WHAT IS A SPECIAL NEEDS TRUST? ESTATE PLANNING FOR THE DISABLED
How do I keep my child with special needs supported after I’m gone? What is a Special Needs Trust in California, and do I need a Special Needs Trust or Supplemental Needs Trust for my disabled child or loved one? Why set up a Special Needs Trust? Who is eligible for a special needs trust? How does a Special Needs Trust work in California? How to set up a special needs trust? How does an SNT fit into an Estate Plan and Life Care Plan for a disabled person? Can my children and loved ones with special needs become ineligible for benefits like Medi-Cal when they inherit money?
By James L. Cunningham Jr, Esq.
Anyone responsible for a person with a major disability faces a big question: what will happen if you die before them? Who will care for them? Manage their finances? What will they inherit and how? Will an inheritance threaten their public benefits?
In this article, I’m going to focus on children with special needs, but the same principles apply if you’re planning for a spouse, a sibling, or any loved one who will never be able to hold a job to support themselves, or who suffers from a significant mental or physical disability.
As of this writing, 61 million adults in the U.S. live with a disability. That’s one in four individuals! Every one of them needs a plan for outliving those who help them cope with modern life.
You have plenty to consider regarding guardians, trustees, caregivers, and other people who can step in to take your place, but let’s start with the financial issues. With that in mind, here is an overview of the types of programs available and how they work.
How to Leave Money to a Child with Special Needs—or Any Person with Disabilities
Hoping to leave a pile of money to take care of your disabled child after you are gone? Terrific—but make sure you do it the right way, so they are provided the right assistance at the right time to avoid the many potential pitfalls.
Many people with disabilities are largely supported by government benefits. Often, those benefits are means-tested, and it’s all too easy to unintentionally screw up those benefits with a pile of cash. Or an investment account. Even a moderately-sized inheritance given outright to a child can boot them off their monthly Supplemental Security Income (SSI) or Medicaid coverage.
What Is the Limit of Personal Assets to Qualify for Medi-Cal in California?
As of July 1, 2022, California will raise the limit of personal assets to qualify for Medicaid (called Medi-Cal in the Golden State) from the ridiculously low $2,000 up to $130,000 for an individual—but that will still exclude many. Keep in mind that the asset limit for SSI is not changing. To keep Medi-Cal, your loved one can earn some income, but many recipients must use income over $1,583 a month to pay long-term care expenses before Medi-Cal chips in. There are plenty more rules, and the laws are ever-changing, but the bottom-line financial question will always be this: How can you set up your loved one with more comfortable assets and income without endangering their benefits?
The answer in many cases will be a Special Needs Trust.
What Is a Special Needs Trust or Supplemental Needs Trust?
You can think of a Special Needs Trust (SNT) as a kind of legal bucket into which you put assets for the benefit of a person with a significant disability or special needs. The bucket is controlled by a Trustee for the person with the disability, who is formally known as the Beneficiary. While you are alive and well, you may be the Trustee. When you die or can no longer serve, you can easily pass control to a Successor Trustee. An SNT, also sometimes known as a Supplemental Needs Trust, can be revocable or irrevocable, meaning you can set it up so it can be changed or not be changed. It can also be set up to be created only upon your death.
A key goal of a Special Needs Trust in California is to keep direct ownership out of the Beneficiary’s hands while giving them support. With an SNT, the Trust owns the assets, not your child, meaning that assets placed in the Trust can usually avoid the means-testing mentioned above. It’s not the child (or other loved one with a disability), but the Trustee you appoint who has control over property in the SNT.
With a properly-constructed SNT, your loved one will not have to report what’s in the Trust to Medicaid and lose their benefits.
In addition, because of this hands-off structure, the Trust funds aren’t considered assets or income of the Beneficiary and can therefore be set aside to pay for other expenses besides healthcare, food, clothing, and shelter. Examples of qualifying expenditures out of the Trust might be a motorized wheelchair or specially equipped van, household furnishings, educational pursuits, travel, and even some entertainment purchases.
