Why you should consider putting assets in a special needs trust

If you're counting on life insurance proceeds to help pay for your child's care after you're gone, there are some reasons to name a trust as the policy beneficiary – specifically a special needs trust – instead of leaving the proceeds to your child. As soon as you set up a trust, it may receive other assets for your child's care as well.

What is a trust? It's basically a legal entity that, if properly established, can receive, hold, and pay out funds to beneficiaries. With a special needs trust (also called a supplemental needs trust), that beneficiary may be your child. You choose a trustee – often a sibling or close family member, but it can also be a trusted professional, such as an attorney. He or she holds and distributes assets according to the terms you decide when you create the trust. As discussed below, you should work with an attorney to set up any trust, including a special needs trust.  Naming a special needs trust as the beneficiary of a life insurance policy has several potential advantages, including: 

  • A trust may give you more control over where assets go after you die, how they can be used, and when, than you might have if the assets were distributed pursuant to a will. 
  • A will is usually probated public, the legal process in which the state rules on a will's validity. A trust can help avoid the time, costs, and uncertainties of probate.
  • You can't leave assets to an underage child without naming a property guardian or a custodian under the Uniform Transfers to Minors Act (UTMA), but you can leave assets to a trust set up to benefit a minor.
  • And significantly, holding assets in a trust may help the child qualify for government benefits.

Transferring assets to a child with special needs is inherently problematic, even if they can function at a high enough level to live independently. If the child holds substantial assets in their name – such as the proceeds of a life policy – it can complicate the process of qualifying for Medicaid or other federal and state assistance programs. A properly designed trust can help avoid that problem because assets aren't in the child's name: the trust holds and controls the assets, which are then used to pay for the child's care according to your specific instructions. 

Some parents choose to leave insurance proceeds and other assets to an alternate caretaker (such as a sibling or other family members), trusting that they will use the funds appropriately. However, there's a significant risk involved: once the money is in the caretaker's name, it's legally theirs to use in any way they see fit. Even if a caretaker is loving and well-intentioned, they may not be a good money manager: funds could be used unwisely and run out prematurely. On the other hand, a trust lets you set out very specific conditions for how and when assets may be used caring for the child, and those instructions must be followed after you're gone.

Setting up a special needs trust

Any trust agreement is an inherently complex legal document. In addition to state and federal law, the trust you create needs to take into account the long-term needs of your child, your financial situation and estate plan, specific care instructions, qualification criteria for government assistance, and other factors. That's why you should use an attorney with specific experience setting up special needs trusts. If you don't know such a lawyer, you can ask another attorney or other special needs parents for a referral. Some organizations can help you learn more about the process and find an attorney, such as the Special Needs Alliance, a national non-profit organization of attorneys dedicated to the practice of disability and public benefits law.

Getting the right insurance policy for your goals

If you're buying coverage to provide for your child after your gone, you'll have to choose between two basic types of policies: term and permanent. 

Term life insurance policies provide coverage for a specific period of time, typically between 10 and 30 years. It is sometimes called "pure life insurance" because, unlike a permanent policy, there's no cash value. Because of that — and the fact that coverage is temporary — term life insurance typically costs less than permanent life for a given amount of coverage. While that can be an attraction, term policies also have a disadvantage: once the term is over, there's typically no death benefit, no monetary value, and nothing to leave for your child. If you already have term coverage but would rather have a permanent policy, ask your agent if your policy has a "convertibility" rider or clause2. If so, you may be able to convert your term policy to a whole life policy without getting a medical exam.

Permanent life insurance, such as whole life, provides coverage that lasts your entire life. In other words, it doesn't matter if you pass away in 3 years or 53 years – as long as premiums are paid, your beneficiary will get the same income tax-free death benefit payment3. Unlike term, it's not a "pure life insurance" product because it includes a cash value component4. A portion of your premium dollars can grow tax-deferred over time – but the entire coverage amount is payable from the first day the policy is in effect. This provides a number of advantages that are particularly useful for the challenges of parenting special needs children. Two examples:

  • If the need arises – for example, there's a medical emergency – you can borrow money against the value of your policy5
  • After it grows past a certain point, the cash value can be used to pay your premiums. That can help you keep the coverage intact while lowering your monthly expenses in retirement.

You can have more than one policy

Depending on your circumstances and plans, you could decide to have more than one policy, and different kinds of policies. For example, it might make sense to get whole life insurance and supplement it with term life coverage as you're paying your mortgage. That way, there are always two potential assets for your child: Before the house is paid off, there are potential benefits from the two policies. After the house is paid off, you have that equity plus the whole life policy. 

