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The role of life insurance in long-term planning for your special needs child

By Jim Sloan on October 22nd, 2010
Life Insurance

The parents of special needs children face many difficult challenges. In addition to being caregivers, parents of special needs children are often faced with the overwhelming task of providing for children after they've passed away. Although state and federal government programs can provide income and medical care throughout their lives, those benefits can be refused if parents or other loved ones unsuspectingly bequeath as little as $2,000 to special needs individuals.

An inheritance, which is intended to provide such basic necessities as eyeglasses, transportation or insurance, received without proper safeguards can wind up costing your special needs child crucial government services, such a Supplement Security Income (SSI), Medicaid or affordable housing. The answer for many families is to set up a special needs trust which, if properly structured, provides a financial safety net for children when parents are no long around to provide care.

What is a special needs trust?

A special needs trust is an estate planning tool that owns assets, including proceeds from a life insurance policy, for the benefit of an individual who is disabled or has other special needs--without jeopardizing government benefits. Unlike other types of trusts, a special needs trust is not considered an available asset to the beneficiary and therefore does not qualify as income under the rules that apply to SSI and Medicaid. A trustee is appointed to manage the assets, including the allocation of investments and the disbursement of funds.

According to the Academy of Special Needs Planners, there are three main types of special needs trusts:

  1. First-party trust: A first-party trust holds assets, such as an inheritance, for an individual with special needs. This type of trust allows the special needs individual to continue to receive SSI benefits. However, when the special needs individual passes away, any assets remaining in the trust are used to repay the government for the cost of medical care.
  2. Third-party trust: This special needs trust can be funded by parents or other family members who want to help the special needs individual. The trust can contain all manner of assets, from homes to stocks, and the assets can be used to supplement government benefits. Rather than going to reimburse the government for the cost of medical care, when the special needs beneficiary passes away, the remaining proceeds of a third-party special needs trust can be passed on to other family members or a charity.
  3. Pooled trust: Rather than serving one individual, a pooled trust contains assets for many beneficiaries with special needs. This type of trust is established by a charity and the assets are invested, while maintaining separate accounts for each beneficiary. When a beneficiary passes away, a portion of that person's trust goes to the nonprofit organization that manages the trust and the remainder reimburses the government for medical care.

Using life insurance to fund a trust

One of the best ways for you to fund a special needs trust is through life insurance. For parents of special needs children, life insurance proceeds can quickly fund a special needs trust. What's more, many types of life insurance--from term life to whole life or survivorship life--can be used. However, the type of life insurance you choose to fund a special needs trust depends on your needs and goals.

  • Term life insurance: These policies provide insurance coverage for a set number of years; typically, from one to 30 years. Although term life is typically the most affordable life insurance policy available, a policyholder can outlive the policy term and leave a special needs trust without the needed proceeds. If you decide to purchase term life insurance to fund a special needs trust, you may consider buying convertible term insurance--this type of term policy allows policyholders to convert the term policy into a whole life policy sometime down the road.
  • Permanent life insurance: A permanent life insurance policy (including whole life, universal life and variable life) provides insurance coverage for your entire lifetime. Lifetime coverage can be beneficial because the policy death benefit can fund the special needs trust no matter when the parent dies. Permanent life insurance policies provide both a death benefit and an investment feature called cash value.
  • Survivorship life insurance: Also called second-to-die insurance, this type of life insurance policy insures the lives of two people and provides the death benefit after the death of the second insured person. Survivorship life insurance may be the optimal insurance vehicle to fund a special needs trust because policy premiums are relatively inexpensive, the funds become available after the second insured person dies (when funds may be needed most), underwriting is less strict because two lives are insured (rather than just one) and policies are available as either whole life or universal life.

How funds from a special needs trust are used

According to the U.S. Department of Health and Human Services, a trustee can use funds from a special needs trust to supplement government assistance, including authorizing the disbursement of funds for the following expenditures:

  • Transportation, including a vehicle purchase
  • Training programs
  • Rehabilitation
  • Insurance, including premium payments
  • Trips and vacations
  • Computer equipment
  • Companion services and home health aides
  • Athletic competitions and training
  • Supplemental medical or dental care

According to HHS, using life insurance to fund your special needs trust can be beneficial because benefits are typically paid out without outside of probate court and without income tax deductions.

Although government benefits for your special needs child are awarded based on your family's income, after the child turns 18 the benefits are awarded based on your child's assets. But the Academy of Special Needs Planners advises parents to create a trust before children reach the age of 18. Setting up a trust now protects your child in the event of your unexpected death. It also allows other relatives to fund the trust with gifts from their own estates.

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