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Effective Utilization of Insurance and Retirement Accounts In Special Needs Planning

Posted by attorney Thomas Begley

Estate planning for parents with disabled children is a very delicate and important proposition. During their lifetime, parents are able to provide emotional and financial support to their children. This support greatly enhances the needs-based government benefits, which are frequently utilized by the disabled, such as Supplemental Security Income (SSI) and Medicaid.

When parents pass away, these special children lose emotional support, which can never be regained. Without proper planning, they can not only lose financial support, but their government benefits can be jeopardized as well.

Estate planning on behalf of disabled children typically takes five forms:

  1. Disinheritance;
  2. Outright bequests;
  3. Putative bequests to siblings;
  4. Support trusts; and
  5. Special needs trusts.

With rare exception, the special needs trust is the only strategy to utilize.

Many individuals disinherit their disabled children based upon poor advice. They love their children very much, but are very concerned with preserving needs-based government benefits. They are told that inheritances will disqualify their children from these benefits. Unfortunately, this advice is inaccurate, because proper planning can preserve these benefits. In most instances, disinheritance is ill-advised. As any reasonable individual knows, our federal and state governments have taken an increasingly adverse position preserving the health and well-being of the disabled. In light of the fact that government eligibility continues to tighten for needs-based programs, it is not speculative to foresee a society in which drastic cutbacks in programs were made that may imperil the well-being of the disabled. Thus, disinheritance is unwise.

On the other hand, outright bequests are often disastrous. In most states, an individual cannot qualify for needs-based public benefits if their assets exceed $2,000. Outright bequests typically will disqualify an individual from these benefits. As such, the inheritance will be used to supplant SSI, Medicaid, HUD or group housing, and any other needs-based benefit. The more significant the needs of the individual, typically will lead to a rapid depletion of the inheritance.

Many parents believe a preferential distribution to a non-disabled child would hope that he or she will use assets to care for the disabled child. For example, Mr. and Mrs. Smith have three children—Susie, who is disabled, John, and Sarah. Instead of dividing their estate three ways, they give two shares to Sarah and one share to John. Their hope is that Sarah will use one of these two shares to provide for her disabled sister. Unfortunately, Sarah does not manage money well, or if she is subject to divorce or creditors, these funds can be compromised. Also, Sarah could predecease Susie and these funds could be completely unavailable.

More and more individuals, attorneys and other professionals recognize the need for trusts to protect the disabled. Unfortunately, most of them do not know how to do it properly. Far too often parents execute wills in which a trust is established with language stating that funds will be utilized for the “health, education, maintenance, and support" of their disabled children. This type of trust, known as a support trust, automatically disqualifies disabled children from needs-based benefits. The individuals who draft these trusts recognize the need to protect the disabled, but are completely unaware of the rules that need to be followed to preserve benefits. Of course, it should be noted that families that are very affluent may benefit from using the support trust, as it allows for a broader range of distributions on behalf of a disabled individual. The basic rule of thumb is that the assets in the trust, and the income generated therefrom, must clearly provide for the child to the extent that needs-based benefits are unnecessary.

In the vast majority of cases, a special needs trust is warranted. A special needs trust can be established as part of a will, but more often is preferably established as a standalone document. A standalone document cannot only absorb the inheritance by the parents, but from other family members or friends who may wish to contribute in their estate plans to the disabled child. The special needs trust follows very strict guidelines, which assert, among other conditions, that: (1) this trust is to supplant rather than replace government benefits; (2) it can be utilized to pay third parties rather than the beneficiary directly; and (3) is managed at the absolute discretion of the trustee. The establishment of special needs trusts allows the disabled child to maintain his or her needs-based government benefits and have a fund available to enhance his or her quality of life.

In order for a special needs trust to be properly established and maintained, two steps needs to be undertaken. First, the trust itself needs to be properly established. Second, the assets of the parents need to be positioned to fund this trust.

The mere establishment of the trust is not enough. On far too many occasions, there have been parents who have established valid special needs trusts on behalf of their children. However, upon their passing, probate assets, such as individually held financial accounts and real property, will pass into the trust, but non-probate assets, such as retirement plans, IRAs, annuities, and life insurance, will not.

Many individuals don’t recognize that many assets pass outside of the will. Typically, wills and trusts are set up years after beneficiary designations have been ascribed to non-probate assets. Thus, there are typically two areas of concern that are seen with non-probate assets when the parents of disabled children die. First, the parents will exclude the child as a beneficiary based on the aforementioned assumption that no proper planning could be undertaken. Second, the parent will use the child as an outright beneficiary. These mistakes are typically made because the parents wish to take care of their children, but are not properly advised by the financial advisor or insurance salesman and establish the aforementioned accounts or policies for them.

A similar situation exists with what is known as the poor man’s estate plan. Basically, individuals, in an effort to avoid probate (often times unnecessarily), establish paid on death designations on bank accounts and EE Bonds. They also will establish a similar transfer on death designation on brokerage accounts. In all of the aforementioned instances, whether it’s the contract assets or TOD/POD accounts, outright bequests will pass directly to the disabled child, regardless of the terms and conditions of the will and/or special needs trust.

It is imperative to coordinate non-probate assets into an estate plan. Quite frankly, this not only affects planning for parents with disabled children, but individuals with taxable estates who wish to minimize federal and state death taxes, as well as individuals who wish to leave a portion or all of their bequests to charity. In the present instance, there are certain steps that need to be undertaken to ensure that special needs trusts are properly funded and that assets do not go outright to a disabled child.

First, for any asset that has a transfer on death or paid on death designation, such designation should be removed. By doing so, the assets will flow through the estate and eventually into the special needs trust. Second, a special needs trust may be a partial or complete beneficiary of a life insurance policy. There are generally no catches to this planning. Third, the special needs trust can be made a beneficiary of a retirement plan, 401k, or an annuity as well. In doing so, one should try to coordinate the tax-deferred characteristics with the overall planning objectives of the individuals who wish to implement the plan.

In many instances, there can be adjustments made to a parent’s estate plan where certain assets may be preferable to go to the disabled child’s trust, whereas other may be more preferable to go to non-disabled beneficiaries. For example, the aforementioned parents, with one disabled child and two non-disabled children, have an aggregate estate of $3 million. Five hundred thousand dollars is in life insurance, $800,000 is in retirement plans, and the rest is in brokerage accounts and real property. In most instances, it would make the most sense that the two non-disabled children be named as beneficiaries of the retirement plans. In doing so, we very frequently can roll the retirement plans into inherited IRAs in their own names; thereby allowing them to take required minimum distributions over the course of their actuarial life expectancies. This allows for a very positive deferral of income taxes. To compensate, the special needs trust can be the beneficiary of the life insurance. There are no income tax consequences in doing so.

Of course, if this step is undertaken, the two non-disabled children will see $400,000 each while the disabled child receives $500,000. If the parents wish to treat their children equally, language could be placed inside their wills or living Trusts to authorize the fiduciary to equalize the distributions of the three beneficiaries, by taking into account assets which were received outside of probate.

The foregoing demonstrates the special issues involving special needs children. Proper planning is often complex. However, it can be successfully undertaken. With proper legal documents and proper titling of assets, parents can effectively provide for their disabled children.

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