Estate Planning: The Basics of a Special Needs Trust

Estate planning is vital for most people, but it is especially important for families with a disabled child. If you’re the parent, your primary objective is probably to ensure that the child’s needs will be met throughout their lifetime. However, you will also want to preserve a portion of your wealth for any other children you have.

One technique that may be appropriate is to establish a “special needs trust” to supplement public assistance benefits. The trust, also called a “supplemental trust,” is designed to meet long-term objectives.

Background: Simply put, a special needs trust is an irrevocable trust that supplements public assistance benefits available to a disabled child. The trust assets and income can be used to pay for items such as travel, education, recreation, rehabilitation and medical expenses that aren’t covered by public assistance.

The trust requires the trustee to use the assets only to supplement benefits available to the disabled child. Conversely, if the trust funds are used as a primary means of support, the disabled individual may be ineligible for public assistance. For example, the trust should not use language directing the trustee to use trust funds for support, maintenance, welfare and education of the disabled child. If trust funds can be used for basic support items, the funds may be considered assets that are available to the disabled child in determining eligibility for benefits.

Furthermore, some states have enacted legislation that excludes assets in a special needs trust when determining eligibility for benefits. In certain states, assets remaining in the trust when the disabled child passed away must be used to pay back benefits that were provided during the child’s life. Nevertheless, the trust assets will be available to meet the child’s special needs while they’re alive.

Reminder: A special needs trust should not be created in a vacuum. Coordinate it with other aspects of your estate plan, including provisions intended to provide security for other heirs.

Typically, you may periodically set aside funds during your lifetime to pay for future expenses of a disabled child. However, funds transferred to a special needs trust don’t qualify for the annual gift tax exclusion ($18,000 per recipient in 2024). Due to the restrictions on the use of the trust funds, the tax law considers this type of trust to be a gift of a future interest. Thus, it’s not eligible for the exclusion.

To shelter the trust contributions from gift tax, you must tap into the unified estate and gift tax exclusion available for other transfers. This erodes your estate tax shelter. The exemption for 2024 is $13.61 million, but it’s scheduled to revert to $5 million (plus inflation indexing) after 2025.

Finally, don’t confuse a special needs trust with an ABLE Account. An ABLE account covers a broader range of expenses, while a special needs trust supplements public assistance benefits. ABLE accounts also have separate requirements (e.g., the child must have been disabled before age 26). It may be possible to use a special needs trust in conjunction with an ABLE account. Consult with your professional advisors.