Life Insurance

6 Tips for Setting Up a Special Needs Trust

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According to the U.S. Census Bureau, there are 41.1 million individuals in the country with disabilities — that's 12.7% of the population. If you're one of them or help care for one, it's good to know about special needs trusts. 

What is a special needs trust? Simply put, it's a financial vehicle that allows an individual with disabilities to receive money without impacting their other sources of income, such as Medicare, Medicaid, or SSI.

Although rules for a special needs trust vary from state to state, you should be aware of some restrictions — including tax implications — when setting up a trust. A special needs trust fund can be helpful for multiple reasons, but following special needs trust fund rules is imperative to make it work for the beneficiary. 

In this article, we'll take a closer look at how to set up and manage a special needs trust.

1. Choosing the right type of trust

What kind of trusts are there? Generally, they can be divided into third-person trusts and first-person trusts. The third-person trust is most common. It's set up by someone other than the beneficiary (the person with disabilities). Often, the beneficiary's parents or grandparents set it up, but it doesn't have to be a family member. 

Third-person disability trusts can be further subdivided into:

•  Stand-alone trusts, which allow the beneficiary to access the trust before the death of the person who endowed it

• Testamentary trusts, which occur when a trust is left to the beneficiary in a will

First-person trusts, meanwhile, are funded by the beneficiary's assets. A first-person special needs trust example may be someone who had significant assets before receiving their disability. To be eligible for means-based assistance, they must place their assets into a trust, so they're not considered when determining income.

2. Understand who is eligible for a special needs trust

Generally, to benefit from a special needs trust, an individual must have a documented, permanent disability. They're likely to receive assistance from a government source, such as SSI. Conditions that may qualify someone for a special needs trust include developmental disabilities, paralysis, cerebral palsy, or blindness. If you're unsure if the disability is permanent, you may still want to explore trusts, since it's possible to dissolve them if they're no longer needed. 

Others who may benefit from a special needs trust are those unable to manage their finances but that don't need government help. This may include, for example, someone with mild autism or bipolar disorder, drug addicts, gamblers, or someone likely to squander their money. These trusts are called spendthrift trusts.

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3. Choosing a trustee

The trustee is the person who needs to know how to manage a special needs trust. They'll handle the paying of taxes and fees on the trust and determine the disbursement of funds to the beneficiary. It's possible to use a lawyer or banker for this role, but their fees may be high. Choosing a family friend or relative is acceptable if it's someone savvy about finances. Both first and third-person trusts require someone to serve as a trustee.

4. How to set up a special needs trust

Once you've chosen a trustee and know what type of special needs trust is best for your situation, you'll need to establish the trust. This may be done with the help of a lawyer or banker, but if the financials are simple, it can also be done using a downloaded form that's notarized. 

In this form, the person setting up the trust, called the "grantor," states what assets are being placed in the trust under the guidance of the trustee. The grantor and trustee can be the same person, but in that case, there should be a successor trustee named in the event of the grantor's death.

5. Funding the trust

Once created, signed, and notarized, the special needs trust must be funded. You'll receive a tax ID number from the IRS for the trust — the trustee should keep that in a safe place, as it'll be needed at tax time. Many people fund their special needs trust by opening a bank account and making a deposit. The trust can also accept other assets, from property, to funds distributed from a will, to the proceeds of a life insurance policy. The trustee must manage all deposits to the account and keep comprehensive records that may be used when paying taxes.

6. What can special needs trust funds pay for?

Special needs trust spending rules should be considered when transferring assets to the beneficiary. Avoid using the funds to pay for food or housing, as this may reduce SSI payments, though this rule has some exceptions. 

Here are some samples of what the trust can pay for:

  • Personal items, from clothing to electronics
  • Travel
  • Services for the beneficiary, such as a cleaning or lawn mowing service
  • Caregiving expenses not paid for by governmental sources
  • Pet care costs
  • Cell phone and Internet

If you're unsure whether you can use trust fund money to pay for something, ask a lawyer or banker with expertise in trusts. The IRS website is also a reliable resource, as is the Special Needs Alliance.

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