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Life Insurance and Special Needs Planning

May 11, 2022
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Life insurance is very important for families with loved ones who have special needs. Life insurance can protect the individual’s financial future and protect their government benefits.

Life Insurance for Parents of Special Needs Children

Your loved one with special needs may outlive you. Life insurance on yourself is extremely important to have if you care for a person who will be dependent on you his or her entire life.

There are two main types of life insurance to choose from: term life insurance and permanent life insurance.

Term life insurance is temporary coverage. You choose how long you want the coverage to last. Terms range from 10-40 years.

Permanent life insurance is designed to provide coverage for your entire life. It also can accumulate cash values that you can access later in life. For these reasons, permanent life insurance is much more expensive than term life insurance.

If you have a child with special needs, you may want to consider permanent life insurance if your child is likely to be dependent on you their entire life.

There are various permanent life insurance options with different benefits and pricing. A more affordable type of permanent life insurance is guaranteed universal life insurance.

If you die before your special needs child, the death benefit from your life insurance policy can help ensure they’re taken care of.

Life Insurance for Individuals with Special Needs

Special needs can range from a mild to severe condition. Some individuals with special needs can get traditional term or permanent life insurance. It depends on the individual situation.

Adding a child rider onto your life insurance policy is the easiest and most affordable way to get life insurance on a child with special needs.

A child rider provides a small amount of life insurance on any dependent, minor children you have when you apply and includes any children you may have in the future.

A child rider costs only a few dollars extra per month. The coverage is typically $10,000 – $25,000 on each child. One child rider covers all minor children. You don’t need to buy a child rider separately for each child.

Most insurance companies ask for a medical questionnaire to be completed on each child eligible for coverage and would then end up excluding any child that has special needs or a disability. However, there are a few companies out there that offer child riders that don’t require any medical information.

Additionally, a child rider can be converted into a standalone permanent life insurance policy for your child without requiring evidence of insurability. This is incredibly beneficial since many individuals with special needs would be uninsurable for their own life insurance policy.

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Protecting Government Benefits

Many people with special needs qualify for government benefits such as Medicaid and Supplemental Security Income (SSI). However, these programs are needs-based.

If an individual has too many assets in their name, they can become ineligible for these benefits, or their benefits may be reduced.

For example, if you buy life insurance on yourself, do not name your loved one with special needs as the policy beneficiary.

When government special needs and disability benefits are involved, a trust can be very useful to ensure your life insurance is setup properly.

Special Needs Trusts

A trust is a legal vehicle that allows a trustee to hold and manage assets on behalf of a beneficiary. A special needs trust, specifically, is an irrevocable trust that holds assets that supplement benefits received from government programs.

An irrevocable trust means that once someone transfers assets into the trust, they give up control over the assets and cannot take it back. The trust now owns the asset.

Assets for the benefit of the person with special needs are placed into the trust, avoiding naming the individual as owner or a direct beneficiary of the assets and thereby keeping them eligible to continue to receive the needs-based government benefits (i.e. Medicaid and Supplemental Security Income).

Life insurance proceeds can be paid to the trust by naming the trust the beneficiary of the policy. This ensures government benefits are protected since the proceeds won’t be in the individual’s name.

The benefits of using life insurance to fund a trust:

  • Cost effective – provides a large sum of money for comparatively low premium payments
  • Typically protected from creditors
  • Death benefit is income and estate tax free if properly structured
  • Can easily distribute proceeds between care for your special needs loved one and any other children or family members you wish to financially protect
  • Brings peace of mind that your loved one will be cared for even after your death

A trust can also own the life insurance policy. A trust-owned life insurance policy is often used as an estate planning tool for individuals with large estates. It’s a way to avoid paying estate taxes.

Types of Special Needs Trusts

There are two types of special needs trusts: first-party SNTs and third-party SNTs.

First-party SNTs (also called self-settled special needs trusts) are trusts that are funded with the special needs beneficiary’s own assets. For example, if the beneficiary has a job, earned income can be placed in the trust. If the beneficiary receives an inheritance, the money can be placed in the trust.

Self-settled/first-party trusts are also “payback” trusts. This means that after the beneficiary dies or the trust is terminated, any remaining funds left in the trust are used to “pay back” the government Medicaid program up to whatever amounts were paid out for the individual’s care.

Because these SNTs are payback trusts, it’s not advisable for parents, friends, or other family members to contribute to it. This is when a separate third-party special needs trust comes in.

Third-party special needs trusts (also called supplemental special needs trusts) are created by and funded with the assets of someone other than the person with special needs. Third party SNTs are not subject to the payback rules.