Finally, a key purpose of an SNT is to protect assets for your loved one so those assets are not taken or misused by others. A well-constructed SNT can be controlled by a Trustee designated by you who has an enforceable legal and fiduciary duty to the Beneficiary, your loved one with special needs.
What Are the Elements of a Special Needs Trust?
To understand “what is a Special Needs Trust,” you need to understand the key players in the Trust.
A Special Needs Trust is organized like other Trusts, with a Settlor (or Grantor) who creates the Trust—usually you, the parent—a Beneficiary (in this case the person with special needs), and a Trustee responsible for managing the funds. But a Special Needs Trust is not a simple document.
Special needs issues are a legal sub-specialty that deals with complicated laws. You need to be sure to work with an Estate Planning Attorney who understands the nuances of setting up the Trust properly. A little knowledge can be a dangerous thing, and attorneys without special training on getting a trust established of this particular type may get important details wrong.
At CunninghamLegal, we have long experience in creating Special Needs Trusts in CA and have specialist attorneys in the field. Contact us to learn more about our expertise in Special Needs Trusts in California.
How Do I Know If Someone Needs a Special Needs Trust (SNT)?
Not everyone with a disability needs a Special Needs Trust. Out of those 61 million disabled adults, about 11 percent have a cognitive disability and another 14 percent have a mobility issue. These are the most likely to require an SNT—largely if they have never been able to work due to their disability.
The needs of those who were able to work, but who have later become incapacitated, are generally taken care of through something different: Social Security Disability Insurance (SSDI).
What Is an Example of Someone Who Qualifies for SSDI?
Tom, for instance, has been a long-haul trucker for twenty years. Recently, while unloading, he suffered a severe back injury and can no longer work. Since he can already get Medicare and SSDI disability insurance, and since he has retained his cognitive ability, Tom probably doesn’t need an SNT. If you are responsible for a Tom, check his award letter and check with a lawyer, but likely no SNT is required.
What Is an Example of Someone Who Needs a Special Needs Trust?
Here’s a Special Needs Trust example: Dolly is a minor with cerebral palsy who will not be able to work when she turns eighteen—and will likely never be able to work. She currently receives SSI (Supplemental Security Income), through both the federal Social Security Administration and the state of California, as well as Medicare. But SSI is means-tested. Once she legally becomes an adult, she is still eligible for SSI, but only if her assets are below the then-current limits.
Dolly’s parents are savvy enough to consult an attorney who specializes in special-needs Estate Planning, and together they create an estate plan with Special Needs Trust provisions. This both provides for Dolly and allows her to keep her essential government benefits, including SSI, while still benefiting from the resources her parents put aside for her.
Without a well-constructed estate plan, if Dolly inherits significant assets, she may well lose her SSI benefits.
Complexities of SNTs: First-Party and Third-Party Special Needs Trusts
I cannot lay out all the complexities of a Special Needs Trust in this article, but they are many—and they truly require a specialized attorney. Let me just touch on a few of the issues.
For starters, there are two kinds of Special Needs Trusts: First-Party and Third-Party. A First-Party SNT is funded by the special-needs person themselves from their own assets if they are under age 65. A parent, legal conservator, or court can also establish such a First-Party SNT with these assets if the Beneficiary is younger than 65.
One form of First-Party SNT is what’s called a “pooled trust,” which is set up by a non-profit on behalf of several Beneficiaries. There are no age restrictions with pooled trusts. A separate account is maintained for each Beneficiary, but funds are “pooled” together and invested.
Your special-needs child will be the First-Party SNT’s Beneficiary but can’t be its Trustee.
Which Is Better: A First-Party or Third-Party Special Needs Trust in CA?
Here’s the big problem with a First-Party SNT: Following the Beneficiary’s death, the state will seek reimbursement from any funds remaining in the trust for Medicaid/Medi-Cal expenses incurred.
In general, therefore, a Third-Party SNT is a far better option.
As the name suggests, a Third-Party SNT is funded by someone other than the Beneficiary. Importantly, funds left in the trust can’t be used to reimburse Medicaid expenses, so the Beneficiary’s own heirs will certainly appreciate receiving a bigger inheritance.
