Special Needs Trust

What is a Special Needs Trust?

A special needs trust is a fiduciary relationship in which persons with developmental disabilities hold legal rights to the benefits of the property contained therein. Individuals planning to convey long-term financial resources to persons with special needs without jeopardizing their eligibility for public benefits resort to using special needs trusts.

Creating a special needs trust is done using one of three different approaches – a grant in a will, an agreement among the parties, or a court decree. The three parties involved in a special needs trust are the creator (also known as the settlor), the trustee, and the beneficiary.

A special needs trust aims to provide long-term economic support to its beneficiary through the funding of financial resources to meet medical care costs and disability expenses or to help offset lost or diminished lifetime earnings.

Understanding a Special Needs Trust

Although federal-state benefits that are provided through various programs are available to people with developmental disabilities or chronic diseases, sometimes the services are insufficient. Usually, such programs provide for the bare essentials, leaving out other necessities that strain family financial resources. As a result, a special needs trust can be created to address the needs of people with developmental disabilities over the long term while maximizing financial resources.

Integral to the trust’s objective is the social protection of people with special needs by providing supplementary care and services. The costs to support a person with special needs is usually outside the financial reach of many families. As a result, an interested party may create a special needs trust to supplement, but not replace, government-sponsored services.

Legal Structure of a Special Needs Trust

A special needs trust is classified under common law as an irrevocable trust. Therefore, creators must consider the provisions of common law when creating a special needs trust by ensuring it is not against public policy or basic laws.

A special needs trust is created by implication and operation of law; hence, it does not necessarily need to be evidenced in writing. The essence of a special needs trust is the law’s presumption that the holder of the legal title does not hold the property personally but within the trust.

However, a special needs trust must be in written form in some jurisdictions as a requirement of the statute of frauds. The funds pooled in the trust can be used to benefit minors and beneficiaries with developmental disabilities, as well as to protect assets.

Creating a Special Needs Trust

A special needs trust can be formed by any individual legally capable of making a contract. The contractual terms of a special needs trust must define the specific property. A special needs trust whose property is not yet in existence or not yet acquired cannot be valid in law.

The trust must include a trustee who is capable of handling property or holding the title of the property on behalf of the beneficiary. If the creator neglects to appoint a trustee or the chosen trustee does not qualify or declines to serve, a court may be forced to select a trustee as either an individual or an institution.

The trustee is required to execute the purpose of the trust, exercise utmost loyalty to the beneficiary, and administer complementary needs to beneficiaries.

Types of Special Needs Trusts

The two broad classes of special needs trusts based on the funding method are:

1. Third-party special needs trust

A third-party special needs trust is created and funded by an individual who is not the beneficiary. It is funded with assets from a third party. Federal law requires that such types of trusts be created by a guardian, parent, grandparent, or the court. The resources are transferred to the trust for the benefit of the individual with the disability.

2. Self-settled special needs trust

In a self-settled special needs trust, assets are contributed by the beneficiaries, which are used to fund their long-term needs. An example is when a beneficiary benefits from a personal injury settlement while funding the trust.

Taxation of a Special Needs Trust

A special needs trust is taxed as a pass-through entity since most of them are third-party entities. In such a way, a special needs trust must disclose its earnings by filing tax returns every year.

Any contributions channeled to the beneficiaries are deducted from the earnings. By doing so, the trust does not incur any income tax on its earnings as long as they are passed on to the beneficiaries. The remaining and undistributed income is taxed, which is charged and submitted to the tax authority.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

• Contingent Beneficiary
• Disability Insurance
• Living Trust
• Social Welfare System
• See all wealth management resources