Using Life Insurance to Fund a Special Needs Trust

Having a child or children with special needs comes a lot of planning in day-to-day life.

The action that often gets put on the back burner when you have a special needs child is financial planning for their future!!

Planning for your child’s future in the event they are unable to support or care for themselves when you are gone should be a vital part of your financial objectives.

Many parents are facing the reality that financial planning is important to ensuring that their adult children will always receive the best care possible.

According to a Cornell University, there are more than 4 million children with one or more disabilities. This is a lot of children that may need to be cared for later in life.

Only you can make sure that your child gets the care that they need after you are gone.

A recent survey conducted of 600 parents with special needs children, 34 percent reported spending at least $650 a month extra to care for their child. More than 65 percent believe these costs will continue as their child grows older, less than half have a plan to cover the cost.

Over half of all parents with a special needs child said they planned to leave money directly to their child or as a beneficiary. Both of these actions could have a negative impact on government benefits even leading to termination of services. About 25 percent of parents have taken the step and established a special needs trust.

What is a Special Needs Trust

A special needs trust, or also referred to as a supplemental needs trust, is set up with your special needs child as beneficiary. All assets including property are owned by the trust.

A trustee is named to oversee the trust and make any distributions. It’s a good idea to name two trustees to make sure that your child’s best interest always comes first.

The special needs trust has few restrictions on distributions that the trustee can make.

Here are some of the restrictions:

• You can’t give cash for any reason
• Taxes
• No buying food or groceries
• Rent or mortgage payments
• Utilities (gas, water, electric, trash pickup)
• Connection charges for utilities

Any of these types of distributions could lead to a reduction in social security/medicaid benefits.

In some instances these payments would only cause a 1/3 reduction in benefits so it would be up to the trustee to determine if the benefits from making these payments outweighs the loss of services.

All distributions or payments should be paid by the trust. All household goods and items should be in the name of the trust and not the beneficiary (your child).

Here are some items distributions can be made for:

• To Purchase a Home
• Cable T.V., Telephone, Internet, Newspaper, Computers
• Automobile, Auto Insurance, Maintenance
• Travel and Entertainment Expenses
• If unable to travel alone, the trust can pay for a travel companion
• Household Furnishings
• Pre-Paid Funeral Expenses/Burial Arrangements
• Lawyer and Accounting Fees
• Clothing
• Medical Equipment, any Kind of Therapy, Medication
• Tuition and Books

Distributions from a trust will be a challenging and complicated decision made by the trustee/trustees.

We always advise consulting with a lawyer if you have any doubt on the effects of services for your child.

How to Fund a Special Needs Trust

Most of the time a special needs trust are not funded until after the parents or caregiver has passed away.

Special needs trusts can be complex and cause an administrative headache, therefore most parents provide directly to their child while living.

One way to fund the special needs trust is with your 401K or IRA (any qualified retirement accounts). Depending on how much you have saved, these are usually inefficient assets to leave to a trust.

These accounts also have never been taxed, and will be taxed as ordinary income once distributions begin.

Trusts pay taxes at the top federal rate of 37%. This doesn’t include any state income taxes or the 3.8% Medicare surtax.

Life Insurance and Roth IRAs are another way to fund these types of trust and are recommended by special needs and financial planners.

Both benefits are received tax-free, which eliminates many of the tax issues.

While both of these are great choices to fund the trust, Roth IRAs are limited to the amount of contribution allowed, which could lead to inadequate funding.

Most experts agree that life insurance is the best way to fund a special needs trust. Life insurance can provide a lump sum of cash and can be purchased for pennies on the dollar if planned correctly.

What type of life insurance policy should I choose?

There are two types of life insurance:

• Term Life Insurance– Is always going to cheaper, but coverage only last a certain number of years. This could be a problem if you out live coverage.
• Permanent Life Insurance– You have the coverage for life. Premiums will be higher than term.

We recommend purchasing a permanent life insurance policy to fund your special needs trust. We understand that term can be a cheaper alternative, but you are purchasing the life insurance to be there when you pass away.  Since we can’t predict the future, or when we will die, buying a term policy could backfire and cost more in the long run.

The life insurance policy is that is going to be the most cost effective would be “survivorship” or “second-to-die” permanent life policy. These policies cover the lives of both parents and pays out on the second insureds death.

Survivorship policies are usually cheaper than a traditional policy on just one life. To give you an example:

43 year old male and 38 year old female

Preferred Health

$1,000,000 Survivorship Policy

$326/month

43 year old male

Preferred Health

$1,000,000 Individual Permanent Policy

$641/mo

As you can see the “survivorship policy” is the most cost effective.

Permanent life policies also build up cash value that can used to help offset the costs associated with raising a special needs child.

Our Thoughts

It’s always a good idea to have a sound financial plan in place for your child with special needs when you are gone. A special needs trust is the best way to ensure your child’s care doesn’t waiver. Funding for the special needs trust needs to have a solid foundation and life insurance can do this.  If you have any questions please don’t hesitate to reach out and give us a call.

Frequently Asked Questions