Financial planning strategies for children with special needs

Key takeaways:

• More than 1 in 4 Americans live with some kind of disability, but many caregivers have yet to address crucial financial planning gaps. 
• Special Needs Trusts (SNTs) and ABLE accounts could help your clients care for their children with special needs even after they’re no longer able to do so. 
• Traditional methods of succession planning may not account for children with special needs. 

12/05/2024 — 61 million adults in the US live with a disability—that’s more than 1 in 4.¹ While there has been an increase in the availability of information, many caregivers have yet to address crucial financial planning gaps, with less than half even identifying a guardian for their dependent.² Knowing this, it’s important to address financial planning gaps with clients who have children with special needs. 

The parents of children with special needs commonly worry who will take care of their children when they’re no longer able to do so—and many will leave assets directly to their children without considering the affect it could have on benefit eligibility. For many of these parents, a properly structured third-party Special-Needs Trust (SNT) can offer financial stability without jeopardizing government benefits. 

Understanding SNTs

Set up by an attorney, SNTs are legal arrangements designed to benefit people with disabilities. Unlike regular trusts, SNTs serve two primary functions: to preserve the beneficiary's eligibility for government benefits like Medicaid and Supplemental Security Income (SSI) and managing funds for a person who may not be able to do so themselves due to disability. By segregating assets from the beneficiary's direct control, these trusts provide supplemental support for their unique needs without disqualifying them from government benefits.

So how are SNTs funded?

Because taxes on trust income can be complicated, you’ll want to help clients fund the trust in a way that minimizes any tax burden. A life insurance policy, with the death benefit payable to the trust, is often a good option largely because it’s income tax free and provides the certainty of funding from its death benefit. Another option would be to convert retirement assets to a tax-free Roth IRA and leave the Roth assets to the trust. Annuities can also be used to protect the IRA assets of the parent that’ll be left to the trust or used as an investment in the trust for tax deferral and protection. When used in conjunction with a trust, life insurance and annuities can provide financial certainty for the care of a person with special needs.

And if your client has multiple children, they could use life insurance to fund the trust and still leave retirement assets to the other kids. You’ll also want to help clients put a plan in place to pay any potential estate costs and taxes without tapping the assets of the special needs trust. Financial and tax professionals can assist with this kind of planning. 

Types of SNTs

When dealing with a child that has special needs, the two most important goals are to provide for the child’s needs and simultaneously provide financial protection for the assets that are set up to meet those needs. Informal plans, guardianships, conservatorships, and gifts to the child or a third party just won’t be able to meet one or both of these goals. There are two types of trusts and each have different tax implications.

1. First-Party SNTs are funded with the beneficiary's assets, often from an inheritance or personal injury settlement. 
   There are two types of first party trusts: stand-alone special needs trusts that are drafted by an attorney and approved by the court, and pooled special needs trusts that are already established master trusts managed by non-profits where availability depends on the state. 
   
   
2. Third-Party SNTs are created and funded by someone other than the beneficiary, such as parents or grandparents.

Getting started with SNT planning

The planning for children with special needs begins by making an estimate of the financial resources needed to care for them after their parents are gone as compared to the resources currently available. This planning should be coordinated with the parents’ and other children’s financial and estate planning needs. Additionally, they must understand the specific characteristics of the child’s disability and the impact that those limitations will have on the child’s ability to function in the future. Specifically, the following questions can be addressed:

• What’s the nature and degree of the child’s disability? 
• What’s the child’s age? 
• What’re the plans for where the child will reside after the parents’ or caregiver’s death? 
• What, if any, is the child’s earning potential and for how long? 
• What changes in major expenses can be expected?
• What other family members might contribute funds or services to the child’s care after the parents’ death?
• Who’ll take responsibility for enhancing the quality of the child’s life after the parents or current caregivers are gone with respect to religious and family traditions?

What about ABLE Accounts?

“Achieving a Better Life Experience”, or (ABLE) accounts were added to the tax code in 2014, aiming to ease the financial burden that people with disabilities face by creating a tax-free account that can be used for qualified expenses.³ Not all states have this program, so depending on where your clients live, this may or not be an option. Although ABLE accounts could be easier for your clients to set up and manage on their own, there are limits to how much they can contribute. Some clients may opt in to both an ABLE account and a SNT, utilizing the ABLE account for everyday expenses not covered by public assistance, and the trust for succession planning. Some of the advantages of an ABLE account are: 

• Distributions from the account for qualified expenses are disregarded for determining eligibility for federal programs like Social Security Income (SSI) or Medicaid
• It can be funded with annual gifts that don’t exceed the federal annual gift exclusion  
• Earnings accumulate tax-deferred
• You can have $100,000 in the account before considered a resource for SSI and Medicaid
• Distributions for qualified expenses are generally tax-free

By waiting too long to plan, parents could lose certain options that are critical to the length and quality of the child’s life. While advancements in technology have created new educational and vocational opportunities for these children, leading to more independence and more normalized living arrangements, the move from large institutions to small and scattered facilities has increased the cost of their care. The dependency of children with special needs can last for many years, especially now that medical advances are helping them live longer. The greatest danger to these children arises after their parents are gone, so as soon as you can help your clients plan for their special needs children, the better.