Funding a Special Needs Trust
- Don Drake
- Aug 5, 2024
- 7 min read
Funding a Special Needs Trust - Protecting Essential Government Benefits for the Future
by Don Drake, Connelly Law Offices, Ltd. 8.5.24
"Inquiries through our website often revolve around the purpose and utilization of Special Needs Trusts (SNT)," said professional fiduciary and certified elder law Attorney RJ Connelly III. "To provide a brief overview, special needs planning encompasses various aspects such as special needs trusts, care management, advocacy to safeguard educational or civil rights, and accessing public benefits like Supplemental Security Income (SSI) and Medicaid."
"In today's blog, we want to delve deeper into funding the SNT," continued Attorney Connelly. "Proper funding of an SNT is essential, and this involves designating the trust as the owner of specific assets. This designation enables the trustee to distribute these assets for the benefit of the disabled individual."
To properly fund these trusts, selecting the type of trust best suits the special needs child or adult's situation is imperative. Working with an experienced and knowledgeable special needs attorney, like Connelly Law, is crucial to carefully choosing between a first- or third-party SNT. This decision should be based on maximizing available government program benefits and assessing future tax implications.
Funding the Trust
"Funding options for the SNT are tailored to each family's circumstances," explained Attorney Connelly. "For example, funds from a personal injury settlement can be used to establish a first-party SNT trust if the individual is under 65. Additionally, any inheritance received directly by the beneficiary can also be utilized. However, it's important to note that these trusts are subject to pay-back provisions for Medicaid upon the disabled individual's passing."
A third-party special needs trust can be created either during the creator's lifetime, known as an inter vivos trust, or as a testamentary trust accessed upon the creator's death. "An inter vivos trust enables other family members or friends to contribute to the trust before the trust creator's passing," Attorney Connelly pointed out. "In most cases, third-party SNT funding includes inheritances, family savings, and financial gifts. These funds can be invested in stocks or bonds to ensure the trust's growth and act as a hedge against inflation. With appropriate financial decisions, the SNT trust can become self-sustaining."
Families can take several other approaches to establishing and funding third-party SNTs. Let's explore these possibilities.
Life Insurance Policies
When making your decision, it's important to carefully evaluate the various products available to ensure that you make an informed choice.
Survivorship or second-to-die life insurance policies are often favorable funding choices due to their lower premiums. However, it's important to note that these policies will only pay out after the second member of a couple passes away. According to Attorney Connelly, it's worth highlighting that domestic partners are also eligible to purchase this coverage, as marriage is not a prerequisite for policy acquisition. One potential concern is the financial strain that may arise if the surviving spouse or partner lacks the resources to cover ongoing family expenses from other income sources. It's crucial to thoroughly assess your retirement planning and other income streams when considering a survivorship insurance policy and making provisions for funding a special needs trust.
Term life insurance is frequently considered a cost-effective method of funding a special needs trust. Attorney Connelly states, "Term life insurance policies ensure benefits for a specified period and are generally affordable." These policies can be renewed at the end of the term, provided there are no substantial changes in health. However, renewing these policies as you age or if your health declines will result in higher premiums.
"Whole life insurance covers your entire lifetime, and your premiums accumulate in an investment account. The insurance company then invests these funds to increase the policy's overall value," explained Attorney Connelly. "Additionally, the premium costs of these policies remain fixed."
Attorney Connelly emphasized that variable life insurance offers lifetime coverage. Still, it's important to note that the policy's cash value is tied to the performance of underlying investment options, such as stocks and bonds. As a result, the cash value can fluctuate based on the financial market, potentially exposing policyholders to investment risks.
Real Estate
For individuals with special needs, their family home is a critical source of stability and routine. Therefore, maintaining residence within this familiar environment can significantly contribute to their long-term well-being. However, transferring home ownership to a special needs individual can affect their eligibility for means-tested government benefits. Thankfully, there are alternative solutions available.
One such option involves placing the real estate in a third-party Special Needs Trust, which effectively shields it from Medicaid liens that would otherwise affect a first-party trust and enables the transfer of the property to other beneficiaries upon the individual's passing.
If the individual with special needs must relocate and sell their home, the proceeds from the sale will be retained within the trust. However, suppose the decision to move does not hinge upon the sale of the property. In that case, the SNT trustee retains the flexibility to convert the home into a rental property, generating income that can benefit the trust. Regardless of the scenario, it is paramount to ensure that the trust holds sufficient funds to support the maintenance of the family home within the SNT.
