Haddad Nadworny Wed, Apr 22, 2020 @ 07:00 AM 10 min read

Special Needs Trusts: FAQs & Funding 🎧

The Special Needs Financial Planning Team at Affinia Financial Group John Nadworny, CFP, CTFA | Cynthia Haddad, CFP, ChSNC | Alexandria Nadworny,  CFP, CTFA

Updated January 4, 2022

A Special Needs Trust (SNT) is a legal document and a very important part of your child's long-term financial plan.  The trust may be used to hold money that (1) you have saved or that others have given to your child as gifts or (2) your child receives in a settlement.  Funds in the SNT will not interfere with your child's eligibility for federal benefits like Medicaid and Supplemental Security Income (SSI).

Screen Shot 2022-01-04 at 2.39.29 PMThe establishment of a special needs trust can provide a false sense of security to parents that their child will be all set. It is important to understand that it is the money💰designated to fund the special needs trust that will secure the resources for their care.

For a comprehensive overview of special needs trusts and their role in planning, please read a Parent's Guide to Setting up a Special Needs Trust. 

Funding options for a special needs trust: 

The most common strategy in funding the SNT is to do so upon the death of either one or both parents. There are several reasons why you would fund an SNT only upon the death of the parent, grandparent, and/or caregiver:

Once an SNT is funded, it becomes irrevocable. The money can be used only to meet the beneficiary’s supplemental needs. This means that the money will be inaccessible for any other personal or family needs.

• A separate tax return must be filed for the trust. This will create additional expenses.

• Taxes on any earnings must be paid by the trust. Income earned in the trust is usually taxed at a higher tax rate than the individual tax rate.

• Overall, funding an SNT while you are alive can reduce flexibility in your plan because the terms of the trust cannot be changed if needed.

If you and your advisors determine that it would be most beneficial to fund your SNT upon your death, these are the more common ways to fund the trust:

• Make provisions in your will that provide the directions to transfer money to the SNT.

• Name the SNT as a beneficiary of your life insurance policies, retirement accounts, and annuities.

• If it is determined that specific assets are to be used to fund the trust, you can register the assets as a Transfer On Death TOD account, naming the SNT as the beneficiary. These assets will pass to the trust without going through probate.

• Purchase life insurance on a parent or grandparent. Naming the SNT as the beneficiary will provide a tax-free death benefit to the trust. Communicate your plans with others who may be leaving any gifts or inheritances to your child. They should name the SNT rather than your child directly so not to compromise any planning that you have done to protect their eligibility for government benefits.

Why Fund the Trust During Our Lifetimes?

Although funding the trust may reduce flexibility, here are some of the reasons to consider funding an SNT during the lifetime of the parent, grandparent, and/or caregiver:

• You may have more than enough money to meet your personal needs, so transferring assets to the trust will not jeopardize your personal financial security.

• You may wish to have the comfort of knowing that there will be a certain amount of money available for the beneficiary.

• Money in the trust can provide some protection from creditors.

• If your child directly receives money (i.e., payable to the child’s name) that would otherwise disqualify them for benefits, such as money received through an inheritance and/or a legal settlement, this money might be directed to a first-party SNT with payback provisions.

• Parents who have taxable estates and high net worth and who are implementing strategies to reduce their estate tax liability may wish to make annual or periodic gifts to the SNT to minimize estate taxes. This will result in reducing the estate tax liability because it will remove the appreciation of the asset from the parent’s taxable estate.

• Grandparents or others may also try to reduce their taxable estate by making annual or periodic gifts to your child. As an alternative to gifting to an SNT, grandparents or others may consider gifting to an ABLE account. Remember, a person can only have one ABLE account, but more than one SNT can be created to provide for an individual.

If you and your advisors determine that it would be most beneficial to fund the SNT during your lifetime, here are the more common ways to do so:

• The first step is to establish an account at a financial institution. This requires applying for a separate tax identification number and listing the name of the trust as the applicant. The trustees are required to sign the application.

• Make gifts of liquid assets out of savings or regularly fund the SNT on a periodic basis. It is important to make sure that you stay within the IRS prescribed limits for annual gifts allowed within the provisions of the annual gift tax exclusion ($15,000 per donor per recipient per year in 2021). However, there are reasons for making exceptions to this limit in your personal planning.

• Make gifts of assets that are likely to appreciate over time. Because the assets would appreciate within the trust and not in the donor’s name, they would appreciate out of the donor’s estate, therefore reducing the estate liability at the death of the donor.

• If you do gift investments other than cash, it is important to provide the cost basis of the original purchase price. This will be helpful when or if the assets are sold.

• Own or purchase real estate property in the name of the trust. You need to be mindful of the income tax consequences for both the trust and the donor, as well as the potential increase in trustee fees. When real estate is owned in the name of a trust, it is often more difficult to obtain a mortgage on the property. However, if the property is sold and the proceeds remain in trust, the proceeds will still be a protected asset for Medicaid planning.

• Own or purchase life insurance in the name of the trust. You need to be mindful of the impact on the beneficiary’s eligibility for government benefits with premium contributions. FAQ 3 discusses more about this planning strategy.

Whatever strategies you plan to use, be sure to discuss them in more detail with your advisors.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. 

Affinia Financial Group conducts business under the Special Needs Financial Planning name. Advisory services offered through Affinia Financial Group, LLC, a registered investment advisor.

This content is intended to provide general information about Affinia. It is not intended to offer or deliver investment advice in any way. Information regarding investment services are provided solely to gain an understanding of our investment philosophy, our strategies and to be able to contact us for further information.