In our office, we routinely assist families in creating third party special needs trusts (SNTs) as part of their estate plans. This article explains the background on third party SNTs, the options available, and our process.
Background
To understand SNTs, let’s use the example of Jane Smith. Jane is 30 years old and is physically healthy but has never been able to work or live independently due to an autism spectrum disorder. Jane lives in a group home and receives SSI and Medicaid (MA). Jane’s father, John Smith, is guardian of her person and estate.
Jane’s grandmother Jill, who has always been close to her, would like to name Jane as a beneficiary on a life insurance policy. John has two children and would like to make sure that Jane is well taken care of in the event of his death.
What options are available to Jill and John?
Direct Gifts
The first option would be to give money directly to Jane. This is almost always a bad idea. If money is given directly to Jane, she could lose her public benefits. In some cases, the inherited funds must be spent for Jane’s care until exhausted, or a first-party special needs trust set up for her when the funds are received. Once the funds are exhausted, Jane will need to re-apply for public benefits. In many cases this will be better than leaving Jane nothing, but creates unnecessary problems for her.
Give to Someone Else
A second option is to give directly to someone other than Jane, expecting that the recipient will use the funds for Jane. So, for example, Jill might leave the life insurance policy to John, trusting that he will use the funds for Jill’s benefit. This is very simple and easy from a planning perspective and will not affect Jane’s public benefits. However, there is no legal requirement that John use the money for Jane. He could spend it on himself. He could also end up getting in trouble with creditors, become disabled himself, need long term care late in life, or predecease Jane. In those cases, the funds are his, and would be available for creditors, considered for purposes of his own eligibility for public benefits, or be part of his estate.
This means a gift to someone else can be a good option for small amounts, where the need for legally binding provisions is not significant, and where the funds will be spent rather quickly. But it is not a good idea for large gifts or in situations where the funds are essential for the beneficiary’s support.
Set Up a Third Party Special Needs Trust
The final option is to set up a third party special needs trust (SNT) for Jane. Think of this SNT as a separate entity—a nonprofit business with its own tax ID, bank account, investment account, and so on. The business exists to make Jane’s life better by paying for things that public benefits do not cover. So, for example, the funds in the SNT might be used for home improvements, entertainment, a phone, travel, or medical expenses or equipment not covered by public benefits. The SNT will have a trustee, who is the person making decisions about how the trust funds will be invested and spent.
As long as this fund is properly set up, Jane will continue to receive public benefits. At Jane’s death, any remaining funds will be distributed as determined by the person creating the SNT. (So, for example, John could specify that funds in the trust would be used for Jane’s benefit during her lifetime, then go to Jane’s brother at Jane’s death.) This makes a third party SNT the best option when a third party (parent, grandparent, etc.) wishes to leave a substantial inheritance for a person who is disabled.
The key to setting up the SNT is determining who the trustee will be. The person setting up the SNT can choose between a professional, an individual, or a pooled trust.
Professional Trustee
Running a SNT requires significant skill. The trustee must understand public benefits distribution rules, keep the books for the trust, and ensure that tax reporting is handled properly. The trustee must also make judgment calls about whether to make distributions, which may mean having to say no to the beneficiary at times.
A professional trustee, such as a bank or trust company, checks all of these boxes. They are sophisticated trust managers to serve as trustee for a living. They also are an objective third party who can make decisions that might make the beneficiary unhappy without worrying about damaging a familial relationship. They also can customize investments to meet the beneficiary’s needs, and are an institution that will continue for the beneficiary’s lifetime.
This is a gold standard, but it comes at a price. Most professional trustees will charge a minimum of $4-$5,000 per year to manage SNTs. A $1M trust can easily cover professional trustee fees from its income, but a $50,000 trust cannot. We generally recommend using a professional if trust assets will be $500,000 or more.
Individual Trustee
An individual trustee is often what our clients think of first. In that case, the named individual will be responsible for understanding public benefits rules, trust accounting and tax reporting, and distribution decisions. This can be a good option of a sophisticated family member is willing and able to serve. However, when choosing an individual, clients must choose multiple alternates, especially if the trust is intended to last for a long time. They also must think about how naming a family member (for example, Jane’s brother in this example) might change their relationship.
The price is right in the sense that the individual generally will serve without compensation. However, this can be a burden. In addition, an individual trustee often will rely on legal counsel for advice on distributions, tax reporting, and so on. This can add up, especially with small trusts. For all of these reasons, we rarely recommend our clients name individuals as trustees of SNTs.
Pooled Trust
The final option is a pooled trust. The pooled trust we generally use here in Wisconsin is Wispact, a nonprofit organization that manages a pooled trust for individuals who are disabled. The way this works is that Wispact manages hundreds of different funds for different beneficiaries. It pools all funds with a professional money manager, who invests them (generally, in a fairly conservative investment pool). Each beneficiary has a sub-account within the pool, and Wispact handles distribution decisions, trust accountings, and tax reporting for each sub-account. The person creating the trust can name an advisor, who is an individual that Wispact can consult when making distribution decisions. The advisor has no legal responsibility for decisions or legal authority to force a distribution.
This option is our go-to option for SNTs under $500,000. It provides the professional management and objective third party trustee that is beneficial for beneficiaries and their families, but with a percentage-based fee schedule that allows professional management even for very small trusts. Wispact also runs a grants program that reimburses attorney’s fees for setting up the trust, meaning that the initial cost of the plan is lower as well. (For more information specific to Wispact, see our blog post about Wispact here.)
Getting Started
The first step is for the person who will be making the gift to meet with us to discuss their estate plan and how the gift will fit in. The agenda for the meeting is to discuss the beneficiary’s public benefits, the nature of the gift, and options for structuring it. If a third party SNT is the right option, we make some preliminary decisions about how the trust will work. Sometimes this discussion includes multiple family members who will be contributing to the same trust. (So, for example, we might meet with Jill and John and set up a Wispact trust that will receive funds from both estates.)
Will you be including a beneficiary who is disabled in your estate plan? Call today for a free consultation.