Retirement Plans
As Attorney Connelly points out, funding the SNT with retirement plan assets requires thorough consideration and careful fiscal management. "When funding an SNT with retirement assets, all funds distributed to the trust's beneficiary may be subject to taxation in the transfer year," he continued. "This could lead to disqualification for governmental benefits and higher tax liabilities."
However, there is an exception to this general rule. The exception pertains to designating military survivor benefits to a special needs trust, as recently provided for by the Disabled Military Child Protection Act. Attorney Connelly explains that for an SNT receiving funding from non-military retirement accounts, the trust should function as an "accumulation trust," thereby spreading the required minimum distributions. Additionally, it is recommended that any remainder beneficiaries (those entitled to the remaining funds upon the primary beneficiary's death) be younger than the primary beneficiary to avoid unintended distribution requirements.
Moreover, Attorney Connelly emphasizes the potential negative impact of retirement accounts on the purpose of the special needs trust. There may be a need to encourage drawdowns on the retirement account to facilitate the purchase of life insurance for the SNT or to allocate the retirement funds to other heirs. This underscores the complexity involved in utilizing retirement funds for an SNT.
What the SNT Can Cover
SNTs are specifically crafted to address a diverse range of expenses that contribute to improving the overall quality of life for individuals with disabilities. These trusts typically finance fundamental requirements such as education, recreational activities, counseling, and medical care that extend beyond the necessities of life. Notable examples of expenses that SNTs may cover include:
Medical and dental expenses that are not covered by other sources.
Purchase of equipment such as wheelchairs or specially equipped vans.
Acquisition of a vehicle to provide independence and mobility.
Therapy or rehabilitation services to support physical or mental health needs.
Funding for training and education to develop skills and pursue personal interests.
Assistance with planning and enjoying vacations to create enriching experiences.
Support for starting a business or entrepreneurship endeavors.
Provision of home furnishings to ensure a comfortable living environment.
Financial assistance for travel, including the cost of a companion for support.
Access to transportation services such as Uber, Lyft, or public transportation.
Funding for recreational and entertainment activities, such as summer camps, movies, social events, and sports equipment.
Purchase electronic equipment, appliances, and computers to facilitate communication and independence.
Payments for a companion to provide assistance and companionship.
Coverage of legal or guardianship expenses related to managing the trust.
Payment of insurance premiums to protect the individual and their assets.
Allocation for burial expenses to provide end-of-life arrangements and peace of mind.
"This list illustrates the diverse range of expenses that can be covered by an SNT, demonstrating its importance in providing financial support and enhancing the overall well-being of individuals with disabilities," said Attorney Connelly.
What an SNT Cannot Cover
The SNT should not be used to provide certain essential items, such as groceries, rent or mortgage payments, cash, gift cards, condo association fees, property taxes, and utilities like electricity. Trustees also should not give an SSI or Medicaid beneficiary cash or a cash equivalent or pay for food or shelter without consulting a special needs planner first. However, in consultation with the planner, the trustee might consider using trust funds for food and shelter if it's in the beneficiary's best interest, even if it leads to a potential loss or reduction in public assistance. Once cash, housing, and food are taken care of, a special needs trust can cover most other expenses to enhance the beneficiary's quality of life.
A Final Thought
"It is essential to recognize that the SNT primarily aims to preserve government benefits for the designated beneficiary," explained Attorney Connelly. "The SNT can be established specifically for the proceeds from a life insurance policy or a will, even before the funds are available for financing. Once the funds become accessible, they can be placed into the trust. It is crucial to inform anyone intending to leave money to a person with special needs in a will that directing the funds into the SNT, rather than giving it directly to the individual, may help protect their public benefits. In such instances, it is essential to collaborate with an attorney specializing in SNTs to determine the most suitable approach for your family's requirements. Due to the potentially serious implications of errors in establishing an SNT, involving a knowledgeable and experienced professional in such circumstances is vital."
Please note that the information provided in this blog is not intended to and should not be construed as legal, financial, or medical advice. The content, materials, and information presented in this blog are solely for general informational purposes and may not be the most up-to-date information available regarding legal, financial, or medical matters. This blog may also contain links to other third-party websites that are included for the convenience of the reader or user. Please note that Connelly Law Offices, Ltd. does not necessarily recommend or endorse the contents of such third-party sites. If you have any particular legal matters, financial concerns, or medical issues, we strongly advise you to consult your attorney, professional fiduciary advisor, or medical provider.
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