After the substantial response we received from the posting/newsletter on different special needs trusts, I thought it would be valuable to mention a strategy for magnifying the inheritance of a special needs beneficiary. Life insurance can provide a great amount of inheritance for a special needs beneficiary, but only if handled properly. The restriction on providing direct assets to a special needs beneficiary still holds true, whether it is done through a good revocable living trust for you or a separate special needs trust for your beneficiary.
Life insurance can provide a large sums of money for your loved ones for pennies on the dollar, particularly if you start early enough that the initial insurance is inexpensive. But what kind of insurance should you get? There is a large and never-ending debate between the merits of term and permanent insurance. Both have their benefits. “Term insurance is much less expensive, and you can make more money by investing the difference in stocks, bonds or CDs” and “Why throw your money away on term insurance if you don’t die within 20 years? Get permanent insurance so the value stays with you no matter how long you live.” The truth is neither is completely right or wrong. It all depends on the goals and situation.
When looking at life insurance to support a special needs child, more people tend to look at permanent insurance since it will be there no matter what. Many people who look at a large term insurance policy will do so to support children and their education should they pass on while the children are still young. When the children are out of the house and on their own, the need for a large term policy disappears. For most people, that’s fine. It is not OK for parent trying to leave a large sum of money to support a special needs child.
The next question is whether or not having a large life insurance policy would have any negative estate tax implications.
Here’s the general outline of events and procedures:
• Establish an Irrevocable Life Insurance Trust which will both own the policy and be the beneficiary of the life insurance with the special needs beneficiary being a beneficiary of the trust.* There will be other beneficiaries of the trust.**
• You can not be the trustee of this trust. Instead, have a trusted friend, sibling, or even adult child other than the beneficiary act as the trustee.
• Have the trustee apply for the life insurance policy with you (or you and a spouse/partner) as the “insured.” The trust will be the “owner” of the policy, it will be the “beneficiary” of the policy, and any and all payments for the insurance will come from the trust.
• Premium payments must go to the trustee, and they pay for the insurance.
• When the parent passes on, the insurance money will go to the irrevocable life insurance trust to take care of the special needs beneficiary. All of the life insurance goes to the trust estate tax free.
There are a few caveats and points to make the strategy work correctly, but that comes with anything that can save an estate hundreds of thousands of dollars in estate taxes. For example, the beneficiary of the irrevocable life insurance trust may well be the subtrust established for the special needs beneficiary through a Revocable Living trust or a separate Special Needs Trust. In order for the life insurance to be estate tax free, there has to be a “meaningful and genuine opportunity” for beneficiaries to take the premium money each time it goes to the trust, and the special needs beneficiary can not be that person without disqualifying them from benefits. Therefore, it is crucial to name other beneficiaries in the life insurance trust who will sign that they are not taking the premium money and allow it to go to the insurance company. These and other important restrictions make it essential to work with an attorney and life insurance agent who understand the process and can guide you through it.
As you have read, it is one thing to shelter any inheritance from disqualifying a special needs beneficiary from their benefits and have the inheritance available to help with supplementary needs. It is quite another to exponentially compound the money available through life insurance while also making sure that lie insurance is estate tax free.