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Global Tax Insights

Setting Up a Special Needs Trust

February 03, 2016

Interested in leaving money or property to a disabled loved one? A special needs trust might be the answer.

Are you looking to leave assets to a disabled family member? A special needs trust, sometimes called a supplemental needs trust, is usually formed on behalf of elderly or disabled beneficiaries to provide benefits beyond those the individuals already receive through other government programs like Medicaid or Supplemental Security Income (SSI). You need to plan carefully so the funds your loved one is already receiving are not jeopardized.

What expenses are covered by a special needs trust?

Often times, the nature and amount of an elderly or disabled person’s income and assets serves to condense or eliminate the government benefits available through various state or federal agencies, hence the need for these trusts. The special needs trust can only be used for items and services beyond what is already supplied by the individual’s governmental assistance program, meaning essentials are not covered.

Instead, the trust is used to cover:

  • Medical treatments
  • Visits to relatives or companions
  • Personal items

Can’t I just transfer cash to my disabled loved one?

A gift of cash to a disabled individual can disqualify them from receiving SSI and Medicaid, hence the purpose of the special needs trust.

How are the trusts formed?

Forming a special needs trust can be done with the disabled person’s own money or property, or a third party’s assets. These two options should not be melded together in a single trust.

Self-settled trust- The disabled individual can use his/her own money or property to form the trust, and this option works out particularly well if the disabled person has too many assets to qualify for Medicaid. The self-settled trust can be funded with personal assets, inheritances, personal injury settlements, or accrued wealth. It must be established before the individual is 65.

Third party trust- The other, more widely used version of the trust is through a third party. A third party in this case is typically a parent or relative, but anyone can contribute to the trust. Funds can be distributed to a special needs trust from a will or living trust, or you can use a beneficiary designation form (controls what happens to a deposit or brokerage account, stocks and bonds, or retirement plans) and name the trustee of the special needs trust as a beneficiary. You can leave essentially any kind of property in your will to a special needs trust (bank accounts, personal possessions, houses, businesses, etc.)

You can designate a trustee for the account who will be in charge of the trust property and spending on the disabled person’s behalf. The beneficiary of the trust will have access to many things like classes, hobbies, transportation, vacations, etc., but always through the trustee—the beneficiary never has direct access to the trust funds.

Finalizing the trust

The trust goes into effect once it is signed by you and notarized. Once the IRS sends you the trust’s tax ID number, you can open a bank account for the trust and add some starter cash. After that—wills, living trusts, and other accounts (as mentioned above) can fund the trust.

How does tax affect the trust?

A third party special needs trust is considered a “complex trust” under IRS Section 662, meaning that the trustee generally must file Form 1041, or the Estate Income Tax return (due April 15th).

Questions? Contact any member of our Tax Services Group.

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