Planning for a Special Needs Child with Life Insurance

If you have a client whose child has special needs, at some point the client probably has thought “What will my child’s life be like when I’m no longer around?”

There are many steps clients can take to plan for a child with special needs. Of course, they should have an up-to- date Will, which names a guardian of the child if he or she is a minor. They should also ensure that they have communicated their wishes and thoughts to any intended caregivers. Once the disabled child attains the age of majority and is deemed to be an adult, a client may take action (the precise contours of which depend on applicable state law) in order to be authorized to make financial and medical decisions if the adult child is not able to do so herself or himself. Beyond this basic planning, clients should consider whether to create a special needs trust (often referred to as a supplemental needs trust, hereinafter SNT). This type of trust is designed to be the receptacle of any property that is intended to benefit the special needs child. The primary purpose of the SNT is to provide for the child’s care without compromising the child’s eligibility for government assistance. If properly structured, the SNT will ensure that property that passes for the benefit of the child will not be deemed a resource in determining the child’s eligibility for federal and state needs- based benefits, such as Medicaid and Social Security. As a result, the property of the SNT may be used to provide for a higher level of support than would otherwise be possible, thereby enhancing the child’s quality of life. As examples, such services might include health aide and home care; education; transportation and travel; entertainment and recreation; and special equipment and professional services. It’s important that any property that is intended to benefit the child be directed to the SNT so that the child never has direct ownership.

While a disabled person can create a SNT for himself or herself, the “self-settled” SNT is not treated as favorably as one created by another person for the benefit of the disabled person. For example, a self- settled SNT must include a provision to repay Medicaid (or other government providers) upon the beneficiary’s death. To ensure that the SNT assets do not diminish the child’s eligibility for government benefits, the trust must contain language ensuring that the trust assets will be used only to supplement, and not supplant, the benefits available to the child. These trusts are governed by both federal and state law and thus clients should consult an attorney who is expert in this area. One of the most important issues to address is the identity of the trustee. Often a family member is chosen to be trustee, but the client should assess carefully whether naming a family member as trustee imposes undue burdens or otherwise has the potential to damage family relationships and dynamics. Even if a family member is chosen to act as trustee, in many cases it will be advisable to turn to an institutional trustee to serve as a co-trustee or successor trustee for the professional oversight, record-keeping and accounting and independence that a corporate trustee brings to the office.

Establishing the trust is just the first step; the next is to determine how to fund the trust. A SNT can hold the as- sets that an ordinary trust may hold, such as cash, stocks, bonds, mutual funds, real estate and life insurance. The trust can be funded with lifetime gifts and with a bequest at death. Insurance on the life of the grantor may be a particularly useful tool to provide a specific sum and, if the arrangement is properly structured, the insurance may pass free of estate tax. For this reason, a carefully structured irrevocable life insurance trust that contains special needs provisions may be an important part of the planning for a child with special needs. The general benefits of creating an irrevocable insurance trust in the non- special needs context may be relevant as well in the case of the child with special needs: for example, the ability to create a discrete fund to augment family wealth through potentially gift tax-free gifts to the trust to pay premiums; and to generate liquidity where an estate is otherwise illiquid.

The unique concerns relative to a special needs trust typically will drive decisions about what type of insurance to acquire. For example, the SNT likely will be funded with permanent insurance; term insurance, which only covers a specific period (usually, 10, 15, 20 or 30 years), generally is unsuitable when planning for a special needs child. Furthermore, clients often will conclude that only a policy with a guaranteed premium and guaranteed death benefit, such as a guaranteed universal life policy, provides the security and certainty they need. When both parents are living, they can consider a survivorship or “second-to- die” life insurance policy. This type of policy can be a guaranteed universal life policy, but will insure two lives, which is less expensive than single-life insurance for each parent. Further- more, the funds may not be needed until the second parent’s death. To provide a specific example, if we assume a couple, both age 55 and in good health, acquire a $1,000,000 survivorship life insurance policy on their joint lives, the premium would be approximately $7,500 per year (under current pricing). If they each live to age 92 (which is their actuarial joint life expectancy under IRS tables), the policy performance would equate to a tax-free rate of return of 5.95%. By way of comparison, if that same $7,500 was gifted to a trust and invested in a taxable environment, it would have to earn an after-tax/after-expense rate of 5.95% in order to grow to $1,000,000. The guarantees, leverage and tax-free nature of life insurance are reasons often cited for implementing this type of coverage in special needs planning. The strategies most appropriate to benefit a special needs child will vary by circumstance. Life insurance is not the only tool that can be used to fund a special needs trust, but in the right circumstances it can be an appropriate solution.