What is a special needs trust?

People with disabilities often have particular needs for services and supports, beyond the basic necessities of life. One way for family and friends to support people with disabilities is to set up a trust to help provide funding for those needs, or to pay for things that will improve quality of life.

A special needs trust holds funds used to benefit a person with disabilities (called a “beneficiary”). It is governed by a trust document that specifies how those funds can be used. A trustee is named to manage the trust and make distributions to help the beneficiary.

Protecting access to public benefits

Special needs trusts often have provisions to ensure that the beneficiary will not lose public benefits.

That’s because some public benefits programs benefitting the disabled, such as Medicaid or Supplemental Security Income (SSI), have restrictions on how much a recipient can own, or receive in income. (These are called means-tested programs.)

Grandma may think she’s helping her Suzie, her autistic granddaughter, with a handsome inheritance, but the inheritance could cause Suzie to lose her medical benefits because she would have too much money. Suzie may have to spend down her inheritance to pay for medical care that was previously covered, and then go back on benefits with her inheritance exhausted.

If a special needs trust is set up the right way, Suzie can often keep her benefits and the trust can pay for a variety of supports and service that will improve Suzie’s quality of life for years to come.

Types of trusts

Trusts for the benefit of those with special needs come in different varieties. Most, however, fall into one of three categories.

First party trusts. (Also called “self settled” or “payback” trusts.) This type of trust is created when a person uses his or her own funds, or funds earmarked to go to that person, to establish a special needs trust.

For example, Joe was injured in a severe accident and is now a paraplegic. Joe may later receive an inheritance or a payout from a personal injury lawsuit. Joe may want to establish a special needs trust to avoid losing public benefits he receives now, or might receive in the future.

Keep in mind that a first party special needs trust for Joe can be established only if Joe is under age 65 at the time.

These trusts are sometimes called “payback” trusts because they must contain a provision that when the beneficiary dies, any amount remaining in the trust must go to pay back the state for the value of any public benefits the beneficiary received. If anything remains after that payback, it can go to other beneficiaries, such as family members.

Sometimes you will hear people call first party trusts “(d)(4)(A)” trusts, referring to 42 U.S.C. §1396p(d)(4)(A), which was part of the Omnibus Budget Reconciliation Act of 1993, or “OBRA ‘93.” That federal law exempts certain trusts from being considered the property of the beneficiary for public benefits purposes.

Third party trusts. When the funding for a special needs trust comes from someone besides the beneficiary, that’s called a third party trust.

The typical situation is for a parent, grandparent, or other relative to give the money for the trust. The person establishing the trust may do so while alive, or at death with a provision in his or her will.

Unlike a first party trust, a third party trust does not need to be a payback trust. Instead, any amount remaining when the beneficiary dies can go to others, perhaps the beneficiary’s brothers and sisters, with no requirement to pay back the state for public benefit costs.

Also unlike first party trusts, the beneficiary can be any age – even over 65 – when the trust is established.

Pooled trusts. A special needs trust can also be established as a “pooled” trust with an approved nonprofit association. Funds in this type of trust are pooled together with other special needs trusts for investment purposes, but a separate account is maintained for each beneficiary.

Funds to establish a pooled trust account can come either from the beneficiary or from a third party.

A pooled trust is often used when the amount of the trust is relatively small. Administrative fees for trust management can be lower due to efficiencies and shared costs, and the cost of establishing an account in a pooled trust are often minimal.

Nonprofits operating pooled trusts are permitted to retain funds of deceased beneficiaries to assist other persons with disabilities, but not all of them do. When a beneficiary dies, funds remaining in that beneficiary’s account go to pay back the state for any Medicaid benefits the beneficiary received, unless the trust retains those funds.

The legal shorthand for a pooled trust is a “(d)(4)(C)” trust, referring to 42 U.S.C. §1396p(d)(4)(C).

Which is the right one?

Whether to establish a special needs trust, and is so what type, can be a complicated decision, often taking into account such considerations as the amount of money involved, the source of the funds, the beneficiary’s age, type of disability, type of benefits (if any) the beneficiary receives now or could receive in the future, and a number of other factors. Objectives vary from client to client.

