Special needs trusts and life insurance: protecting benefits eligibility

Many parents of a child with a disability buy life insurance so that someone will provide for that child after they are gone. The usual instinct is to name the child as beneficiary. For a child who receives needs-based public benefits, that instinct can do harm: a large payout can disqualify them from the very programs that pay for care, and they may have to spend it down before they qualify again. A special needs trust is the standard way around the problem. This post explains how the benefit rules work, why a trust fixes them, and what to bring to the attorney who sets it up.

It is general information. Benefit rules are federal and state, they change, and they depend on the program. A special needs or elder law attorney in your state, and the agency that runs each benefit, are the places for answers about your family.

How needs-based benefits work

Two programs matter most to families in this position.

Supplemental Security Income (SSI) is a federal cash benefit for people with limited income and resources who are disabled, blind or elderly. It is means-tested, which means that what a person owns and receives is counted. For SSI, a countable-resource limit applies, and for an individual it has long been $2,000 (the limit has not moved in decades; check the Social Security Administration for the current rule). Some things do not count, such as a primary home and, in many cases, one vehicle, but cash, bank accounts and most investments do.

Medicaid pays for health care and, through waiver programs in many states, for the long-term supports that matter most to adults with disabilities: day programs, residential services, in-home aides. Eligibility rules differ by state and by program, and in many states SSI eligibility opens the door to Medicaid. Losing one can mean losing the other.

Not every disability benefit works this way. Social Security Disability Insurance (SSDI), which is paid on a person's own work record, and the childhood disability and survivor benefits paid on a parent's record are not means-tested in the same way. A family should list the benefits the person receives, because the right plan depends on which ones they are.

The practical effect is simple. A person with a disability who owns a large sum in their own name is, for these programs, no longer poor. They may lose the benefit until the money is spent down.

What happens when a policy pays the child directly

Take a hypothetical. Say Priya and Dev have a son, Arjun, 24, who has an intellectual disability. He receives SSI and Medicaid and lives in a supported living home. Priya has a $400,000 term policy through work, and she names Arjun as beneficiary, thinking: "It will be there for him."

When Priya dies, the insurer pays the death benefit to Arjun, or, since he may be unable to manage it, to a guardian or conservator appointed to manage it for him. Either way, the money belongs to Arjun.

• Countable resources after the payment: $400,000 plus whatever he had.
• SSI resource limit for an individual: $2,000.
• Excess over the limit: $400,000 - $2,000 = $398,000 (ignoring his other assets).

He generally loses SSI eligibility until the excess is spent. In most states he can also lose Medicaid coverage, including waiver services that were paying for his supported living. A sum that looked like security turns into a countdown, because the cost of care that Medicaid used to cover must now be paid from the $400,000. If the supports cost $60,000 a year, the money lasts under seven years ($400,000 divided by $60,000 is about 6.7), before taxes, fees and a guardian's costs. After it is gone, he applies again, and approval is not instant.

Several variations produce the same result:

• Naming a sibling or relative informally, with a promise to "look after" the child. The money is the relative's, legally. It is exposed to their creditors, a divorce or their death. A moral duty is not a legal one.
• Naming a minor child. An insurer will not pay a large sum to a minor, and a court appoints a conservator. See naming a minor child as life insurance beneficiary.
• Naming the estate. The proceeds pass through probate and then through the will, and may land with the child anyway.
• A grandparent's will that leaves money to the child outright, or a bank account with the child as a joint owner. The same problem arises from any source, not only life insurance.

How a special needs trust solves it

A special needs trust is a trust that holds money for a person with a disability. The trustee owns the assets for the beneficiary's benefit and decides how they are spent. Because the beneficiary cannot demand the money or direct it, the trust is generally not counted as the person's own resource, so it does not trip the resource limit.

The trust usually pays for things public benefits do not: therapies, equipment, travel, education, a better home, a van, an advocate, recreation, a care manager. A well-drafted trust gives the trustee discretion, rather than a list of required payments, because discretion is what keeps the funds from being treated as the beneficiary's.

The trustee has to be careful about one category. Payments for food or shelter can reduce an SSI payment, because the program counts that kind of help as income (the SSA calls it in-kind support and maintenance). That does not mean the trustee may not pay for housing. It means the trustee weighs the cost of a reduced check against the benefit of the help, and an attorney or a care planner can explain the trade-off for the beneficiary's situation.

Two kinds of trust

Life insurance that parents buy is a third party's money, so the beneficiary should be a third-party trust. Do not name a first-party trust as the beneficiary, and do not move the child's own assets into a third-party trust, because that would destroy the no-payback feature.

Making the trust the beneficiary

There are two ways to set up the trust, and both can work with life insurance.

1. A standalone (living) trust created now. The parents sign a trust agreement with an attorney, name a trustee and successor trustees, and then name the trust as primary beneficiary on the insurance form. The policy pays to the trust directly, quickly and outside probate. This is the more common and usually the more reliable path.
2. A testamentary trust in a will. The will creates the trust on the parent's death, and the policy names the estate or the trust. A testamentary trust needs the will to go through probate before the trust exists, so there is a delay, and the policy proceeds may be exposed to probate costs and creditors. It is a fallback, not a first choice.

