Stand-Alone Special Needs Trust
The most common form of Special Needs Trust (“SNT” also known as a Supplemental Needs Trust), is that which the grantor establishes in his or her own trust or will, with his or her own assets, and which becomes effective when the grantor dies. This is known as a third-party (because if was established by someone other than the beneficiary) testamentary (because it was established by a document that only takes effect when the grantor dies) SNT. Another common form of Special Needs Trust is that which is established with the assets of the disabled person, this is known as a first-party SNT. A first-party SNT is sometimes referred to as a “grantor trust” because the beneficiary is the grantor.
But there is another form of Special Needs Trust that is particularly helpful in many situations, the non-testamentary trust (sometimes referred to as a stand-alone SNT). This is a third-party trust that is not testamentary because it is established and becomes effective before the grantor dies. It becomes effective as soon as it is established by the grantor. There are many benefits to a stand-alone special needs trust. Here are but a few:
- Makes it Safer and Easier (and Less Expensive) for Other Family Members to Benefit Your Special Needs Child)
Other family members (grandparents, siblings, aunts, uncles, or friends etc.) may want to benefit the person with special needs, however, leaving assets directly to the disabled could cause more harm than good, jeopardizing the disabled’s access to public benefits (such as SSI, Medicaid, public housing, etc.). On the other hand, including a special needs trust in their own estate plan would add complexity and expense, which could dissuade them from leaving anything to your child. However, if you establish a stand-alone special needs trust for your child, you make it very easy and inexpensive for other family members to provide for your child, and assures they will do so “the right way.” All you need is a letter from you to them that tells them you have established a special needs trust for your child, and provides them the name of the trust. All they then need to do is use the name of this trust, instead of your child’s name, in their own will, trust, insurance, IRA, or retirement plan beneficiary designation, or even a check. Making it easier for other family members to benefit your special needs child is a subtle and effective means of encouraging them to do so.
- Making Your Own Beneficiary Designations Safer and Easier
If you establish a special needs trust in your living trust or will, you may think that, in doing so, you have “taken cre of things.” Often, that’s not the case.
If you have inadvertently named your disabled child as beneficiary on your insurance, IRA or retirement plan documents, those benefits would be paid directly to your special needs child and cause the problems described above. If you name a special needs trust that is to be established when you die under the terms of your living trust or will, you’re naming a trust that doesn’t yet exist and may never exist if your will or trust would be later changed or redone, or declared invalid when you die. Also, it can be difficult and cumbersome to try to describe a trust to be established when you die in the limited space provided on many beneficiary forms, and if the form asks for the name of the current trustee or the trust’s tax ID number, your only honest answer would have to be “there isn’t one yet.”
In contrast, it’s fairly simple to describe a stand-alone special needs trust on a beneficiary form, and doing so will assure not only that you got it right, but that you won’t have to change it if you later redo your estate plan.
- Making It Easier to Assure That Your Special Needs Child Will Be Provided for in the Event of Your Lifetime Incapacity
If you become incapacitated and unable to handle your own financial affairs, someone else will have the responsibility of doing that for you. By law, a guardian or conservator appointed for you by a court (the outcome if you don’t have proper legal documents naming someone that were executed while you had full capacity) can only spend your money for your personal benefit. Most power of attorney forms, and many living trusts, impose that same limitation. If you use your will or living trust to establish a special needs trust for your child upon your death, that will not, and cannot yet help, because you are still alive.
The best way to legally assure that your special needs child can be properly provided for, from your assets, in the event you become incapacitated, is to have a stand-alone trust in place to receive the funds, and to have your financial power of attorney document (and living trust, if you have one) specify that, in the event of your incapacity, funds can be paid into that special needs trust for your child’s benefit.
Dispelling a Common Misconception
Establishing a Stand-Alone Special Needs Trust Doesn’t Mean You Need to Fund It Right Away. Some people mistakenly believe that if you establish a stand-alone special needs trust for your child, you need to immediately figure out how much of your estate you want to leave to that child, and put those assets into the trust right away. Fortunately, that’s not the case. You can establish the trust now, and you (and others) can put assets into it at later times. Think of it like buying a safe deposit box. It will be there whenever you need it, and your decisions and the course of future events will determine when that will be.
Tax Implications of a Stand-Alone SNT
Tax advice is best left to tax professionals, but there is at least one tax concern that you should be aware of if setting up a stand-alone SNT for your disabled child. When it comes to the income produced on an annual basis by a SNT, there are different rates at which the IRS taxes them. For example, the trust rate is notoriously high, 35% as of the publication of this blog post. However, some trusts can have their income taxed at the rate applicable to the beneficiary, which is often times lower than 35%. Usually, it is grantor trusts that receive this beneficial tax rate. Unfortunately, stand-alone trusts, whether SNT or not, are not grantor trusts. However, in certain circumstances, attorneys may be able to include language in the trust instrument that will cause the trust income to be taxable to the donor rather than to the trust or the beneficiary. This is sometimes called an “intentionally defective grantor trust.” This can be very advantageous, depending upon the particular situation – for example, if the donor of the funds has a lower tax bracket than the trust or the beneficiary.
Regardless of Whether it is a Stand-Alone SNT or a Testamentary SNT
Regardless of whether taxable income is attributed to a stand-alone or a testamentary SNT, it is important to make sure your trustee is ready to advocate if necessary concerning the difference between “taxable” income and “countable” income for purposes of Medicaid and other government benefits. This is important because government agencies often get a “tracer” report from the IRS about beneficiary income, and may issue preliminary notices that benefits will be terminated unless they receive proof that the beneficiary did not have countable income. The trustee should be prepared to explain that although the income was reportable to the IRS as the beneficiary’s income for tax purposes, the beneficiary only received distributions “in kind” which in general (with certain exceptions) are not counted as income for purposes of SSI, Medicaid, or other programs.
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