How does a special needs trust work?

The assets held in the special needs trust (SNT) are managed by a designated trustee. The trustee can be a family member or friend. Or parents may use an independent trustee, such as a lawyer or bank official.

The trustee should not use the funds to pay for things that the government benefits pay for. Medicaid and Supplemental Security Income (SSI) provide for a person’s basic needs of shelter, medical care, and food. Needs outside of these can be paid for with the trust funds.

If the special needs trust pays for the beneficiary’s basic needs, such payments are reported to Social Security and then the individual’s SSI check will be reduced. This situation should be avoided. The trustee needs to pay close attention to how he or she is using the funds on behalf of the person with special needs.

ABLE Accounts

The expenses that come with managing a trust may not be feasible for families with limited assets. To meet the needs of more families, Congress the Section 529A Achieving a Better Life Experience (ABLE) Act.

The ABLE Act allows tax-free growth on after-tax contributions. It also will not disqualify a special needs individual from receiving needs-based programs like Medicaid and SSI.

Essentially, an ABLE account is a tax-advantaged savings account for individuals with disabilities and their families.

How the ABLE Account Works

Parents, grandparents, or other family members can create a 529A account for the special needs individual. To qualify for a 529A account, the special needs individual must have been diagnosed with the disability prior to turning age 26 and the condition is expected to last at least 12 consecutive months. The individual must also be receiving benefits under Supplemental Security Income or Social Security Disability Insurance.

Individuals with special needs may also open a 529A account on their own behalf.

Contributions into the account cannot exceed the annual gift tax exclusion amount ($15,000 in 2021). The account funds are not taxed when distributed as long as they are used for qualified expenses.

Qualified expenses include education, housing, transportation, employment training, personal support services, health and wellness costs, legal fees, financial management, and funeral and burial costs. Distributions used for non-qualified expenses will be taxed and fined a 10% early withdrawal penalty.

If the 529A account total balance exceeds $102,000, the special needs individual will become ineligible for SSI benefits. Using distributions for housing can also disqualify individuals for some or all SSI benefits.

If the beneficiary dies before using up the entire balance of the ABLE account, the remaining funds are used to pay back Medicaid services provided to the beneficiary. This is unlike a special needs trust in which unused funds are able to be distributed to other named beneficiaries.

Most U.S. states have established an ABLE program, but not all have.  You may be able to set up an account even if your state does not yet have its own program. Many state programs allow out-of-state beneficiaries to open accounts.

Other Steps Parents of Special Needs Children Need to Make

Create a Will

Your will specifies how you wish to distribute your assets after death. Without a will, a probate court judge, following state law, is likely to name your special needs child as a beneficiary of your estate.  Unfortunately, this is likely to make your child ineligible for government benefits. By writing a will, you ensure that your assets are distributed properly.

Name an Executor, Trustee, and Guardian

Selecting an executor for your estate, a trustee for any trusts, and a guardian for your special needs child is an important and often challenging task. In selecting these important people, keep in mind that the family member who may be best at handling administrative and financial matters after your death may not be the right person to supervise the care of your special needs child.

Give careful consideration to whether or not there is a family member who is willing and capable of caring for your child after you are gone. If need be, consider naming an agency that specializes in providing the services your child will need.

Apply for Guardianship or Power of Attorney

When children turn 18, they’re considered adults in the eyes of the law. This gives your special needs child the right to make medical and financial decisions.

If your child is not capable of making these decisions or needs guidance, consider assuming legal guardianship. A less restrictive alternative is to have a power of attorney and health care proxy for the child’s financial, legal, and medical affairs.

Write a Letter of Intent

A letter of intent lets you express your personal concerns about how your child’s everyday needs will be met when you are not around. Include a list of contact information for your child’s physicians, therapists, and other medical support people, as well as current medications with their dosages and schedules.

If your child’s daily routine is very important, write it down and be as detailed as possible. The same goes for activities you want your child to maintain, travel or enrichment you want to be sure continues, and your child’s likes and dislikes.

Since this is an informal document, it’s easy to update as needed. Keep a copy with your will and make certain your child’s appointed guardian has a copy as well.

Educate and Communicate

Communicating with family members can avoid costly misunderstandings. Grandparents and other loved ones may want to make gifts to your special needs child, but well-meant gifts can have adverse consequences. Explain to everyone the importance of not putting anything in your child’s name, not even in wills or as a named beneficiary.

It’s advisable to work with a financial planner if you have a special needs child. They can advise you on what financial products are best for your situation.

Watch the Life Insurance and Special Needs Video


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