Special Needs Trust

An Important Planning Tool for Special Situations

By Michael Lackey, J.D., CFP®

Sometimes it happens at birth, or soon after. Parents are faced with the toughest-of-all scenarios: their child has severe developmental problems and will require special care throughout his or her life. Or it may happen later on. A diving accident, a car wreck, a brain tumor or a sustained high fever—and a previously healthy person will never again function without help. Whatever the cause, the individual's family faces difficult challenges, both emotional and financial. Even for families with the resources to cover this type of care, the need for long-range planning remains. Often, the plan involves a customized special needs trust.

Dealing with disability is difficult for families, both emotionally and financially. It's also not an uncommon issue, given that 28% of American families have at least one family member with a disability.* Situations involving special needs children are particularly challenging, given that the child's needs may very well extend beyond the parents' lifetimes.

"Situations involving special needs children may very well extend beyond the parents' lifetimes."

There are federal and state programs in existence for the benefit of qualifying children and adults with special needs, such as Supplemental Social Security Income (SSI) and Medicaid. But these programs are designed to cover only the basics. There are also asset limitations in place which, if exceeded, will disqualify the recipient from further aid.

One way to address this is through the creation of a special needs trust. There are two general categories of special needs trusts. The first category consists of “self-settled” trusts, funded with assets owned by the beneficiaries. The second category includes “third-party trusts,” created with funds belonging to someone other than the beneficiaries.

Beneficiary-funded trusts are effective in providing additional care for individuals whose trusts are created before age 65; however, upon the beneficiary’s death, the agency providing Medicaid must be reimbursed from remaining trust assets for care provided during the existence of the trust. Note that some states have “pooled trust” arrangements for smaller trusts within this category that are established and maintained by nonprofit charitable organizations.

A viable alternative for wealth clients is the use of trusts fitting within the second category. These third-party trusts, created typically by parents or grandparents, may be funded at death as a part of the creator's estate plan, or established during the grantor's lifetime (inter-vivos trusts) and may be either revocable or irrevocable. This year and 2012 may be a particularly advantageous time to set up irrevocable inter-vivos trusts, considering that each person has a $5 million gift and generation skipping transfer tax exemption during this time period.

When this type of trust is properly drafted, the disabled children have no ownership, control or access to the trust funds. Because of this, these assets are not considered in determining eligibility for SSI or Medicaid. Thus, third-party supplemental special needs trusts provide an extra level of funding for the beneficiaries without disqualifying them from government assistance.

Points to Consider

In order to maintain eligibility, family members such as aunts and uncles should be made aware of planning and should make gifts to the trust rather than directly to the child. During the planning phase, parents' retirement account, life insurance policy, and investment account beneficiary and ownership designations should be reviewed to avoid having funds flow directly to the child.

Examples of supplemental assistance might include vacations and recreational activities, transportation and professional services, or simply medical care in excess of that covered by Medicaid. It is possible to create a trust designating other beneficiaries in addition to the special needs child. Also, at the death of the special needs beneficiary, the remainder may be distributed to others, such as the decedent child's siblings.

Trustee selection is important to consider in contemplating the trust. In order to prevent the control aspect noted above, neither the beneficiary nor their spouse should serve as trustee. Consider instead a different individual or professional trustee—or a combination—to oversee and administer the trust. Family members may serve, but beware of the potential for adverse tax consequences if the family appointees are current or remainder beneficiaries.

One of the emotional challenges in funding such a trust is dealing with the idea that it may not be possible to treat all children in a family equally in terms of providing a legacy at the death of the parents. A possible approach is to provide an additional pool of funds through the use of life insurance.

While the trust document gives legal direction—setting forth the terms of how distributions are made, to whom, and when—it may also be desirable for the parents to provide additional knowledge and guidance to trustees and caregivers in the form of a letter of intent or instruction. This provides insight as to how the daily activities of the child have been managed in the past.

Key Documents

Parents should have properly drafted and executed estate planning documents including a last will and testament with selection of a guardian for minor children, durable financial power of attorney, healthcare power of attorney, and a living will. Upon consultation with an estate planning specialist, some clients will also include a revocable trust agreement (living trust) as a part of the estate plan. The special needs trust may be drafted as a stand-alone document, included as a testamentary trust in the will, or in the revocable trust agreement.

Adult special needs children who are legally competent should have their own set of estate planning documents, with a focus on providing a means of allowing parents to receive medical information and assist the child in making medical and financial decisions. Parents of adult children who are not legally competent will need to follow state law requirements regarding guardianship in order to manage the child’s needs.

Requirements regarding the establishment of these types of trusts vary from state to state, so it is critical to consult an attorney with expertise in this area. The drafting attorney will take into account not only the laws regarding Social Security and Medicaid, but also the income, gift and estate tax consequences of the structure of the special needs trusts. Working in conjunction with your BB&T Wealth Management team helps ensure a comprehensive, integrated approach to financial planning.

BB&T and its representatives do not offer tax or legal advice. Please consult your individual tax or legal professional regarding your personal circumstances.

Mike received his B.A. from Wofford College and earned a law degree from Woodrow Wilson College of Law, where he received the American Jurisprudence Book Award for excellence in the study of insurance law. He is a member of the State Bar of Georgia and its Fiduciary Law section. He also is a member of the Greenville, S.C., Estate Planning Council and the South Carolina chapter of the Financial Planning Association. He maintains the Certified Financial Planner (CFP®) designation.

* Disability and American Families: 2000. U.S. Census Bureau. July 2005.

This article originally appeared in the Summer 2011 issue of Wealth magazine.

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