A Third-Party SNT can also be either revocable (changeable) or irrevocable (nearly unchangeable except by a judge or a Trust Protector). Each type has advantages and disadvantages, so be careful and get expert advice: for example, funds contributed to a revocable third-party SNT are taxable, but funds contributed to an irrevocable trust are not.
There are other questions to consider, and you should work closely with your attorney to decide whether to establish a First- or Third-Party SNT—though, in general, a Third-Party SNT will be much more advantageous.
A few of the other key issues in an SNT you will discuss with a good attorney:
- A viable succession plan of committed Trustees.
- A “Trust Protector” who can modify even an irrevocable Trust if needed over the years, without going to court. Trust protectors are vital for Special Needs Trusts for many reasons, including the possibility that adult disabled children will move to other states with better resources—requiring a modification to the Trust.
- Indeed, all SNTs are highly state-specific: for example, a California SNT will not work the same way in Oregon, so be sure to consult with an attorney before a move.
- A careful balancing of “Guardian or Conservator of the Person” and “Trustee of the Trust” in the overall Estate Plan.
- Carefully constructed inheritance rights for assets after the disabled loved one passes away.
- A long-term relationship with an Estate Planning firm to handle issues over the years.
Are Special Needs Trusts Tax-Free? How Are Special Needs Trusts Taxed?
Special Needs Trusts are generally not tax-exempt, and will need to pay Special Needs Trust taxes. They have to file their own annual tax return, and without expert guidance, can result in a “tax disaster.” Any income to the Trust from interest, dividends, rents, and realized gains must be reported on the trust level on Form 1041, but distributions to or for the benefit of the Beneficiary can mitigate the tax bite. Importantly, because the Beneficiary is a person with disabilities, their income is probably very low, so these distributions will generally face a lower tax rate than the Trust. But care must be taken on the timing of distributions to preserve needs-based public assistance benefits. With the right oversight, that means a Special Needs Trust can be a good tax planning vehicle.
Stand-By Special Needs Trusts in California
SNTs are so important that at my Estate Planning law firm in CA, we include provisions for a “stand-by Special Needs Trust” in every Estate Plan we create. These stand-by provisions will kick in if any Trust Beneficiary unexpectedly becomes disabled and needs to have their assets properly protected.
An SNT as Part of a Comprehensive Life Care Plan for Children with Special Needs
Any Special Needs Trust, of course, is only part of the long-term planning you need to do for a disabled loved one.
By working with a qualified Estate Attorney, you should craft—and continuously update—a “Comprehensive Life Care Plan.” Such a plan will consider:
- Who will care for your loved one after you die or become incapacitated?
- Where will they live?
- Who will make healthcare decisions?
- Will they need a conservatorship?
- How will they maintain client status at the local Regional Center?
- Who will handle money, finances, and taxes?
- What about special housing and transportation accommodations?
- What about your loved one’s social and recreational interests?
- How will your loved one’s quality of life be maintained?
- What about work and seeking employment—is that a goal?
- How will you integrate care for your loved one into your overall estate plan?
- What special rules are there for IRAs and other retirement accounts? (See more on this below)
- How are their needs balanced with the needs of other heirs?
What is the Role of the Trustee in a Special Needs Trust?
One of the most important decisions you will make in constructing a Special Needs Trust (SNT) or Supplemental Needs Trust is choosing a Trustee to control the Trust after you pass. You need an individual just as competent, involved, trustworthy, reliable, and loving as yourself. It’s vital to discuss the role in-depth with this Trustee well in advance and to have a succession plan if they become unable to serve. The role of the Trustee is broad, and along with all the above responsibilities, they must:
- Manage and invest Trust funds in accordance with the terms of the Trust document and state law
- Spend Trust assets only for the Beneficiary
- Not do things like “borrow” from the Trust for other purposes
- Understand the SSI and Medicaid laws to not run afoul of the government benefits
- Keep careful records of all spending
- File federal and state Trust tax returns
- Decide how to use Trust funds to meet the beneficiary’s ongoing needs
Remember that the powers granted to the Trustee you designate for the SNT will be limited by the provisions of the SNT as written. That means you have to be sure to give your Trustee the power, for example, to potentially hire an expert “Care Manager” to oversee your child’s care and resources when you no longer can. This knowledgeable Manager could serve as an advocate for a loved one unable to advocate on their own behalf. A committee of more than one person could also be appointed to oversee the work of the Care Manager and assist the Trustee. Think of this as your disabled heir’s “Board of Directors.”
