Special Needs Trusts - An Introduction

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There is a common saying among insurance salesmen that a person does not buy life insurance for himself, but for those he leaves behind. Certainly many parents have considered how insurance, savings, investments, and other material assets might be used to provide for their families if God should call them home unexpectedly. However, families with special needs children must be aware that many of the traditional methods of estate planning might not be appropriate for them.

There are some unique tools provided in Illinois law, and while these tools are not right for every situation, for the right circumstances they can mean the difference between making life simpler or making it far more complicated. Even more importantly, many of these tools can be used right now, while the parents are alive, to maximize the financial resources available to provide for a child’s special needs. 

One such tool is the Special Needs Trust – a financial planning mechanism that allows assets to benefit a person with disabilities but does not disqualify that person from receiving public and private assistance.

Basic Trust Concepts

The concept of the trust dates back thousands of years. In ancient , King David ordered that certain property be held in trust for the welfare of Mephibosheth, the son of David’s best friend Jonathan. (See, 2 Samuel 9). This arrangement was a legal trust, very much like the type of trusts that are used by estate planning lawyers today to provide for the continued care of children after the death of the parents.

A more modern example can be found on the shelves of every grocery store in . In 1918 Mr. & Mrs. Milton Hershey of Lancaster, PA, gifted $60 Million of stock in the Hershey Chocolate Company to a trust that would own the stock and use the income derived from the company to operate a home and school for orphans in Derry Township, Pennsylvania. Today, the original gift from Milton and Catherine Hershey has grown to over $7 Billion in assets, all managed by the Hershey Trust Company for the benefit of the Milton Hershey School and several other charities. 

The basic structure of a trust involves three distinct roles:

  1. a donor – Mr. and Mrs. Hershey or King David,
  2. a trustee – Hershey Trust Co. or Ziba in 2 Sam. 9, and
  3. a beneficiary – the orphans’ home or Mephibosheth.

Some of these roles might be filled by the same person, or they might be filled by multiple people, companies, or institutions. The most basic form of a trust is often created over and over again in a person’s lifetime. Remember, a trust only requires three things.

Consider this more common example: a mother (the Donor) gives $50 to her teenage daughter (the Trustee) with specific instructions to run to the store for some bread, milk, and fruit to provide dinner for the family (the Beneficiary). The same trust concept is demonstrated when one neighbor asks another to sell a $10 gadget in the family garage sale, or when an adult child agrees to handle the checkbook for an aging parent who might need some help keeping the bills straight. It is a common misconception that trust funds are only used by wealthy people, or only to manage money after someone dies. In fact, they are used by ordinary, everyday men and women more often than they realize.

Special Needs Trusts

Most parents consider a trust fund to be the primary means of support in case they die before their children are able to live independently. For parents of a special needs child, trusts can enhance the financial security of the child, even while the parents are living. This is because certain trusts can be used to supplement other sources of financial support that a family might need in order to provide for the special needs of their child.

Many special needs children receive some sort of financial benefit other than the family’s traditional income. Some children receive social security or other disability benefits; some qualify for Medicaid, Medicare, SSI, or other government benefit programs; some might receive private, charitable, or locally funded assistance. There are such diverse programs available to families, that it becomes overwhelming to try to categorize each option. Some are based on financial need, but others are not. Some are only for a certain type of disability, while some programs are open to a variety of children. Some programs pay cash or benefits directly to a family, while some only provide services or assistance indirectly through supplements to doctors, meal programs, or living arrangements.

The basic concept of a special needs trust is to provide the financial and lifestyle benefits that cannot be provided by other resources. For example, a child with a physical disability might qualify for Medicaid assistance for basic healthcare concerns. But, the child would be disqualified from Medicaid if she suddenly inherited thousands of dollars. The rules for actually determining Medicaid eligibility are very complex and vary across state lines, and the rules for other benefit programs are different yet.

For simplified purposes of this discussion, one common example of financial eligibility is that person receiving disability benefits cannot have more than $2,000 in liquid assets in her own name. Thus, a person who qualifies for Medicaid assistance would suddenly be disqualified if she inherited only a few thousand dollars from a parent, aunt, uncle, or grandparent. At the same time, that inheritance could be used up in only a few weeks if it had to be spent for therapy, medication, or other treatment. As soon as the inheritance is gone, the person has to resubmit an application to qualify for Medicaid assistance all over again. In the end, the inheritance did nothing to change the child’s welfare, and only made matters more complicated by starting over with Medicaid eligibility.

With a carefully prepared special needs trust, the same situation would allow the gift of a few thousand dollars to be set aside to provide some extra benefits that basic assistance programs do not provide. For example, money in a special needs trust can be used to pay for a summer camp program, higher quality medical equipment like a motorized wheelchair, special ized tutoring, some nice clothes for a special occasion, the extra expense of including a special needs child on a family vacation, and any number of possibilities that would enhance the life of a child beyond basic subsistence.

