A Special Trust for Special Needs: Be Careful

Bequeathing assets to a disabled loved one is a benevolent gesture, but in some cases it can cause problems that were never intended.

An inheritance can disqualify the disabled person from government needs-based aid programs including:

  • Supplemental Security Income (SSI), a Social Security Administration program that pays extra cash to people with limited assets and income.
  • Medicaid, which provides far-ranging medical assistance including doctors’ visits, home health care services and nursing homes.

Some assistance plans for the disabled require enrollment in SSI, Medicaid or similar programs. Losing those benefits can mean the loss of other essential help.

But there’s a solution to the dilemma: Create a “special needs” or “supplemental needs” trust. This can protect the benefits and provide other amenities for a disabled child or adult who receives an inheritance or proceeds from a personal injury settlement or suit.

A special needs trust can supplement government benefits by providing, among other needs, amenities such as:

  • Entertainment
  • Electronic equipment
  • Trips and vacations
  • Computer equipment
  • Athletic training
  • Companion services
  • Home health aides
  • Transportation, including the purchase of a vehicle

The trust can hold cash, stocks, investments, and personal and real property. It can own life insurance and be used to hold money from personal injury settlements or judgments.

One way to establish a special needs trust is to set up a charitable remainder unitrust (CRUT), which can provide a lifetime income to the beneficiary, and eventually distribute the remaining assets to a charity or charities chosen by the trust creator.

A CRUT also offers upfront income tax deductions, estate tax advantages, and deferral of capital gains if appreciated assets are contributed.

IRS Revenue Ruling 2002-20 allows a special needs trust to be the beneficiary of a CRUT if it meets four criteria:

1. The trust is solely devoted to caring for a disabled beneficiary.

2. The beneficiary has a physical or mental impairment a doctor can describe.

3. The condition is expected to last for at least a year.

4. No one else manages the individual’s financial affairs.

Typically, the CRUT makes payouts to the special needs trust at a fixed percentage of the assets, with a 5 percent annual minimum. The trustee then makes distributions for the benefit of the disabled beneficiary.

Done with care, these distributions can provide a desirable lifestyle without jeopardizing government benefits.

How it Can Work

Suppose you have a permanently disabled 10-year-old child who is receiving SSI and Medicaid benefits because the family has limited assets and income and cannot afford the child’s monthly medications and therapy.

A relative wants to leave the child a $150,000 inheritance. Without planning, the child’s government benefits will be stopped and the inheritance must be used to pay the medical expenses for the next five years. After that time the benefits will resume, but the inheritance will be gone. A special needs trust could preserve the inheritance for the disabled child’s benefit.

Caution: Trusts are governed by state laws and should be drafted only by professionals who specialize in this area. In addition to professional fees, there may be costs associated with transferring assets to the trust and administering the trust.