The beneficiary form must name the trust correctly. The wording usually includes the trustee's name, the trust's name and date, as the attorney supplies it. A form that reads "my son Arjun, in trust" without a real trust behind it does not work. Check the form once the policy is issued, and again after any change.

Also name a contingent beneficiary. If the trust is not in place or cannot take the money for some reason, the fallback should not be the child.

Choosing what kind of policy

A family's need for this money often lasts for the child's entire life, which may run many years past the parents' own. That drives the policy choice.

• Term life is the affordable way to cover the years the parents are earning. It works if a lump sum is needed only until other plans mature. A term policy ends, so the parents need to pick a term that outlasts the period of risk, and ask about the conversion option to permanent coverage.
• Permanent coverage (whole or universal life) is designed to last for the insured's life as long as it is funded, so the benefit arrives whenever the parent dies. It costs several times more than term for the same face amount. It fits a goal without an expiry date.
• Survivorship (second-to-die) life pays at the second parent's death, which is the point when many families need the money. It is usually cheaper than two individual permanent policies, but pays nothing if only one parent dies. See survivorship (second-to-die) life insurance.

Many families combine a term policy on each parent for the near term and a permanent or survivorship policy for the long term. The right mix is a budget and risk question, and the post planning life insurance for a child with disabilities, step by step walks through it. life insurance for parents of a child with special needs covers the sizing arithmetic.

What the trust does not do

A trust is not a cure-all. Know its limits so you can plan around them.

• It does not pay for everything. Public benefits are the base. The trust adds to them.
• It needs a good trustee. The trustee manages money for decades, deals with benefit rules and the family. A relative may be loving and unprepared. A professional trustee charges fees. Many families name a relative and a professional as co-trustees, or name a relative with a professional as a successor. Choosing the person is its own task; see choosing a successor caregiver and trustee for a dependent adult.
• It costs money to set up and run. There are drafting fees, and there may be tax returns and annual trustee fees. A modest policy may not justify a complicated structure. In that case a pooled trust, run by a nonprofit that manages many beneficiaries' money together, may be an option for the attorney to discuss.
• It can be undone by mistakes. A trust that the child's own money funds, a parent who names the wrong beneficiary, or a relative who leaves money outright can each defeat the plan.
• Rules change. Benefit thresholds and state rules are updated, so the trust should be reviewed from time to time.

An ABLE account is a companion, not a replacement

An ABLE account (named for Section 529A of the tax code) lets a person whose disability began before a set age save money without losing means-tested benefits. The account owner controls it, the contribution limit each year is small compared with a death benefit, and a state may have a claim on what remains at the person's death. The trust and the ABLE account work together: the trustee can fund the ABLE account for monthly expenses, and the larger funds stay in the trust. life insurance for parents of a child with special needs gives current figures and sources.

Questions to ask the estate attorney

Bring the insurance policies, the list of benefits and a rough idea of the child's future needs. Ask:

1. Which type of special needs trust fits our situation, and how will it be funded, now and at our deaths?
2. Who should be trustee and successor trustee, and what should the trustee be told about our wishes?
3. Does the trust avoid Medicaid payback, and what do we need to do to keep it that way?
4. What should the beneficiary designation say on each policy, and who checks the forms?
5. How should our wills be written so a relative's gift or an inheritance goes to the trust and not to our child?
6. How does the trust treat payments for housing and food, given the effect on SSI?
7. What happens if our state's benefit rules change?
8. If we move to another state, what needs to be redone?
9. How often should we review the plan, and what events should trigger a review?
10. What does the whole structure cost, now and each year?

Then ask the insurance agent three things: can the policy name a trust as beneficiary, does the insurer need the trust to exist at the time of application, and what is the process to change the form later.

A completed example

Return to Priya and Dev. They meet with an attorney, create a third-party special needs trust for Arjun and name Arjun's older sister as successor trustee behind a professional trustee. They keep the $400,000 group coverage Priya has at work and add a $500,000 20-year term policy on each parent, with 80% of each benefit going to the trust and 20% going to the sister as a thank-you and for her own family. They also name the trust on a $300,000 survivorship policy they buy to last past the term policies. They check each form, bring a copy to the attorney, and write a short letter of intent describing Arjun's routines, doctors, interests and the services he receives.

The figures are invented. The pattern is real: a trust first, policies second, forms checked, and a letter of intent so the people who come after can run his life as he has lived it.

Key takeaways

• Needs-based programs such as SSI and Medicaid count what a person owns, so a death benefit paid directly to a disabled child can end eligibility until the money is spent down.
• A third-party special needs trust holds life insurance proceeds for the child, with a trustee who spends the money on things benefits do not cover, and generally does not count as the child's resource.
• Name the trust as beneficiary, not the child, a sibling informally or the estate, and name a contingent beneficiary behind it.
• Choose the policy to match how long the need lasts; many families pair term coverage now with a permanent or survivorship policy for later.
• Hire a special needs or elder law attorney, choose trustees with care, and review the plan when benefit rules or family circumstances change.