How Do Special Needs Trusts Work?

Special needs trusts (SNT) are critical tools for protecting a beneficiary with disabilities’ benefits while providing for their needs.

Special needs trusts (or supplemental needs trusts) have been used for many years. However, there are two factors that are changing and clients need to be aware of them, says the article “Special-Needs Trusts: How They Work and What Has Changed” from The Wall Street Journal. For one thing, many people with disabilities and chronic illnesses are leading much longer lives because of medical advances. As a result, they are often outliving their  primary caregivers. This makes planning for the long term more critical, and the use of special needs trusts more critical.

Second, there have been significant changes in tax laws, specifically laws concerning inherited retirement accounts.

Special needs planning has never been easy because of the many unknowns. How much care will be needed? How much will it cost? How long will the person with disabilities need them? Tax rules are complex and coordinating special needs planning with estate planning can be a challenge. A 2018 study from the University of Illinois found that less than 50% of parents of children with disabilities had planned for their children’s future. Parents who had not done any planning told researchers they were just overwhelmed.

Here are some of the basics:

A special needs trust, or SNT, is created to protect the assets of a person with a disability, including mental or physical conditions. The trust may be used to pay for various goods and services, including medical equipment, education, home furnishings, etc.

A trustee is appointed to manage all and any spending. The beneficiary has no control over assets inside the trust. The assets are not owned by the beneficiary, so the beneficiary should continue to be eligible for government programs that limit assets, including Supplemental Security Income or Medicaid.

There are different types of Special Needs Trusts: pooled, first party and third party. They are not simple entities to create, so it’s important to work with an experienced estate elder law attorney who is familiar with these trusts.

To fund the trust after parents have passed, they could name the Special Needs Trust as the beneficiary of their IRA, so withdrawals from the account would be paid to the trust to benefit their child. There will be required minimum distributions (RMDs), because the IRA would become an Inherited IRA and the trust would need to take distributions.

The SECURE Act from 2019 ended the ability to stretch out RMDs for inherited traditional IRAs from lifetime to ten years. However, the SECURE Act created exceptions: individuals who are disabled or chronically ill are still permitted to take distributions over their lifetimes. This has to be done correctly, or it won’t work. However, done correctly, it could provide income over the special needs individual’s lifetime.

The strategy assumes that the SNT beneficiary is disabled or chronically ill, according to the terms of the tax code. The terms are defined very strictly and may not be the same as the requirements for SSI or Medicaid.

The traditional IRA may or may not be the best way to fund an SNT. It may create larger distributions than are permitted by the SNT or create large tax bills. Roth IRAs or life insurance may be the better options.

The goal is to exchange assets, like traditional IRAs, for more tax-efficient assets to reach post-death planning solutions for the special needs individual, long after their parents and caregivers have passed.

Reference: The Wall Street Journal (June 3, 2021) “Special-Needs Trusts: How They Work and What Has Changed”

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Common Mistakes when Making Beneficiary Designations

Beneficiary designation mistakes prevent assets such as retirement and life insurance accounts from going to the right beneficiaries.

No matter what kind of estate plan you use, your plan can be undone by some common mistakes when making beneficiary designations.  Modern banking and worker economics also means that a lot of your financial value, usually in retirement accounts like IRAs or 401(k)s for example, are governed by beneficiary designations.  That means one mistake affects a huge portion of your financial worth.   Many events make it necessary to review beneficiary designations, as the author in the article “One Beneficiary Mistake You Really Don’t Want to Make” from Kiplinger points out.

Now, there is no definitive guide on how to handle beneficiary designations.  The best solution is to review them with your estate planning attorney to ensure the designations fit your estate plan.  However, this article will cover some common mistakes that can undo even the best of estate plans.  You may also want to review some common estate planning mistakes as they somewhat overlap.  See here for more info:  https://www.galliganmanning.com/what-estate-planning-mistakes-do-people-make/ 

Life Changes.  Any time you experience a life change, including happy events, like marriage, birth or adoption, or unhappy events such as the death or disability of a loved one, you need to review your beneficiary designations.  If there are new people in your life you would like to leave a bequest to, like grandchildren or a charitable organization you want to support as part of your legacy, your beneficiary designations will need to reflect those as well.  A very common and likely very obvious mistake is to not review and update your beneficiary designations after one of those events.

