Parents with disabled children worry about how their offspring will manage when parents are no longer able to care for them. Leaving money directly to a child receiving means-tested government benefits, like Social Security Supplemental Income or Medicaid, could make them ineligible for these programs, explains an article from Kiplinger titled “Estate Planning: A Special Trust for a Special Need.” In most states, beneficiaries of either program are only allowed to have a few thousand dollars in assets, with the specific amount varying by state. However, the financial support from government programs only goes so far. Many families opt to have their special-needs family members live at home since the benefit amount is rarely enough.
The solution is a Special Needs Trust, which provides financial support for disabled individuals. The SNT owns the assets, not the individual. Therefore, the assets are excluded from asset limit tests. The trust funds can enhance the quality of life, such as a cell phone, a vacation, or a private room in a group living facility. The SNT ensures that a vulnerable family member receives the money and that other relatives, such as siblings, don’t have a financial burden.
SNTs can only be created for those younger than age 65 and are meant for individuals with a mental or physical disability so severe they cannot work and require ongoing support from government agencies. A disabled person who can and does work isn’t eligible for government support and isn’t suitable for an SNT. However, an estate planning attorney can also create a trust for this scenario.
Each state has its own guidelines for SNTs, with some requiring verification from a medical professional. There are challenges along the way. A child with autism may grow up to be an adult who can work and hold a job, for instance. However, estate planning attorneys recommend setting up the SNT just in case. If your family member qualifies, it will be there for their benefit. If they do not, it will operate as an ordinary trust and give the person the income according to your instructions.
SNTs require a trustee and successor trustee to be responsible for managing the trust and distributing assets. The beneficiary may not have the ability to direct distributions from the trust. The trust’s language must state explicitly that the trustee has sole discretion in making distributions.
Because every state has its system for administering disability benefits, the estate planning attorney will tailor the trust to meet the state’s requirements. The SNT also must be reported to the state. If the beneficiary moves to another state, the SNT may be subjected to two different sets of laws, and the trustee will need to confirm the trust meets both states’ requirements.
SNTs operate as pass-through entities. Tax treatment favors ongoing distributions to beneficiaries. Any earned investment income goes to the beneficiary in the same year, with distributions taxed at the beneficiaries income tax rate. A Trustee may use trust assets to pay for the tax bill.
As long as all annual income from the trust is distributed in a given year, the trust will not owe any tax. However, the trustee must file a return to report income. For any undistributed annual investment income, the trust is taxed at one of four levels of tax rates. These range from 10% and can go as high as 37%, depending on the trust income.
An SNT can be named as the beneficiary of a traditional IRA on the parent’s death. Investments grow tax-deferred as long as they remain in the retirement account, and the SNT collects the required minimum distributions for the retirement account each year, with the money passing as income. However, any undistributed amount of the required distribution will be taxed at the trust’s highest tax rate.
Reference: Kiplinger (June 8, 2022) “Estate Planning: A Special Trust for a Special Need”