Inner Circle Special Report
By John J. Bowen Jr.
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