While there are certainly permutations and small differences, there are three basic special needs trusts that we work with in the law office. Before getting into those, let me eliminate one option that is used far too often; using a testamentary trust in a Last Will and Testament. When a trust is set up through a Will, it is an invitation for the court to continue probating the special needs beneficiary’s share for the remainder of their life with all of the accompanying inventories, receipts, and cancelled checks. Worse, the court has discretion to turn down requests for expenses from the trustee you may or may not have chosen. My clients come to me to help avoid bureaucratic entanglements, not plan to involve a court bureaucracy for decades.
The three main types of Special Needs Trusts my law firm sees and uses are: 1) subtrusts under a Revocable Living Trust, 2) separate Special Needs Trusts, and 3) D4A Trusts. In all cases, the terms of the trust documents keep the beneficiary from losing whatever benefits they may otherwise qualify for.
The revocable living trust is the mainstay of our firm’s estate planning practice, and the vast majority of our clients come to us to have their estates avoid the probate process. The thing is, all of the language needed to protect a special needs beneficiary is already in the standard revocable living trusts we use. Most clients who are planning to protect their own special needs beneficiary do not need a separate special needs trust except in certain circumstances, which leads us to the second type of special needs trust.
Separate Special Needs Trusts are not necessary under most circumstances mainly because most planning scenarios have parents without current estate tax problems leaving their own children inheritances, and if there are one or more special needs beneficiaries, then the revocable living trusts that our office uses protects that inheritance from loss of benefits. But what if someone other than the parent wants to leave their special needs child an inheritance, or even make a gift during their lifetime? That is when having that separate special needs trust makes sense. In addition, if the parents do have a taxable estate (currently over $11.7 million for federal estate taxes) AND they want to leave more money to the special needs beneficiary, a tax-efficient way to do that is to buy life insurance through an irrevocable special needs trust. This way, when the parents pass on, the life insurance pays into the trust without any estate tax consequences. In short, the separate Special Needs Trust doubles as an Irrevocable Life Insurance Trust.
Finally, we get to the D4A Trusts, named after the code section that makes them an effective tool… of last resort. I keep hearing professionals and even parents of special needs children praise the D4A Trust up and down like it’s the best thing to happen since electricity. However, that’s like praising the life-saving treatment NARCAN for heroin overdoses as an effective treatment for drug addiction. If you are actually planning ahead, then D4A trusts are something to avoid. While the assets inside the trust won’t count towards a special needs beneficiary losing their benefits, a court oversees the distributions, the trustee has to report to the court, (basically a living probate) and when the beneficiary passes on the money left in the trust goes to the government. Why would anyone want to have living probate AND give the government any unused trust funds rather than having them go to their chosen beneficiaries?
We will use D4A Trusts when needed because a special needs beneficiary received an unplanned inheritance or proceeds from a lawsuit, but as a Certified Medicaid Planner™, I’ve seen far too many other options that don’t involve living probate or loss of the unused trust funds. Again, like NARCAN, it can be that item of last resort, but if there are more effective ways to create better outcomes, then people should do what they can to take advantage of those other options.
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