Seven Traps and Five Power-Ups in Special Needs Estate Planning

There are multiple traps, myths, and outright falsehoods when it comes to estate planning for a special needs beneficiary, and it doesn’t help when these lies spread like wildfire. But why do they spread? Usually because someone had a single good or bad experience, and they wrongly translate that to be a universal truth that everyone should follow.

For example, many of my clients have adult children with special needs who receive Medicaid as their health insurance or some other public benefits. This means that their income must remain below a certain threshold and their bank accounts can’t grow too large. However, adults with special needs often find great benefit in working, earning some money, and the socialization that comes along with having coworkers. But if during one pay period their child works an extra shift, they get paid more, and their deposit makes the bank account exceed the benefit program’s limit, they get kicked off Medicaid until the money is spent down. They may even have to reapply for Medicaid. The parent, after having to deal with a ton of red tape, may start cautioning other parents. “Don’t let your child work!” they’ll say. “They’ll make too much money, and they’ll lose their benefits!”

This one bad experience led them to the extreme conclusion that their child shouldn’t work at all when the real lesson is to not take an extra shift and to monitor work hours and pay closely. When it comes to estate planning for a beneficiary with special needs, there are many such myths. However, there are also some incredible solutions that will allow families plan their estates to help a beneficiary with special needs live the best life they can after they have gone. Here are the top seven special needs estate planning traps as well as five solid solutions, or “power-ups.”

Trap 1—Cutting Out Beneficiaries: The biggest and most popular trap in estate planning for a beneficiary with special needs is believing that you can’t provide an inheritance for them at all. After all, giving someone receiving disability or Medicaid a bunch of money is a sure way for them to lose their benefits, and lose the inheritances paying for things their benefits would have handled until all of the money is spent. When looked at from that point of view with no other context, it does look like leaving money to an adult child receiving benefits is a bad thing to do. However, there are plenty of legal ways to provide an inheritance that does not put the money in the direct control of the beneficiary so they can get the support they need without having to actually have the cash in their pocket (or their bank account.)

Trap 2—Leaving Assets to Others to Provide Support: As a way to get around the disability and Medicaid program’s harsh denial of benefits if an inheritance is received, I often hear of families “leaving the inheritance with another child.” So if a couple with three adult children has one child with special needs and benefits, they’ll leave two-thirds to the oldest child, a third to another child, and nothing to the child with special needs. They’ll then tell the oldest child to take care of their sibling with the extra third they are providing. With all of the good intentions the family may have, life may have other ideas. What if the oldest child dies and leaves their entire estate to their spouse? Will the spouse carry on this role? What if their children need help with college? Are you sure they wouldn’t tap into that money to care for their own children rather than their deceased spouse’s sibling? Without an actual trust in place, and consequences for the trustee if the money is diverted, there is a very real danger that the funds could end up going where you didn’t want them to go.

Trap 3—Using a Last Will and Testament: Medicaid and other government benefit programs have their own measure of red tape, but so does the probate court system. When someone passes on using a Will as their estate plan, it means that their assets go through that court system, which has several big downsides: 1) probate generally costs 4-10% of an estate, 2) it generally takes 6 months to a year and a half to finish, 3) it’s more open to being contested, and 4) all accountings and inventories are publicly available since they are court documents. (For more on this, check out my book Estate Planning Basics at https://www.EstatePlanningBasicsBook.com). This also becomes a pain for the executor of the Will.

What makes using a Will even worse is that any trust set up in the terms and conditions of the Will often end up requiring the court to supervise that trust for the life of the beneficiary with many of the same downsides on an ongoing basis. So if you leave an inheritance to a beneficiary with special needs, and they live another 30 years, then the court oversight and red tape will also last another 30 years.

Trap 4—Obtaining Guardianship: For many parents, it becomes a frustrating experience to help their child with special needs for eighteen years and then be told by banks, doctors, and other institutions that they can no longer speak to you on your child’s behalf. These organizations rightly tell the parent that they now have to deal with their adult child… unless the parent obtains guardianship. This is a huge trap with a lot of drawbacks that people don’t generally think of. First, once guardianship is obtained, the adult child loses the ability to represent themselves, and guardianship is now an ongoing obligation without end and is no longer a matter of convenience.

