A special needs trust offers an effective way to safeguard assets while preserving essential government benefits for a family member with disabilities. However, the process of setting up this type of trust is not without challenges. Many individuals and families make avoidable mistakes when creating an irrevocable special needs trust.
Understanding the common pitfalls can help you avoid them and ensure your trust is structured properly to meet its intended purpose.
What Is a Special Needs Trust?
A special needs trust is a legal tool used to hold and manage assets on behalf of a person with disabilities, ensuring they can continue to receive government assistance programs like Medicaid and SSI without jeopardizing their eligibility. The trust is usually funded by a third party, such as parents or relatives, and allows the beneficiary to receive financial support without jeopardizing their access to these critical benefits.
One of the key features of a special needs trust is that it provides discretion to the trustee in terms of making distributions to the beneficiary. This flexibility is important, as it allows the trust to cater to the unique needs of the individual.
Special Needs Trust Pitfalls: Mistakes to Avoid
When setting up a special needs trust, there are several potential mistakes that should be avoided to ensure the trust functions as intended:
Failing to Avoid the Payback Provision in a Third-Party Trust
A payback provision is required in first-party special needs trusts under the Omnibus Budget Reconciliation Act of 1993 (OBRA-93). This provision mandates that any remaining assets in the trust must be used to reimburse Medicaid after the beneficiary’s death. However, this provision does not apply to third-party special needs trusts.
Including a payback provision in a third-party special needs trust can create unnecessary complications and may lead to legal consequences. A third-party trust should never include this provision, as it is not required and can result in malpractice claims.
Creating a Self-Settled Trust for an Individual Over Age 65
Self-settled special needs trusts are often used when a beneficiary receives a personal injury settlement or inheritance. However, these trusts have age restrictions. If the beneficiary is over the age of 65, they are no longer eligible to have a self-settled trust. This mistake is commonly made when attorneys or planners fail to inquire about the beneficiary’s age, which can result in the loss of Medicaid eligibility. Always verify the beneficiary’s age before creating this type of trust.
Requiring Mandatory Distributions of Income
A special needs trust is designed to offer flexibility and prevent any loss of government benefits. If the trust requires mandatory distributions, it can interfere with the beneficiary’s eligibility for SSI and Medicaid. Distributions from the trust that count as unearned income can lead to reductions in SSI payments, or even a complete loss of SSI and Medicaid benefits. To avoid this, the trustee must have full discretion over distributions, ensuring that no mandatory income requirements are included in the trust agreement.
Including Crummey Powers in a Special Needs Trust
Crummey powers, which allow beneficiaries to withdraw funds from the trust, can disqualify a disabled beneficiary from receiving government benefits. If a special needs trust contains a Crummey power, it may result in income being attributed to the beneficiary during the month they could exercise the power of withdrawal. This could lead to a reduction or loss of benefits like SSI and Medicaid. A more appropriate solution is to use a Cristofani Power, which grants someone other than the beneficiary the right to withdraw, thus protecting their benefits.
Using a HEMS Standard in a Special Needs Trust
HEMS (health, education, maintenance, and support) is a common distribution standard used in many trusts. While it works for general trusts, it is not suitable for special needs trusts. Including a HEMS standard in a special needs trust can negate its purpose. The key to a special needs trust is the trustee’s discretion in making distributions, which may be necessary based on the beneficiary’s unique needs. A trust with a HEMS standard may be considered a support trust, which does not offer the same protections as a special needs trust.
Failing to Make the Trust Irrevocable
One of the most important aspects of a special needs trust is that it must be irrevocable. A revocable trust would allow the trustor to modify or terminate the trust, which could make the assets available for the beneficiary to use, thus disqualifying them from government benefits. An irrevocable trust ensures that the assets remain protected, and the beneficiary remains eligible for public assistance. For self-settled special needs trusts, the document must specifically state that the trust is irrevocable.
How Nevada Trust Company Can Help You Set Up a Special Needs Trust
At Nevada Trust Company, we specialize in managing special needs trusts that ensure the financial security of your loved ones while maintaining their eligibility for government benefits. Our experienced professionals can put you in contact with an estate planning attorney to guide you through the process of setting up an irrevocable special needs trust or a self-directed IRA, helping you avoid common pitfalls and tailor the trust to your specific needs.
Reach out to us today to learn more about how we can assist you in protecting your family’s future.
