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PLANNING FOR INDIVIDUALS WITH SPECIAL NEEDS PART 3

by: Begley Law Group

by Thomas D. Begley, Jr., CELA

General

This is the third part of a five-part series dealing with planning for individuals with special needs.  Part 1 discussed the reasons to establish a trust and some of the requirements for a Special Needs Trust (SNT).  Part 2 discussed Self-Settled Special Needs Trusts (SSSNTs).  This article will discuss Third Party Special Needs Trusts (TPSNTs).

A distinguishing characteristic of a TPSNT is that the trust is funded with the assets of someone other than the individual beneficiary.  This type of trust is usually used in connection with Estate Planning for the parents of a child with disabilities; however, it could be established by anyone other than the beneficiary. Generally the reasons to establish a TPSNT are to preserve eligibility for means-tested public benefits for the disabled beneficiary and/or to obtain expert money management.  Most means-tested public benefits have income and asset tests. Monies in the TPSNT do not count as assets.  If the TPSNT is administered properly, the distributions do not count as income.

Estate Planning Options

There are five estate planning options with respect to estate planning:

  • Disinherit Child with a Disability. The first estate planning option is to simply disinherit the child with a disability.  The problem is once the parents are gone, the child may have financial needs that would go unmet.

 

  • Gift to Child with a Disability. The second option is to make a bequest to the child with a disability. The problem with distributing assets to the child with a disability is that it would cause a loss of means-tested public benefits.

 

  • Distribution to Sibling. The third option is to distribute the assets to a sibling of the child with disabilities with the understanding that the sibling will set the money aside and use it for the benefit of the disabled sibling.  This is a risky proposition.  Assets held in the name of the sibling are exposed to creditors of the sibling, and potentially to divorce if the assets are comingled with the sibling’s spouse.  There is also a risk of misappropriate or mismanagement by the sibling.

 

  • ABLE Account. A parent could leave all or a part of the inheritance to an ABLE account. Part 5 of this series will discuss ABLE accounts.

 

  • Special Needs Trust. In most instances, the best option is to establish a TPSNT.

Testamentary or Inter Vivos

As a rule, it is preferable to have the TPSNT established as an inter vivos trust.  The advantage of an inter vivos trust is that if other family members or friends want to provide for the person with a disability, they may do so through the already existing SNT.  The inter vivos trust can be a stand-by trust that remains unfunded until the death of the grantor, or it can be funded during the lifetime of the grantor.

If the trust is a testamentary trust it does not exist until the death of the individual who is establishing the trust. Therefore, if another family member wants to fund the TPSNT, they cannot do so until the death of the individual establishing the trust, usually the parent.

Revocable or Irrevocable

Whether an inter vivos SNT is revocable or irrevocable is often determined by the tax objectives of the settlor.  If the grantor wants to maintain maximum control over trust assets and is not concerned about federal estate and gift taxes, the trust can be revocable until the death of the grantor or until it is funded by assets gifted by a third party such as a grandparent, uncle or aunt.  With the federal unified credit for estate and lifetime gifts, now at $11,180,000, these are not concerns to most clients.

If the grantor intends to use the trust to save income or estate taxes, he might establish the trust as irrevocable from the outset.

Trust Assets as Resources

The POMS discusses the trust assets as resources as follows, “If any individual (claimant, recipient, or deemor) has legal authority to revoke the trust and then use the funds to meet his food or shelter needs, or if the individual can direct the use of the trust principal for his or her support and maintenance under the terms of the trust, the trust principal is a resource for SSI purposes.”[1]Again, the test is clearly whether the beneficiary has a right to revoke the trust or compel distributions.

Qualified Disability Trust

A qualified disability trust (QDT) is a form of TPSNT. A QDT must be a non-grantor trust.[2]  To satisfy the requirements of the Code, a QDT must be (1) an irrevocable trust (2) established “solely for the benefit of” (3) an individual under age 65 (However, the trust can continue to claim QDT treatment after the beneficiary turns 65.) (4) who is disabled as defined in the Social Security Act 42 U.S.C. § 1382c(a)(3).  A QDT is allowed a deduction equal to the personal exemption, which is $4,100 in 2018. This is true even though the personal exemption for individuals has been repealed.

Attorneys vary in their practice in regard to reporting a TPSNT. If the beneficiary is receiving public benefits or applying for public benefits, then any funded third-party trust should be reported to the agency, whether SSA or the state Medicaid agency. If the beneficiary applies for financial aid for college, the question arises whether or not the trust must be reported on the financial aid application.[3]It appears that any SNT must be reported regardless of whether it is a first-party or third-party trust and regardless of whether or not distributions are discretionary.

Payback

There is no Medicaid payback required on the death of the beneficiary from a TPSNT.  Many practitioners do not realized this and draft TPSNT documents with a Medicaid payback provision.  Care should be taken to avoid this result.

[1]POMS SI 01120.20.D.1.a.

[2]Instructions for Form 1041 and Schedules A, B, D, G, I, J, and K (2014).

[3]https://studentaid.ed.gov/sa/sites/default/files/2017-18-fafsa-worksheet.pdf