For this reasons, it’s best to consult an experienced professional in your jurisdiction before establishing a special needs trust.

Qualifying for Medicaid the right way by buying exempt resources

There’s a right way and a wrong way to do everything, as your mother always told you.

The same holds true in qualifying for Medicaid.

Today I’ll pass on a true story about a client of mine who (with our help, naturally) qualified her husband for Medicaid, while protecting assets and putting herself in a better position, by buying an exempt resource.

(If you don’t know about exempt resources, click here.)

I’ll call her Mrs. Walker. While she was walking across the street after church one evening, a motorist struck her. A period of painful physical therapy ensued, after which Mrs. Walker got around on two canes. The stairs in Mrs. Walker’s house became dreaded obstacles.

Around that time, Mrs. Walker’s husband suddenly – but permanently – required full-time care in a skilled nursing facility to the tune of about $8,000 a month.

We crunched the numbers and found that Mr. and Mrs. Walker owned about $150,000 too much in resources to qualify for Medicaid benefits. But one simple strategy solved two of their problems.

Mrs. Walker sold her old three-story house and combined her proceeds with the couple’s extra $150,000 to buy a newly constructed ranch condo. She loved having everything all on one floor, and Medicaid benefits started paying for the cost of her husband’s care.

So what’s the wrong way to qualify by buying exempt resources? Getting too cute and buying a Porsche with your extra dough is one example. Even if you don’t end up with a denial (and trying to explain the propriety of the purchase to an administrative law judge), you still have the problem of what to do with an asset that depreciates in value rapidly, may require expensive maintenance, and could be subject to Pennsylvania’s estate recovery program.

It’s always best to make sure your Medicaid qualification strategy fits in with your overall circumstances and estate planning goals. It should also make simple common sense.

Finally, keep in mind that when using this strategy to qualify for benefits, timing can be critical. (See example.) It’s best to have professional advice.

IRA & 401(k) book recommendation

Let me tell you about my favorite book on individual retirement accounts (IRAs) and 401(k) plans: The Retirement Savings Time Bomb…and How to Defuse It by Ed Slott.

Here are the reasons I like it so much and refer to it often.

It makes a dry subject interesting

I’m continually amazed at how the author takes dull, technical rules and turns them into entertaining, informative advice. Reading the rules on IRA distributions and taxation could put a valium to sleep. Somehow Ed Slott explains them so that they make sense, while keeping the reader interested.

Now granted, I’m interested in this subject because it relates to what I do for a living. But I think even casual readers would enjoy reading this book.

It’s practical

By the time you’ve read the book, you’ll understand the important rules about rollovers, early distributions, required minimum distributions, designated beneficiaries, Roth plans, and so on.

Knowing the rules is useless, though, if you don’t know how they relate to you. That’s where Slott’s book really shines. He relates the rules to practical questions about whether you should roll over a 401(k) into an IRA, how and why to name a designated beneficiary, the consequences of early withdrawals, reasons to insure an IRA, and other issues that probably never occurred to you.

It gives great advice

As you might guess from the title, Slott believes that many people don’t do enough to protect the value of retirement plans from taxation, forced distributions, and other problems. He shows the reader the many ways things and go wrong and offers this observation about those with large IRAs who stand to lose much of it to estate and income taxation:

“Why do IRA owners let their savings fall into such an abyss? The reasons can be summed up in a single word: admiration.

“Rather than doing whatever it takes (even—oh, horror of horrors!—spending some money) to keep their accounts from being sacked and pillaged by the IRS after they’re gone, they just sit there admiring how much the balance is.”

He then presents different approaches to help you keep from losing the value of retirement accounts, and making sure that your beneficiaries can get the maximum benefit from it after you’re gone. The book offers five chapters devoted to protecting your retirement savings:

Step #1: Time It Smartly

Step #2: Insure It

Step #3: Stretch It

Step #4: Roth It

Step #5: Avoid the Death Tax Trap

If you have an IRA, 401(k), or 403(b) retirement plan, I highly recommend that you read this book. You’ll learn things you need to know about how to make the most of it and how to avoid mistakes that could rob it of its value. And you’ll enjoy the read.