Suppose you have a client named Madeline Jones, who has a 25-year-old granddaughter, Sharon, who is disabled and gets government benefits. Madeline, whose net worth is now about $3 million, wants your opinion on her plan to leave Sharon $300,000 in her will. What do you tell her?
If you told Madeline she would jeopardize her granddaughter's benefits by leaving the money to her outright and she should instead consider a special needs trust, you might be helping Madeline as well as her granddaughter. And you would be providing insight on a planning tool that, unfortunately, many advisors and attorneys implement incorrectly or are unaware exists.
There are many variations of special needs trusts, but they are either third-party funded trusts or those created under the Omnibus Budget and Reconciliation Act of 1993 (see sidebar). Because expenditures need to be approved by a trustee, the trusts can protect a disabled person from being exploited by people looking for money. Perhaps even more important, the trusts allow the beneficiary to continue receiving public benefits, such as Medicaid, Section 8 housing assistance and Supplemental Security Income (SSI), but the trusts can pay only for supplemental needs not covered by those programs. Those extras might include things like private-duty nursing care, furniture and supplemental housing expenses, and even a few luxuries, such as swimming lessons or vacations. In fact, a carefully drafted, funded and administered special needs trust could provide many things to enhance a disabled person's lifestyle and keep him or her from living in poverty.
But if the trust money is used to pay for things covered by those government programs, benefits may be reduced or cut off. That may not seem like a big problem if a mentally or physically disabled person suddenly has another source of income. But many inheritances or other financial windfalls can be quickly exhausted if the person must use them to pay for the medical, prescription, housing or food costs government programs typically cover. The result is that money doesn't improve the quality of life for the disabled person, as it would for someone who didn't need assistance. And with some benefits, such as Section 8 housing, long waiting lists mean it can be many years before affordable housing again becomes available for them under the program.
Special needs trusts are not just being used by parents who want to provide for a disabled child; they increasingly are being used in litigation settlements that, for example, result from a person having been disabled in an accident. The money from the settlement funds the trust, which allows a disabled person to remain eligible for government benefits.
"The underlying concept of a special needs trust is you want to make private sources of funding available for a disabled individual while preserving the public benefits. But coordinating private and public benefits requires a lot of forethought," says William L.E. Dussault, an attorney who has his own firm in Seattle that places an emphasis on the rights of people with disabilities. He has specialized in issues involving the disabled for 25 years.
Parents leaving a net estate of $5 million to $8 million to a disabled child usually are providing enough money that they don't have to be concerned with setting up a special needs trust to preserve public benefits, Dussault says. If the amount left for the child will be less than that, a special needs trust may be very important, depending on the child's needs and the size of the estate, he adds.
But he and other experts agree special needs trusts are tremendously underutilized and often grossly underestimate a disabled person's supplemental expenses. Not only that, but they often are incorrectly drafted or administered, resulting in successful government challenges that cause benefits to be denied.
"Nine out of 10 wills and trusts I review are drafted in such a way that the child can either not receive government benefits or remain eligible for them. Most lawyers don't understand government benefits," says Theresa Varnet, an attorney with Spain, Spain & Varnet, based in Chicago and Waltham, Mass. Varnet, also a teacher and licensed social worker, is an active volunteer with the ARC and has been an advocate for people with disabilities for more than 25 years.
Even when a special needs trust is drafted correctly, trustees sometimes make mistakes in administering it that may result in the individual's benefits being reduced. For example, Varnet said, if a trustee makes a payment for something that is already covered by a government program, the benefits may be reduced by that amount. Knowing what is covered by a host of programs that may be available to a beneficiary is critical. It also can be complicated because what's covered-even by federal programs-can vary greatly from state to state, she adds.
Another mistake occurs when a trust gives money directly to a beneficiary, even when the money is to be used for an item or service not covered by a government program, Varnet said. Those payments, regardless of their intended purpose, will be viewed as income, and the beneficiary could exceed the income cap for government benefits. Instead, the vendor needs to be paid directly, she says. So rather than the trust giving money to a beneficiary for, say, a new television set, it must pay the store where it's purchased. Special needs trusts should state "at no time shall the trustee distribute cash to the beneficiary," but that language is not usually found, says Varnet, who is the parent of a disabled daughter.
In fact, Dussault says, some attorneys have become defendants in malpractice lawsuits because they didn't structure special needs trusts correctly. Even when an attorney does a good job setting up the trust, advisors who then are given the trust to manage may be held liable if they distribute money in such a way that disqualifies the beneficiary from receiving government assistance, Dussault adds.
What Should Advisors Do?
