How Do Special Needs Trusts Work?

Special needs trusts (SNT) are critical tools for protecting a beneficiary with disabilities’ benefits while providing for their needs.

Special needs trusts (or supplemental needs trusts) have been used for many years. However, there are two factors that are changing and clients need to be aware of them, says the article “Special-Needs Trusts: How They Work and What Has Changed” from The Wall Street Journal. For one thing, many people with disabilities and chronic illnesses are leading much longer lives because of medical advances. As a result, they are often outliving their  primary caregivers. This makes planning for the long term more critical, and the use of special needs trusts more critical.

Second, there have been significant changes in tax laws, specifically laws concerning inherited retirement accounts.

Special needs planning has never been easy because of the many unknowns. How much care will be needed? How much will it cost? How long will the person with disabilities need them? Tax rules are complex and coordinating special needs planning with estate planning can be a challenge. A 2018 study from the University of Illinois found that less than 50% of parents of children with disabilities had planned for their children’s future. Parents who had not done any planning told researchers they were just overwhelmed.

Here are some of the basics:

A special needs trust, or SNT, is created to protect the assets of a person with a disability, including mental or physical conditions. The trust may be used to pay for various goods and services, including medical equipment, education, home furnishings, etc.

A trustee is appointed to manage all and any spending. The beneficiary has no control over assets inside the trust. The assets are not owned by the beneficiary, so the beneficiary should continue to be eligible for government programs that limit assets, including Supplemental Security Income or Medicaid.

There are different types of Special Needs Trusts: pooled, first party and third party. They are not simple entities to create, so it’s important to work with an experienced estate elder law attorney who is familiar with these trusts.

To fund the trust after parents have passed, they could name the Special Needs Trust as the beneficiary of their IRA, so withdrawals from the account would be paid to the trust to benefit their child. There will be required minimum distributions (RMDs), because the IRA would become an Inherited IRA and the trust would need to take distributions.

The SECURE Act from 2019 ended the ability to stretch out RMDs for inherited traditional IRAs from lifetime to ten years. However, the SECURE Act created exceptions: individuals who are disabled or chronically ill are still permitted to take distributions over their lifetimes. This has to be done correctly, or it won’t work. However, done correctly, it could provide income over the special needs individual’s lifetime.

The strategy assumes that the SNT beneficiary is disabled or chronically ill, according to the terms of the tax code. The terms are defined very strictly and may not be the same as the requirements for SSI or Medicaid.

The traditional IRA may or may not be the best way to fund an SNT. It may create larger distributions than are permitted by the SNT or create large tax bills. Roth IRAs or life insurance may be the better options.

The goal is to exchange assets, like traditional IRAs, for more tax-efficient assets to reach post-death planning solutions for the special needs individual, long after their parents and caregivers have passed.

Reference: The Wall Street Journal (June 3, 2021) “Special-Needs Trusts: How They Work and What Has Changed”

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Protecting Money from a Child’s Divorce

Families with concerns about a child’s marriage are often interested in protecting money from a child’s divorce.   This often arises in situations where a parent wishes to give away assets to her children and grandchildren.  Giving assets directly to a child with an unstable marriage can put those assets in jeopardy, and this problem can be solved with the use of estate planning strategies, according to the article “Husband should keep inheritance in separate account” from The Reporter.

Everything a spouse earns while married is considered community property or marital property in most states.  However, a gift or inheritance is usually considered separate property or separate from the marriage, which is articulated differently depending on what state you are in.  If the gift or inheritance is not kept totally separate, that protection can be easily lost.

An inheritance or gift should not only be kept in a separate account from the spouse, but it might be a good idea to keep it at an entirely different financial institution. Since accounts within financial institutions are usually accessed online, it would be very easy for a spouse to gain access to an account, since they have likely already arranged for access to all accounts.

No other assets should be placed into this separate account, or the separation of the account will be lost and some or all of the inheritance or gift will be considered belonging to both spouses.  There may be other considerations about the income generated by that money, but check with your local estate planning attorney on that issue.

The problem comes when the money from the gift or inheritance is mixed or commingled with the other assets of the marriage.  Depending on what the assets are, they might be able to be untangled.  More likely, the mixing will “poison the well” and make all of it subject to the divorce.  Here is another issue: if the child does not believe that the spouse is a problem or if the child is being pressured by the spouse to put the money into a joint account, they may need some help from a family member to ensure protecting the money from the child’s divorce.

This “help” comes in the form of the parent putting the gift or inheritance in an irrevocable trust.  Everyone concerned with protecting money from a child’s divorce should consider one.

This trust will keep the money separate and will be administered under its terms.  The trust can benefit the child, but will keep the money owned by the trust from being commingled and therefore, separate property.  That way, if they divorce later, the money in the trust is protected.  Many clients love this option and include it as part of their estate plan, especially as trusts of this type have similar benefits with the child’s creditors.

The best solution is for the parent to meet with an estate planning attorney who can work with her on protecting the money from the child’s divorce.

People often attempt to find simple workarounds to complex estate planning issues, and these DIY solutions usually backfire. It is smarter to speak with an experienced attorney, who can help both parent and child in protecting the money from a child’s divorce.

Reference: The Reporter (Dec. 20, 2020) “Husband should keep inheritance in separate account”

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Is Transferring the House to Children a Good Idea?

Clients frequently ask this question, especially as mom or dad is aging and perhaps living in assisted living or some other senior care arrangement.  Many try to do so using online forms, and find later that it was a mistake.  Transferring your house to your children while you’re alive may avoid probate, but gifting a home also can mean a rather large and unnecessary tax bill or could effect eligibility for long term care benefits. It also may place your house at risk, if your children get sued or file for bankruptcy

You also could be making a mistake, if you hope it will help keep the house from being consumed by nursing home bills.

There are better ways to transfer a house to your children, as well as a little-known potential fix that may help even if the giver has since died, says Considerable’s recent article entitled “Should you transfer your house to your adult kids?”

If a parent signs a quitclaim to give her son the house and then dies, it can potentially mean a tax bill of thousands of dollars for the son.

Families who see this error in time can undo the damage, by gifting the house back to the parent.

People will also transfer a home to try to qualify for Medicaid, but any gifts or transfers made within five years of applying for Medicaid can result in a penalty period when seniors are disqualified from receiving benefits.  A capable elder law attorney can advise you on better ways to address this, as well as potential corrections if necessary.

In addition, transferring your home to another person can expose you to their financial problems because their creditors could file liens on your home and, depending on state law, take some or most of its value. If the child divorces, the house could become an asset that must be divided as part of the marital estate.

Section 2036 of the Internal Revenue Code says that if the parent were to retain a “life interest” in the property, which includes the right to continue living there, the home would remain in her estate rather than be considered a completed gift. However, there are rules for what constitutes a life interest, including the power to determine what happens to the property and liability for its bills.

There are other ways to avoid probate. Many states and DC permit “transfer on death” deeds that let homeowners transfer their homes at death without probate.  Texas has both transfer on death deeds and “Lady Bird Deeds,” and an attorney can advise you on the differences and the best way to utilize them with your estate plan.  An excellent solution is to use a living trust which allows assets it owns or receives at death to avoid probate.  Having the trust own the property, or possibly using a deed to convey the property to the the trust at death, are excellent solutions.

If you are interested in learning more, please see this article for various ways to own and hold real estate.  https://galligan-law.com/how-to-own-your-real-estate/  

In sum, there are many unexpected consequences to transferring your home to your children, so it is important to discuss the best way to convey the home to your loved ones with an attorney.

Reference: Considerable (Sep. 18) “Should you transfer your house to your adult kids?”

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