This issue of The Voice is written by Ken Shulman who is a partner in the Boston, Massachusetts, office of Day Pitney LLP. Ken focuses his practice on estate planning and related issues for families who have children with disabilities and on elder law. He has served as a board member for several human service agencies including the Greater Boston ARC and presently serves as a board member for the Asperger’s Association of New England. He also serves on the Combined Jewish Philanthropies Committee on Disabilities and previously served on the Board of Directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys. He is a co-author of Managing a Special Needs Trust, People with Disabilities Press (2010). Ken often serves as a trustee of special needs trusts at his clients’ request.
Ken is a member of the Special Needs Alliance, a national, non-profit organization committed to helping individuals with disabilities, their families, and the professionals who represent them. Contact information for a member in your state can be obtained by calling toll-free 1-877-572-8472, or by visiting: www.specialneedsalliance.org.
Family members often experience a feeling of accomplishment when they sign their special needs trusts (SNTs), but signing trust documents is really only the first step in reaching the ultimate goal. The SNT is just a piece of paper if the clients and their team of advisers (often a lawyer, financial adviser, and accountant) have not planned how to fund the trust.
Funding the Trust-Common Alternatives
Some families have sufficient assets to fund their SNT by directing their assets into the trust through their estate plans. However, even these families may be concerned about future financial setbacks or long-term illnesses that may deplete their assets and reduce the funds available for the trust. Other families may have significant retirement assets (examples: IRAs, 401(k) plans, and 403(b) accounts) that they are counting on to fund their SNTs. However, as discussed in past issues of The Voice (Veterans and Special Needs Trusts, Retirement Accounts and Government Benefits, and Planning Options With Retirement Benefits), leaving retirement funds to an SNT poses some unique problems that parents and their advisers may want to avoid. Still other families of more modest means may have insufficient funds and other assets with which to fund their SNT and need to explore other alternatives.
Life Insurance as a Funding Source
Life insurance has become a common answer to the question of how to fund an SNT. Even for those with larger estates, life insurance can be an attractive funding source. A life insurance policy can provide the family with the comfort of knowing that even if there are financial setbacks in the future, there will be a source of assets for the SNT. Life insurance directed to an SNT can also provide flexibility to a family by providing adequately for the child with special needs while allowing the parents to direct retirement assets or business assets that may be inappropriate for an SNT to their other children. Life insurance is also a useful tool when parents want to leave a larger share for the special needs child and smaller shares for his or her siblings.
Types of Life Insurance
What type of life insurance might be appropriate for funding an SNT? A qualified insurance broker should be able to help answer this question, but here are three points to consider:
Irrevocable Life Insurance Trusts for Estate Tax and Special Needs Planning
Persons with estates large enough to be subject to the federal estate tax (currently estates over $5,120,000) regularly create irrevocable life insurance trusts. Such trusts own, administer, and receive proceeds from life insurance policies purchased in the name of the trust in order to prevent the death benefit from being included in the estate of the insured person for estate tax purposes. People often mistakenly assume that life insurance is not taxable. While it is true that the proceeds of a policy are not taxable for income tax purposes, they are taxable for estate tax purposes. A properly drafted, funded and administered irrevocable life insurance trust removes the value of the policy from the taxable estate of the insured person because the policy is not owned by the insured at the time of his or her death.
Such irrevocable life insurance trusts can be coordinated with SNTs by making an SNT the ultimate beneficiary of the irrevocable life insurance trust. Moreover, a life insurance policy owned by an irrevocable life insurance trust may not be considered a disqualifying asset for Medicaid purposes if the insured person requires long-term care him or herself in the future. Such asset sheltering and tax reduction, of course, ultimately benefit the beneficiary of the SNT.
Drafters of irrevocable life insurance trusts often make a common error when the trust is intended to serve special needs beneficiaries: the inclusion of so-called “Crummey” powers in the trust instrument. (This odd name–Crummey–comes from a court case that authorized such powers.) Crummey powers allow the trust beneficiaries a specific limited period of time to withdraw contributions made to the trust. This limited withdrawal right allows the person contributing the premiums to classify his or her contributions as gifts that will qualify for the annual gift tax exclusion ($13,000 per donee in 2012). Trust beneficiaries who have these Crummey withdrawal rights intentionally and typically do not exercise them, and then the trustee uses the gift to pay the insurance premium. However, if the life insurance trust is to function as an SNT for a beneficiary who is receiving Supplemental Security Income (SSI) from the Social Security Administration, such Crummey powers can cause a disaster. The Social Security Administration will treat the trust beneficiary’s failure to exercise the withdrawal right either as a transfer of resources without consideration, i.e., as a gift, or as income in the month the premium payment is made to the trust and as a resource in the following month. It will then impose a period of disqualification on the SSI beneficiary. For this reason, it is advisable not to give withdrawal rights to an SNT beneficiary receiving means-tested benefits like SSI or Medicaid. Restricting the withdrawal rights to non-disabled beneficiaries (typically other children) is usually sufficient for gift tax purposes and, if not, the gift can be credited against the donor’s lifetime gift tax exclusion (also $5,120,000 in 2012). Giving up the Crummey tax benefits is almost always preferable to the trust beneficiary’s loss of SSI benefits (and often loss of Medicaid as well, because the beneficiary’s Medicaid is likely to be tied to his or her SSI eligibility).
As with any investment or strategy to benefit a person with special needs, it is prudent to consult with an experienced special needs attorney when considering using life insurance to fund an SNT. Remember, as well, that life insurance is by no means the only way to fund an SNT but that it may be an appropriate way to do so for some families.
About this Newsletter: We hope you find this newsletter useful and informative, but it is not the same as legal counsel. A free newsletter is ultimately worth everything it costs you; you rely on it at your own risk. Good legal advice includes a review of all of the facts of your situation, including many that may at first blush seem to you not to matter. The plan it generates is sensitive to your goals and wishes while taking into account a whole panoply of laws, rules and practices, many not published. That is what The Special Needs Alliance is all about. Contact information for a member in your state may be obtained by visiting the Special Needs Alliance online.
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