For people who are married, their spouse is usually the primary beneficiary, but do you have a contingent? Beneficiary designations typically have multiple tiers.  The first person to receive is the primary beneficiary.  For married couples, this is typically the other spouse.  However, many clients forget to include contingent beneficiaries to receive if the primary is deceased.  Children are often contingent beneficiaries who receive the proceeds upon death if the primary beneficiary dies before or at the same time that you do.  But, a lack of a beneficiary is a big problem and many companies direct to the proceeds to your estate, which I’m guessing isn’t what you wanted.

It is also wise to notify any insurance company or retirement fund custodian about the death of a primary beneficiary, even if you have properly named contingent beneficiaries, or even better, just update the beneficiary designation to remove the deceased beneficiary’s name.

Not understanding the financial institution’s terms.  Clients often ask what will happen if a named beneficiary of their retirement account dies.  Who does it go to next?  I always have the same answer, what do the account policies say?  For example, let’s say you’re married and have three adult children. The first beneficiary is your spouse, and your three children are contingent beneficiaries. Let’s say Sam has three children, Dolores has no children and James has two children, for a total of five grandchildren.

If both your spouse and James die before you do, all of the proceeds would pass to who?   It could be your two surviving children, and James’ two children would effectively be disinherited. That might not be what you would want. It is also possible that the assets go to the children of the predeceased child.

The difference between these are the difference of what are typically termed per stirpes and per capita.   Some companies allow you to indicate your preference, but not always.   So, you’ll need to speak with the company to better understand how their designations are ruled.

Not incorporating into your estate plan.  Finally, and I made this point briefly in the introduction, you want to coordinate your beneficiary designations and your estate plan.  For example, many clients utilize trusts for their beneficiaries to provide them creditor and divorce protection.  If your life insurance policy goes directly to your child, that money will not receive the creditor and divorce protection the trust affords.  So, arranging the beneficiary designations so that the insurance proceeds will go to that trust protects that money as well.

These are some common mistakes in making beneficiary designations.  Your estate planning attorney will help review all of your assets and means of distribution, so your wishes for your family are clear and effective.

Reference: Kiplinger (March 23, 2021) “One Beneficiary Mistake You Really Don’t Want to Make”

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How Does a Special Needs Trust Work?

Special Needs Trusts hold assets for an individual using government benefits to provide for them without losing the benefits.

Clients uses trusts for a lot of reasons, including probate avoidance, creditor protection, privacy and smooth and efficient estate administration.   Some trusts, such as Special Needs Trusts (aka Supplemental Needs Trusts) are used specifically to maintain government benefits for the beneficiary while still providing for their needs.  Not using the right type of trust can lead to financial devastation explains the article “Take special care with Special Needs trusts” from the Herald Bulletin.

The purpose of a Special Needs Trust is to help people because they have a disability and are or may be supported by government benefits.  Most of these benefits are means-tested, meaning, a beneficiary’s eligibility is dependent upon their income, assets or potentially both.  The rules regarding the benefits are very strict. An inheritance may disqualify a person with a disability from receiving these benefits, possibly putting them in dire circumstances.

However, clients may still want to provide for that loved one, and the Special Needs Trust is the way to do it.  The value of assets placed in a Special Needs Trust does not count against the benefits.  However, this area of the law is complex, and requires the help of an experienced elder law estate planning attorney. Mistakes could have lifelong consequences.

The trustee manages assets and disperses funds on a discretionary basis.  Selecting a trustee is extremely important, since the duties of a Special Needs trust could span decades. The person in charge should be ready to work with competent advisors who are familiar with the government programs and benefits and who can advise the trustee of the consequences of disbursements.

These are just a few of the considerations for a trustee:

  • How should disbursements be made, balancing current needs and future longevity?
  • Does the request align with the rules of the trust and the assistance program requirements?
  • Will anyone else benefit from the expenditure, family members or the trustee? The trustee has a fiduciary responsibility to protect the beneficiary, first and foremost.

Parents who leave life insurance, stocks, bonds, or cash to all children equally may be putting their Special Needs child in jeopardy.  What’s more, children who try to provide for their parents often don’t consider that their parents may require governmental assistance at the end of their lives such as long term Medicaid.  Well-meaning family members who wish to take care of their relative must be made aware of the risk of leaving assets to an individual with disabilities, and in fact, good planning suggests including contingent Special Needs Trusts in your estate planning documents.  After all, a loved one might not have a disability when you create your estate plan, but they might by the time they receive from your estate plan.

An experienced elder law or estate planning attorney will be able to create a Special Needs trust that will work for the individual and for the family and can advise you how to include such planning in your estate documents.

Reference: Herald Bulletin (March 13, 2021) “Take special care with Special Needs trusts”

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