The way a Special Needs Trust provides these benefits actually depends on the type of trust established. In general, the law recognizes two types of Special Needs Trusts: the “Self-Funded” trust and the “Third-Party” trust. These trusts may be called by a variety of names (e.g., Self-Settled trusts, OBRA or OBRA ‘93 trusts, Pay Back trusts, Pooled trusts, etc.). All of these names, though, are just labels that describe the same two categories of trust.

The “Self-Funded” trust is a Special Needs Trust that is funded by the disabled person’s own assets. If a person becomes disabled later in life, or if a disabled person already owns property, money, or other assets in his own name, then assets can be transferred into a trust so that the individual is not disqualified from receiving financial benefits.

Under Illinois law two different types of “Self-Funded” trusts are permitted. One is usually referred to as a Pay Back trust, and the other is called a Pooled trust.

The rules for how each type of trust is established, administered, and funded are different. Also, certain individuals might qualify for one type of trust but not the other. It is important to understand these differences and to carefully review each individual situation, or the trust might not qualify for proper treatment under the law. That could result in a loss of financial benefits, or an unintended expense to the family or the child’s resources. While the rules for these trusts are complex, the basic distinctions involve who manages the trust assets, and what happens to those assets at the end of the child’s life.

The Pay Back trust, as its name implies, must be drafted so that when the special needs child dies, any money still in the trust is used to repay the State for any financial benefits that the child received during life. During the child’s life, the trust can be managed by a family member or professional trustee to supplement the lifestyle and resources of the special needs child.

The most common use of this type of trust is for Medicaid recipients. During the disabled person’s life, he might receive Medicaid benefits to pay for his medical needs. For a Medicaid beneficiary, the Illinois Department of Human Services keeps track of the total amount of Medicaid benefits paid over his lifetime.

After he passes away, any remaining trust funds must be used to repay Medicaid for those medical benefits. If there is not enough money to pay for all of the Medicaid expenses amassed over his life, then the State absorbs the loss. On the other hand, if there are extra funds left after repayment to Medicaid, then those funds can be paid to other family members, charities, or anyone else just like a typical trust or last will and testament.

The other type of “Self-Funded” trust is usually called a Pooled trust. This type of trust is different because the trust funds are held and managed by a non-profit organization approved by the State to manage such trusts. Having the trust funds managed by this type of organization might be appealing to certain families, either because of the expenses involved or the complexities of investing and managing the funds. A key difference between a Pooled trust and a Pay Back trust as described above is that any funds left in a Pooled trust account at the end of the child’s life will be given to the non-profit organization that has managed the fund.

Both Pooled and Pay Back trusts are designed to maximize the use of assets already owned by the special needs child, or assets that might come directly into the child’s name in the future. The other type of Special Needs Trust, called a “Third-Party” trust is established with assets owned by anyone other than the child himself.

Third-Party trusts can be established by parents, grandparents, friends, extended family members, or anyone other than the child. Third-Party trusts are much more flexible than Self-Funded trusts, because they include provisions for giving assets to brothers and sisters, other family members, or anyone else designated by the creator of the trust.

The most common use of a Third-Party trust is for estate planning by parents and grandparents. A husband and wife who have three children, only one of which is disabled, should include a Third-Party Special Needs Trust as part of their last will and testament or other estate planning documents, so that if they both die before their special needs child, the child can receive maximum financial benefits from the resources left by the parents.

The general concept of a Special Needs Trust is not very complicated. It is simply a tool for a family to enhance the financial resources available to their special needs child, both during the parents’ lives and after they are gone. However, the rules for creating, funding, and administering such trusts must be followed precisely. Unfortunately, many lawyers who do “typical” wills and/or trusts might not understand the complexities of Special Needs Trusts.

The proper use of a Special Needs Trust is not a “scheme” or deception that tries to use “loopholes” to gain an unfair advantage. Rather, Special Needs Trusts are specifically authorized by our state and federal legislators, as long as the rules for creating and managing such a trust are followed.

A family makes a wise investment by seeking out good legal counsel from an experienced attorney who knows the different types of Special Needs Trusts that are available, and how to make use of them. In order to know that a particular attorney is well-versed in these matters, parents should interview the attorney to get a feel for his working knowledge of this area of the law. An attorney competent in preparing Special Needs Trusts should be able to explain the basic differences between the types of trusts available, when to use them, who qualifies for them, and what to look for to avoid problems. This is an area where good personal counsel is necessary, and mass-market or internet-based documents probably cannot address a family’s specific circumstances. Most importantly, a good attorney will take the time to listen to a family’s story and make sure that the family’s priorities are the driving factors in planning any legal strategy.

This article was printed in the 2007 summer/autumn edition of “The Alliant” magazine by Illinois Christian Home Educators.