Second, there are often two types of guardianship in the law where being a guardian of the person means you handle all medical and personal oversight, and then there is being a guardian of the “estate,” meaning handling the money and reporting on finances to the court. I have heard of many parents going for just the guardianship of the person, since it is generally simple, and not being the guardian of the estate, since it is more difficult and has ongoing reporting. Now problems pop up with businesses not wanting to deal with the adult child since they are under a “guardianship,” but at the same time they can’t deal with the parent because they don’t have guardianship of the estate. So we’re stuck in a red tape feedback loop until guardianship of the estate is obtained.

So what can you do? If the adult beneficiary with special needs is legally competent to execute their own power of attorney documents, then they can name the parent as their agent in their health care power of attorney and their durable general power of attorney. The parent can now use the documents when needed, but at the same time their adult child has not lost their own autonomy. Even better, the court is not involved, and the usual costs and frustrations of a guardianship are not there.

Trap 5—Mandatory Distributions for HEMS: Unfortunately, there are a lot of “special needs trusts” out there that contain standard language about caring for the Health, Education, Maintenance, and Support of the beneficiary (commonly shortened to H.E.M.S.), and many attorneys who “dabble” in estate planning will transfer this language into a Will or Trust for their clients. This is actually a horrible idea, and it’s misapplying language for one purpose versus another. How? The language makes it mandatory for the trust to expend its assets to pay for those things for the beneficiary that are considered a “need,” but it will protect the beneficiary from inheriting everything and spending it recklessly.

So if the beneficiary is on Medicaid, then this trust language mandating that the trust pay for health expenses can cause Medicaid to deny paying for those expenses because the trust is available to handle those costs. It is far better for trusts to leave the money for the beneficiary to be expended in the “sole and complete discretion” of the trustee. This means that the government cannot say the funds are available to the beneficiary in any way that the beneficiary can control the money. The trustee can then, and should, refuse to pay for anything that Medicaid should be paying for, and then only spend money on the extra quality of life expenses.

Trap 6—Detailed Distribution Terms: Many parents of adults with special needs develop workable, regular routines with their family, and they want these same routines to continue forever even after they are gone. This causes some people who are planning their estate to pus these specifics into their trust. Life changes, even if there isn’t a death, so I typically counsel flexibility. This is particularly true with the people you trust enough to put them in charge of the money you are setting aside for a beneficiary with special needs. Trying to force specifics into the trust rather than giving the trustee the ability to adapt to changed circumstances is going to make their job much harder.

Trap 7—Not Planning an Estate Holistically: Over the decades I have been working with parents of children with special needs, I have often found that the parents are so laser-focused on helping this one child that they are not thinking broadly enough when it comes to estate planning. In fact, some couples (who haven’t reviewed my book or videos) will seem downright confused when I start mentioning what their wishes are for each other and the other children for their estates, and some have responded, “We’ll worry about that after we plan for this one child,” they’ll say. “Just set up a special needs trust first.”

Estate planning should be treated like a major surgery in that if you are going to “cut someone open,” then you should take care of everything that can and should be done all at once to avoid multiple surgeries. If we treat estate planning as, well, a plan, and not just several different actions or documents, then your wishes and goals can be enacted in a comprehensive and coordinated manner.

These seven traps are easy to fall into, especially since most people who have children with special needs are more focused on other things and not consistently thinking about estate planning. However, there are five big power-up techniques that can help make the most of a comprehensive estate plan.

Power-Up 1—Solid Revocable Living Trust: When it comes to estate planning with special needs components, the right revocable living trust can carry you most of the way there. In fact, there is often no need to create a separate Special Needs Trust for the majority of the plans we create. The trusts my office uses contain provisions to protect inheritances against Medicaid and disability benefits being lost as standard feature should a beneficiary happen to be in a situation they are receiving benefits. All we really have to do to provide specific protection is to designate the beneficiary with special needs to be treated as such under the terms of the trust. Now it is clear that their share should be protected.

I want to be clear that not all revocable living trusts are created equal, and it is, in fact, very common for most revocable trusts and attorneys to leave this type of language out unless there is a specific beneficiary that needs to be protected and it will then be included. Trying to put together a Do-It-Yourself trust could lead to disaster for a beneficiary whose inheritance is critical to get right.

