Thanks to medical science, longevity has increased. Most people take this as good news, but this change has pushed society's demographics in directions that were difficult to envision even a generation ago. Retirees can now often expect to live for another 20 or even 30 years after they stop working, which brings a relatively greater chance of disability at some point. This has created a growing demand for sound financial planning for those who become disabled, particularly in cases of permanent disability. Find out how a trust may help your future plans if you or someone you love (a spouse, a child) is living with a special need or disability.

A New Era of Planning

The financial need that comes with mental disability have led to the development of a new type of trust that can provide special benefits to recipients without reducing their eligibility for government aid. This is a critical issue, especially for persons with disabilities who qualify for long-term care and/or nursing home benefits under the Supplemental Security Income (SSI) or the Medicaid program. This type of trust, known as either a special needs trust or supplemental needs trust, is often established upon the receipt of either an inheritance or a legal settlement in order to allow for the additional receipt of governmental benefits. These benefits can include:

  • Social Security: Social Security is available to people with disabilities without regard to their current income and/or assets.
  • Supplemental Security Income: Qualified recipients who have not contributed adequately to their Social Security plans and have few or no assets are eligible for this program. However, their income and assets (called "resources" by SSI) cannot exceed a certain amount, with some exceptions. In general, assets above $2,000 for a single person and $3,000 for a couple will result in disqualification. Income must be below the approved threshold as well, which is determined according to the rules of the Social Security Administration (SSA).
  • Medicare: Recipients must be eligible for Social Security benefits, either as retirees or under the above-named characteristics, to qualify for Medicare.
  • Medicaid: Recipients must qualify for Supplemental Security Income benefits in order to be eligible. (To read more, see What's The Difference Between Medicare And Medicaid? )
Under federal guidelines, most people with disabilities who have a source of income and also receive public assistance must foot part of the bill for their own care. The laws also dictate that special needs trusts – also called supplemental needs trusts – must be irrevocable; each must have its own tax ID number. Neither the grantor's nor the beneficiary's Social Security number is used for this type of trust.

Trusts allow the grantor (the person who establishes the trust) to mandate that the trustee not use the assets of the trust to replace any government aid that will be received, such as Medicaid. The trustee in these cases may use income generated by the trust only to pay for expenses that will not be covered by government benefits. These trusts are thus required to state that their purpose is to provide supplemental care that exceeds what the government will pay; a trust that has been done correctly will refer to the appropriate sections of the Social Security manual that allow for its creation. It will also explicitly state that it is not a trust intended for basic support of any kind. Essentially, these trusts are useful for providing effective coordination between governmental and private funding sources, so that neither source impedes the other. Special needs trusts are also legally shielded from seizure or attachment from creditors.

Funding

Special needs trusts can generally be funded with a wide range of assets, such as stocks, bonds, mutual funds, annuities, cash-value life insurance, personal property or even real estate.

Cash-value life insurance can be especially beneficial because of the tax-free death benefit that avoids probate. Furthermore, the cost of the premiums may often be the only way that the family of a person with disabilities may be able to fulfill the need for long-term trust funding. (To learn more, see Skipping-Out On Probate Costs.) The only stipulation is that the trust must be created before the beneficiary reaches age 65 (and in most cases should be created as soon as possible in order to maximize government aid). Once the death benefit is paid into the trust, the trustee can use the proceeds to create an investment portfolio that will provide an appropriate level of income for the beneficiary in the years to come.

If the grantor – or other person who would be the insured person on the life insurance policy – turns out to be not insurable, an annuity can be substituted for a life insurance policy, despite its reduced leverage and tax efficiency. Unlike life insurance, annuity income is taxed as ordinary income. Annuities also do not pay out a benefit greater than their accumulated value.

Private vs. Public Trusts

The grantors of most special needs trusts generally have the option of choosing either a private or a public trustee (or both types) to run the trust. Private trustees are generally family members, while a public trustee is often a financial professional. In many cases, both private and public co-trustees are chosen by the grantor, as this allows one trustee to be a trusted family member who knows the needs of the disabled beneficiary while the other (public) trustee invests the assets and handles the administration of the trust. If no trustee is named, the court will  appoint someone to as a public trustee. (Keep reading about this subject in Can You Trust Your Trustee?)

The Bottom Line

Special needs trusts are complex instruments with rules that vary from state to state. Always use a qualified and experienced attorney when drafting one of these instruments, and be sure the trust is structured to provide the greatest possible coordination between income generated from the trust assets and any and all available governmental aid. To find out more about these trusts, contact your estate-planning attorney or financial advisor.



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