What Is a Letter of Intent (LOI) for Care of a Person with Special Needs?
It can sound overwhelming to construct a comprehensive Life Care Plan. I suggest starting by sitting down to write an informal Letter of Intent (LOI) that communicates your loved one’s needs, which you as their parent and caregiver understand best, to anyone who reads it, including the Trustee and Care Manager. This can later become an important “cover letter” for the Plan itself.
What are your wishes, expectations, and goals for your special-needs child? Put it all down in writing and keep it with your other Estate Planning documents. Use it as you develop your more formal Plan. Don’t neglect to communicate all this to other family members, so everyone understands the motivation behind your LOI.
Consider holding a family meeting to present your LOI and more formal Plan, so you can discuss it with everyone involved. A well-considered LOI and meaningful conversations can prevent a lot of confusion, bad feelings, and worse down the line.
Special Needs Financial Plan for After the Parent Dies
Your LOI and Life Care Plan should include a highly detailed financial plan: What should your child’s monthly income be—including such government benefits as SSI, SSDI, and Social Security? And don’t forget other potential benefits, such as through your employer. What about your loved one’s expenses—including housing, food, transportation, medical, educational, and so on? Will there be a shortfall after you die? How can this shortfall be met—and does an SNT fit into the picture?
Make sure to prioritize health insurance in your Life Care Plan. As I discussed earlier, your child may depend on Medicaid, which is called Medi-Cal in California. Don’t take this benefit for granted. Determination of these benefits is needs-based, and they will be revoked if the government calculates your child’s income or assets as above a low maximum. Someone must monitor benefits qualifications throughout the disabled person’s life.
Update your LOI and Life Care Plan on at least an annual basis: things change. Remember also that your LOI and accompanying Plan may someday be presented to a judge in a probate issue regarding your family: these documents will allow you to “speak from the grave” and give guidance even to that judge.
We recommend that the LOI and Life Care Plan not be included in the Special Needs Trust, as these less-formal documents will be changed frequently. Consider them accompanying, nonbinding guidance, rather than legal directives.
What Happens When a Child with Special Needs Turns 18?
In your planning for a loved one with a disability, make sure to focus on the critical transition period when a child with special needs turns 18 and legally becomes an adult. Because they are adults, the law will assume that they are now competent to care for themselves. But that may be very far from the truth, and you need to set up the legal structures in advance.
Indeed, unless you take legal measures, once your child turns 18, you won’t even have access to their healthcare records.
If your loved one is cognitively competent to sign and give you a Durable Power of Attorney, make sure you have that in place when they turn 18. If not, you may need to seek a conservatorship by going to court to establish yourself as your adult child’s legal guardian. Conservatorships may be looked upon with suspicion in the wake of famous cases of abuse, but most Conservatorships serve a legitimate purpose. Consult an attorney.
Special Needs Estate Planning within Your Comprehensive Estate Plan
One of the most important aspects of your Life Care Plan will be the way it fits into a comprehensive Estate Plan. A Special Needs Trust should be carefully incorporated alongside the other usual documents you’ve been careful to create in this Plan: Living Trusts, Wills, Powers of Attorney, and more.
Within this planning, your SNT should address specific legal issues well beyond the financial—how does it relate to assets you are leaving to other children? What are the corresponding roles of Trustees for other Trusts, such as your Living Trust?
Most critically, you and your qualified attorney will want to review all the beneficiary and ownership designations in your Trusts to ensure that your child’s inheritance won’t get them kicked off any public benefits. These can include many that you haven’t thought about, like access to Section-Eight low-income housing and the services of the local Regional Center for those with developmental disabilities.