Power-Up 2—IRA Trust: While any inheritance for a beneficiary with special needs should be protected from loss of benefits, the tax impact of protecting an inheritance is often overlooked. When a beneficiary directly inherits a retirement account such as an IRA or 401k, they can set up an inherited IRA and spread the taxes over a ten year period at their discretion. However, this is a direct inheritance by the beneficiary, meaning the inherited IRA is established in their name, and this could cause a loss of benefits.

So what are the alternatives? If you name the revocable living trust as the beneficiary, then it will provide protections for the beneficiary, but now the taxes have to be spread out over a five-year period on an equal basis, and, as of the time of this writing, it appears that it has to be a five year schedule for all beneficiaries if it goes to the revocable living trust. So if you have three children but only one of them is receiving public benefits, then by naming the revocable living trust as the beneficiary, all three are losing out on some potential income tax benefits. The second “power-up” solution is to have an IRA Trust established that provides all distributions to the beneficiary to be in the sole discretion of the trustee. Now the beneficiary receiving Medicaid and other benefits can receive their one-third of the IRAs and 401ks through the trust, the other two beneficiaries can receive their thirds in their own right, and all three beneficiaries get a ten-year tax spread. Depending on the size of the retirement accounts and the taxable income of the beneficiaries, this could amount to tens or hundreds of thousands of dollars in income tax savings for the beneficiaries.

Power-Up 3—Trust Company as a Failsafe: Most of my clients have people that they know and trust who can act as a trustee, but these people tend to be the same age or older than my clients. This can be a problem if a beneficiary with special needs lives a full life, as my clients wish for all their children. So if the beneficiary is going to well outlive the people my clients trust to be trustees, then who will end up managing the inheritance for the beneficiary with special needs? This is where a trust company can be named as a backup to the list of three or four trustees named in succession. Now there is an entity that can outlive the trustees and takeover if needed.

Naming a trust company as last in the succession of trustees also has a benefit of giving the trustees some peace of mind in that they know if they pass on or simply don’t want to continue as trustee that they can resign and not leave the beneficiary without a protector overseeing the trust assets for them.

Power-Up 4—Separate Special Needs Trust: As common as it is for my clients with a beneficiary with special needs to initially inquire about a Special Needs Trust, more often than not the situation doesn’t call for one since the revocable living trust (and possibly an IRA Trust) handles protecting my clients’ money from forcing their child to lose their Medicaid and other benefits. However, there are some circumstances where a separate Special Needs Trust is appropriate. The main one is if there are other relatives or friends who want to leave an inheritance to your child with special needs but they don’t want to simply leave the money to the parents. Now a “communal” trust for your child can be established and you can let the various friends and relatives point their estate plans to send the inheritance to the trust so it remain protected. This also works extremely well for gifting, and it has the added benefit of the parents being named as the initial trustees so they can make use of those gifts for their child.

Power-Up 5—Life Insurance for the Beneficiary: “We need to treat the kids fairly,” is something I often hear from my clients. However, there is also an acknowledgement that their child with special needs may need a greater inheritance to meet their needs over a lifetime. While this is purely psychological, it has generally held true for my clients that giving a bigger percentage of the estate to a beneficiary with special needs has caused some resentment. However, providing the proceeds of a life insurance policy to that beneficiary’s share “off the top” and then everything else is divided equally among the children hasn’t had the same type of resentment. There’s just something about seeing percentages in print that the children are not being treated equally that has an impact, but having the “extra” life insurance policy go to the beneficiary who needs it most and everything else is equal often gets the other children nodding their head in agreement that it was a fair plan.

While there are many myths, traps, and complications in estate planning for a beneficiary with special needs, a little bit of knowledge and the right legal help can make all of the difference in the world. And there are more than enough “power-up” estate planning techniques to give you peace of mind that your loved ones are cared for the right way, and without losing the other benefits available to them.

For more information on estate planning for a beneficiary with special needs, check out my book The Simple Guide to Special Needs Estate Planning at https://www.specialneedsestateplanningbook.com as well as my online Special Needs Planning Crash Course at https://www.specialneedsplanningcrashcourse.com.