If you're married, you and your spouse can each have separate life policies. Depending on your situation, you may choose to designate your spouse as the primary beneficiary and the child's trust (or caretaker) as the contingent beneficiary. That way, when the first spouse dies, the death benefit goes to the surviving spouse; when the second spouse dies, the benefit goes to the child's trust. 

There's another possibility that could be simpler and more affordable: A life insurance company may offer "survivorship" (or "second-to-die") joint life insurance. These are whole life policies that cover both parents but only pay a death benefit when the last parent dies. This is typically less expensive than having two individual policies, and can make the application process easier for a spouse with health conditions.

How much life insurance do you need?

The answer depends on a number of factors, including the kinds of care your child will need and for how long, what types of government assistance your child may qualify for, and what other savings or assets will be available for your child or their trust. If you haven't already done so, you should consider speaking with a knowledgeable financial professional to get a better understanding of your needs. The lifetime cost of care may seem staggering at first, but there are resources available – and the right life insurance can go a long way to filling in the gaps. 

Don't put off getting life insurance because coverage typically gets more expensive with age. If you're in the process of setting up a special needs trust (or still undecided), don't worry: you can always change your beneficiary later on. And if you do decide to leave the death benefit in a trust for your child, make sure that the full legal name of the trust is listed as the beneficiary – and not your child's name. You should also make sure the insurance company has up-to-date contact information for the Trustee.

Life insurance coverage for a special needs child

So far, we've discussed the needs of parents who are concerned about outliving their special needs child. But others have the opposite – and equally heartbreaking problem: What if a parent expects to outlive their child? 

In such cases, parents are often left with considerable debts to go along with their grief. There are medical costs. Caretaker expenses. And too often, wages and career opportunities are lost due to months or years of absence from the workforce. Life insurance can help lessen the burden.

While children's whole life policies are available, they generally may not be sufficient. Coverage amounts are typically modest, and rates are often high, even compared to a similar typical adult policy. Also, many special needs children may not qualify. If you have or are getting your own policy, another option is to take advantage of a child coverage rider if available from your life insurance company. While coverage amounts are also modest, rates are generally affordable. Some policies may also give the option of conversion to whole coverage later on, for example, when your child turns 25. 

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Talk to a life insurance professional about your needs

Life insurance can be a powerful financial tool to help protect your child and your family. But as a parent of a child with special needs, your situation and needs are more complex than most. Professional guidance and estate planning can help you arrive at the right solution for your needs. Discuss your situation with an insurance agent or financial professional with experience helping families with special needs children. If you don't know such a professional, ask friends or other parents for a recommendation. Or, Guardian can connect you to a financial professional who can help. 

Frequently asked questions by parents of children with special needs

Can a special needs trust purchase life insurance?

Special needs trusts don't typically buy life insurance policies. However, a trust is often the beneficiary of a policy. Parents set up a trust to hold assets and help pay for their child's lifetime care after they are gone. Then, the parents designate the trust as the beneficiary of their life insurance policy. Other family members, such as aunts, uncles, and grandparents, can also do so. After the policyholder passes away, the death benefit helps to fund the trust.

Can someone on disability get life insurance?

People with disabilities can and do get coverage from life insurance companies. If the disability doesn't impact life expectancy, then there may be little or no impact on insurability. However, any disability that impacts life expectancy will also affect a person's ability to get many forms of coverage. However, guaranteed issue policies are available that provide a limited amount of protection regardless of health considerations.

What happens when a special needs child turns 18?

Once a child reaches age 18, benefits eligibility changes. They may qualify for supplemental security income benefits (SSI) based on their own income and assets (as opposed to their parent's income and assets). In order to receive benefits, the child must meet the Social Security Administration's disability standard, have less than $2,000 in assets, and receive minimal income – and that is one reason why many parents choose to set us a special needs trust to hold assets for their child out of that child's name6.

What is the best life insurance policy for a child?

Children don't typically need life insurance because others aren't dependent on their income. Having said that, one of the most cost-effective ways to get life insurance coverage for a child is to take advantage of a child coverage rider (or optional clause) on a parent's life insurance policy, if available. 

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1 Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.

2 Riders may incur an additional cost or premium. Riders may not be available in all states.

3 All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values.

4 Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more Information.

5 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

6 The Social Security Administration has not approved, endorsed, or authorized this material. Contact the Social Security Administration for complete details regarding eligibility for benefits.

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