Document your strategies in writing. This will help you think them through more thoroughly and keep you from missing important points. If you are a business owner, for instance, you want to make sure that your special-needs child doesn’t inherit a business they won’t be able to run. The list goes on and on.
Do I Need a Team of Lawyers, CPAs, and Financial Advisors for My Child with Special Needs?
None of this is one-size-fits-all: you need expert advice. And so will those who succeed you. When you create this complex plan, you must also create your own “A-Team” of a lawyer, a CPA, and a financial planner—and check in with them regularly. You need a plan for A-Team succession as well! Remember that lawyers, CPAs, and financial planners will age right along with you, retire, and pass away: so look for firms of more than one person that also plan for the future, and can help the SNT Trustee when you pass.
Do IRAs and 401(k)s Belong in a Special Needs Trust?
Here’s a critical point most people, including non-specialist attorneys, don’t know about. IRAs, 401(k)s, and similar instruments are generally not included as assets in a Trust. IRAs have very special rules you need to understand.
Say you have a million-dollar IRA and put it in your child’s Special Needs Trust—big mistake. In the state of California, as soon as your child inherits the IRA, they’ll need to pay $500,000-plus of that in taxes. Not good!
The IRS has very strict rules about the distribution of IRAs to beneficiaries. For instance, all of an IRA’s funds usually need to be taken out within ten years. However, the government gives special treatment to those who are disabled or chronically ill. If you establish a “special” Special Needs Trust, they can take their minimum distributions out over the full course of their lifetimes.
For a twenty-year-old grandchild, this could be sixty years or more. That means, at a distribution of 1.5 percent annually, that grandchild could receive a total of $10 million on the million-dollar IRA and will only be taxed on each year’s distribution rather than on the entire amount as soon as it is inherited. This is a perfectly legal strategy, not a trick. But of course, only those who know about the strategy can implement it. Most lawyers simply don’t have this kind of specialized knowledge. Get the right lawyer, and work your IRA properly into your financial plan.
Click here to learn about specialized IRA Legacy Trusts, also known as SRTs.
ABLE Accounts / CalABLE Accounts for Disabled and Special Needs Loved Ones
One alternative or supplement to a Special Needs Trust is an ABLE account, authorized by the 2014 Achieving a Better Life Experience (ABLE) Act. In California, these are known as CalABLE accounts. They permit those with disabilities to save and invest money, with tax-free distributions for so-called Qualified Disability Expenses related to their health and quality of life. All without losing such federal benefits as Medicaid/Medi-Cal, SSI, or SSDI—provided the total amount in the ABLE account remains under certain limits.
There also are important limits on one-time, as well as overall contributions. Learn more in our blog about CalABLE accounts.
When Should I Create a Special Needs Trust?
Now that you have a sense of both the benefits and complexities of a Special Needs Trust, let me add a sense of urgency: If you have a child, grandchild, or other loved one with a significant disability or special needs, you should establish such an SNT as early as possible so the funds begin to grow and you are ready for anything. Assemble your A-Team as soon as possible, and be sure you construct your overall plan with the help of an attorney who specializes in this area of law.
It can be a burden to plan the future for a loved one with special needs or a significant disability. But it can also be a joy, and it is certainly an honor. Build a team of family and professionals to help ensure a solid future and share the burden. I know that I and my firm always consider it an honor and a privilege to help in this work.
What Do We Do?
The lawyers and staff at CunninghamLegal help people plan for some of the most critical times in their lives; then we guide them when those times come. Our legal staff includes attorneys with highly specialized and personal experience in issues regarding children with Special Needs and other disabled individuals.
Make an appointment to meet with CunninghamLegal for Estate Planning, Trusts, Tax Planning, and much more. We have offices throughout California, and we offer in-person, phone, and Zoom appointments. Just call (866) 988-3956 or schedule a free call online.
We look forward to working with you!
James Cunningham Jr., Esq.
We guide savvy, caring families in the protection and transfer of multi-generational wealth.