Special needs trusts are set up to benefit persons who are minors, mentally/physically disabled, or suffer from long-term illnesses that render them unable to carry on fiduciary activities.
These trusts provide a way to protect assets and can be seen as “asset reservoirs.” The disabled person may receive an inheritance or an accident benefit settlement, or contributions from well-wishers.
Government programs are designed for people whose income is too low to support their needs. Hence, a person with a disability who has an income above the specified limit will not be eligible to receive these benefits.
Special needs trusts enable beneficiaries to receive a regular income without jeopardizing their ability to receive supplemental benefits from government sources that they are eligible for.
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A typical trust must have three elements in it:
In general, the donor expresses her/his wishes in a written document that gives specific instructions on how the funds are to be managed, distributed, and monitored.
This is to ensure the best outcome for the person with special needs. A trust document is something that can be referred to even after the death of the donor and held as legally binding on the trustees.
Special needs trusts follow these broad guidelines, but they have certain special features as well.
Different types of special needs trusts have come into existence because they need to comply with regulations of the Supplementary Security Income (SSI) that is a government initiative to assist low-income people with special needs.
This scheme mandates that applicants should have not more than $2000 in their names. If there is an excess of income, the applicant can still qualify for SSI if these excess assets are parked in a first-party SNT.
The funds in this trust must be used for specified benefits of the special needs person during their lifetime. After their death, the remaining funds in the trust revert to the government as reimbursement for medical expenses made during the special needs person’s life.
The law allows anybody to establish an SNT that can be drafted in accordance with the donor’s own requirements of reducing their taxable assets.
SNT’s are advantageous because they enable larger amounts of money to be contributed to the trust without affecting eligibility to receive federal benefits.
The beneficiary can use large amounts of trust funds for a variety of needs whenever it’s required. The trust does not pay any income tax on any income that it earns if it can be shown that all the income is passed to the beneficiary.
There are two main types of SNT’s: Third-party trusts and First-party (self-settled) trusts. Pooled trusts may also be set up.
Third-Party Trust: This is the most common vehicle used to convey benefits to a person with a disability by parents or other family members. A third-party trust is funded by the assets of the third party that may consist of parents/relatives etc.
It also allows people to give gifts or bequests in the future into the trust without affecting the Medicaid or SSI benefits that the beneficiary is eligible to receive.
A donor can also name the person with special needs as the beneficiary of life insurance. The third-party trust can also benefit a senior as well as a person with a disability in terms of Medicaid eligibility.
Once the trust has been in existence for more than five years, the assets available in the trust can be used to fund long-term care, nursing home, etc.
Third-party SNT can also be included in the will or Living Trust of an individual who wishes to contribute to it.
The income from the trust is distributed only to third parties for goods and services rendered, and not directly to the beneficiary. This allows the donor to manage their own tax goals more effectively.
An important aspect of SNTs is that the government need not acquire the funds remaining in them on the beneficiary's demise as reimbursement for Medicaid etc.
The trust remains in control of distribution of remaining assets on the demise of the beneficiary.
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This is a type of trust that is also termed a “self-settled” trust because it uses funds owned by the person with a disability. However, it must be established by a parent/grandparent/guardian of the person with a disability or by the Court.
It can benefit only the person with a disability and cannot be established if the beneficiary is above age 65. An important difference between first and third party trusts is that any funds remaining in first-party trusts must be used to reimburse the government for Medicaid expenditure incurred during the lifetime of the beneficiary.
First-party trusts don’t provide as much flexibility in terms of tax planning as third party trusts.
First-party trusts are usually set up when a person with a disability inherits a large sum of money or receives a large court settlement in a tort case.
These trusts are also useful if someone who has considerable assets in her/his name becomes disabled due to an accident/illness/injury. The beneficiary must meet the government requirements for the definition of disability.
Pooled Trusts are another type of SNT created by a non-profit organization that benefits several individual beneficiaries who are “pooled” within it.
The funds can be used to cater to the needs of diverse persons whose income levels may differ.
It’s important to thoroughly evaluate the circumstances, needs, and preferences of the person with a disability and the donor while setting up an SNT.
This is best done in consultation with a reputed, well-established professional experienced in special needs financial planning.
Without a customised legal strategy, you put yourself at risk.
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*Note for U.S. citizens: US citizens are limited in their tax reduction possibilities due to FATCA and CFC laws. Opening an offshore company can increase privacy and asset protection, but you can not eliminate your taxes without giving up your citizenship. If you are a US citizen you are obligated to pay taxes on all worldwide income. Read more here about FATCA and CFC laws.
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