by: Begley Law Group

by Thomas D. Begley, Jr., Esquire, CELA

This is the second article in a two-part series that will discuss the various tools for planning for children with disabilities in a Family Law setting. (Here is a link to Part One)

  • Third Party Special Needs Trust
    • Requirements. There are three key requirements to be met with establishing a Third Party Special Needs Trust.
      • The trustee must be given absolute control over the distribution of the funds.
      • The person with special needs cannot have authority to revoke, amend, or terminate the trust.
      • The person with special needs cannot have the power to compel a distribution from the trust.
    • Advantages. The advantages to the Special Needs Trust are that it can help maintain the individual’s public benefits and assist in enriching the beneficiary’s life.
    • Funding and Distributions from the Trust. The Third Party Special Needs Trust must be funded by assets of someone other than the trust beneficiary.  In this situation, the assets would belong to the parents.  It could be funded in whole or in part by grandparents, other family members, or even friends.  If the beneficiary is receiving SSI, the SSI is intended for food and shelter.  Therefore, any distribution from the trust for food or shelter will reduce the beneficiary’s SSI payment.  The maximum deduction is one-third of the maximum federal payment plus $20.  Sometimes the reduction is unavoidable, but frequently a Lease or other arrangement can be used as a workaround.  Typically, Special Needs Trusts pay for:  household goods, furniture, automobiles, durable medical equipment, technology, clothing and shoes, telephone, recreation and entertainment, services of a Care Manager, medications, medical treatment for which public funds are unavailable, education, dental care, physical therapy, massages, and home care services not covered by another program.  Child support cannot be used to fund a Third Party Special Needs Trust, because child support is considered to be income to the child.
    • Account. The trustee opens an account, which is invested conservatively but with an idea toward earning money over time for the individual with disabilities.  At the time the trust is funded, a family member should meet with the trustee and establish a budget for the individual with disabilities.  The budget would include shelter, transportation, and personal needs.  A determination should also be made as to how long the trust should last.  To oversimplify, there is a rule of 4%.  Some commentators believe that the 4% should now be reduced to 3.3% based on economic forecasts.  This means that if money is intended to last for 30 years, the trustee can only distribute 3.3% or 4% per year for the benefit of the beneficiary.  For example, if $500,000 is placed into a trust and the trust is intended to last 30 years, the trustee can only distribute $20,000 on behalf of the beneficiary each year.  This is a concept that many people do not understand but is it important if the trust is intended to last.  There are more sophisticated ways to determine distribution levels such as Monte Carlo simulations, but the 3.3% or 4% rule is a good rule of thumb.
    • How the Trust Account is Handled. The Social Security Administration requires an annual accounting of the expenditure of funds in a special needs trust.  This accounting is intended to ensure that trust funds have not been mishandled, and it serves to protect the person with special needs, as well as any other beneficiaries of the trust.

Because the accounting work is fairly technical and must adhere to the rules of the Principal and Income Act, it is best handled by an accountant, who can be hired by the trustee.

  • Tax. Income, estate, and gift taxes must all be considered in designing and drafting a Special Need Trust.
    • Funding on Death. In most cases the Special Needs Trust is not funded until the death of the grantor.  Therefore, income tax and gift tax would not be a consideration, but federal and state estate and inheritance taxes must be considered.
    • Lifetime Funding
      • Income Tax. In order to shift income tax from the grantor to the beneficiary, trusts are sometimes funded with significant assets.  Those trusts cannot be Grantor Trusts.  They are Complex Trusts and any income distributed to the beneficiary is taxed to the beneficiary.  Any income retained by the trust is taxed to the trust at the usually higher trust rates.  These trusts must be irrevocable.
      • Gift Tax. If an irrevocable Special Needs Trust is funded during the Grantor’s lifetime and the trust is not a Grantor Trust, then gift taxes must be considered.
      • Estate Tax. Estate and inheritance taxes must be considered in connection with Special Needs Trusts.  If the trust is large enough, the grantor may elect to fund it during lifetime while the federal estate tax is high, since the IRS has indicated that there will no clawback if and when the federal estate tax exemption is reduced (i.e., January 2026).
  • Benefits of a Special Needs Trust
    • Enriches a Child’s Life. By establishing the Special Needs Trust, the funds in the trust can be used to enrich the child’s life while at the same time maintaining important public benefits.
    • Assets Not Countable. The assets in the Special Needs Trust are not countable, and distributions from Special Needs Trusts are not considered income so long as distributions are not made directly to the trust beneficiary.  Distributions are made to a third party who delivers goods are services to the individual with disabilities.  For example, the individual with disabilities or a family member may obtain a credit card.  The trustee and the individual with disabilities or family member agree on a budget.  Items in the budget are charged on the credit card, and the credit card bill and receipts are sent to the trustee for payment on a monthly basis.  Cash is not given to the trust beneficiary, because cash distributions to the beneficiary would reduce or eliminate public benefits.
    • ISM. The SSI is intended for food and shelter.  Therefore, distributions from the Special Needs Trust for food or shelter for the beneficiary are considered in-kind support and maintenance (ISM) and reduce the beneficiary’s SSI payment dollar-for-dollar not to exceed one-third plus $20.  To the extent possible, food and shelter should be paid for out of the SSI payment and the trust should pay for other items.  This can all be covered in detail when the individual with disabilities and/or family member meet with the trustee and develop the budget.
    • What is a Life Plan? As part of the process of planning for the future of a special needs child, it is very important for parents to prepare a Life Plan laying out their wishes for the child’s standard of living.  A Life Plan provides parents with an opportunity to explain, in detail, their child’s unique life and background.  The Plan helps ensure that those responsible for the child’s care in the future will see him or her as a “real,” multi-faceted person, rather than a number, statistic, or faceless subject in a legal document.  The letter also serves as a vital document for the trustee, providing him or her with a greater understanding of the child, and ensuring that the family’s specific wishes, goals, and expectations can be carried out.
  • Disadvantage of a Special Needs Trust.  The disadvantage of funding a Special Needs Trust during the lifetime of a parent is that either parent would not be eligible for Medicaid to fund long-term care for five years after the trust is funded.  Typically, the Third Party Special Needs Trust is not funded until the death of the surviving parent.
  • Insurance. Consideration should be given to appropriate insurance for the parents.  These include:
    • life insurance;
    • medical insurance;
    • disability insurance;
    • long-term care insurance; and
    • an umbrella insurance policy.
  • Beneficiary Designations. Beneficiary designations must be coordinated so that monies left for the benefit of the disabled child, such as life insurance, retirement accounts, or annuities, name the trust as beneficiary not the disabled child.  Because of the SECURE Act, there may be a huge advantage to using retirement accounts to fund the Third Party Special Needs Trust.