"The thing that any attorney or financial advisor should be looking for, should be alerted to, is if a client's family member has any sort of disability, whether it's a younger person or someone who is acquiring disability due to age. That's the first thing you need to look for: someone who will need or may possibly need any sort of government assistance," says John Staunton, of Labelle & Staunton in Palm Harbor, Fla.
Dussault notes advisors may find it uncomfortable to ask if clients' children have disabilities, but they need to do so for their clients' sake. "If the financial planner doesn't ask about the nature and the extent of the disability, there's no way they are able to do appropriate planning for a family," he says.
Staunton says advisors then need to assess their familiarity with the issues. "Anyone who doesn't know something about these government benefits and special needs trusts, or isn't willing to spend considerable time learning, should spend time developing contacts to bring in the proper professionals," he comments.
Advisor Cynthia Haddad, who is a partner with advisor John Nadworny in Bay Financial Associates in Waltham, Mass., adds advisors need to realize that financial planning for a family with a disabled individual is different from what's done for traditional clients. "What we do with most of our clients is provide them with a comprehensive financial plan that includes security for the child with special needs. You need to plan for two generations, not only for the parents but for the child's future financial security-where the child will live, how much it will cost, what the child likes to do. You need to look at the cash-flow needs for the disabled individual and then from there try to tap into a variety of sources of public funding," she says.
Advisor Kate Dussault, president of Trust Management Services Co. in Littleton, Colo., says a case she's been working on involving a little boy who was burned over 80% of his body is a good example of how a team of people can work together to provide a positive result. "We took a life-care plan developed as part of the litigation in which a nurse and rehab person gave us an outline of expenditures. That is the basis of the plan, and we figured out how to invest to meet the child's needs. The trustee, investment advisor and a case manager/compliance person who understand the benefits well all work together. It's a three-pronged process," says Dussault, who provides settlement and trust-consulting services as well as case management to her clients.
Advisors may also be very helpful in working with a family to select a trustee for a special needs trust. "It should be someone you trust. Many times, it's another brother or sister, or a relative or friend. It needs to be someone who will be able to work in the best interest of the individual," says Haddad, who has two siblings with special needs.
Haddad notes it can be tremendously helpful to have a co-trustee. "The family member might be a little more caring, but then you also have a professional who knows more of the regulations and how to handle financial matters. Ideally, you try to find someone who can do both," she says.
Nonprofit groups that operate pooled trusts are another option for trustee. The trusts pool the funds of many beneficiaries to invest and manage. Even though the funds are pooled, each beneficiary still has his or her own account. A big advantage of pooled trusts is that they are willing to handle much smaller accounts than a bank or trust company, so people of modest means can have access to sophisticated trust services, Varnet points out. Some nonprofits are willing to manage third-party funded trusts as well as trusts created under OBRA, she adds. With the OBRA variety, any remaining money in the trust when the beneficiary dies must be retained by the trust or go to the state.
Types Of Special Needs Trusts
Although there are many variations of special needs trusts, they all will be third-party funded trusts or ones drafted under the rules of the Omnibus Budget and Reconciliation Act of 1993, says John Staunton, of Labelle & Staunton, Palm Harbor, Fla.
Third-party funded trusts offer more flexibility and usually should be the choice for parents, relatives or anyone else who wants to provide supplemental care for a disabled person receiving government benefits. The trusts can be funded at the grantor's death or during his or her lifetime. They are established by someone other than the beneficiary and with funds in which the beneficiary has no ownership interest, says Staunton. If the trust is properly drafted and administered, the state has no claim to the assets, he adds. Because the beneficiary never had an ownership interest in the assets, the grantor can direct how the assets will be distributed at the beneficiary's death.
All other special needs trusts are established with assets that belong to the beneficiary and are classified as OBRA '93 trusts, Staunton says. Among them are disability trusts-often referred to as (d)(4)(a) trusts- which may only be established by the beneficiary's parent, grandparent, legal guardian or a court. The beneficiary must be under age 65. Any remaining assets in the trust when the beneficiary dies must be used to repay the state for government assistance the disabled person received. These trusts are frequently used in personal injury awards that include insurance settlements.
Pooled trusts-also called (d)(4)(c) trusts-also fall under OBRA. A nonprofit association pools trust assets to invest and manage, but it must keep separate accounts for each beneficiary, Staunton says. Parents, grandparents, legal guardians or courts may establish the accounts, as well as beneficiaries themselves, Staunton adds. Beneficiaries must be disabled, but they do not need to be under age 65. With a (d)(4)(c) trust, the nonprofit may retain any assets remaining in a beneficiary's account when the beneficiary dies, but if it doesn't retain the assets, they are paid to the state. Staunton says there are only about a dozen such trusts in the country. His law firm is co-trustee of one of them, The First Florida Pooled Trust.