Sales Strategy Planning for Special Needs

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1 Although the unique care of a family member with special needs can often be a significant concern for clients, the task of planning for a high level of ongoing support and funding may be daunting enough that planning never gets started. And if the client is the primary caregiver, the prospect of how the family member, often a child, will be cared for in the caregiver s unexpected absence can be overwhelming. Fortunately, there are government programs, Special Needs Trusts (SNT), and life insurance coverage that can help address and fund the ongoing care of a loved one with special needs. Individuals who are considered as having special needs include persons with physical, mental and/or emotional disabilities stemming from either a condition of birth or childhood development, or as a result of disease or personal injury during lifetime. In order to maximize the quality of their lives, individuals with special needs may require additional medical care, special education support, physical, occupational or speech therapies, as well as financial help to adapt their adult living environment to their unique set of needs in an effort to establish and maintain a relative degree of independence. GOVERNMENT PROGRAMS Special needs individuals are entitled to government programs that may include access to residential and medical care facilities that may not be available through a private program even if a client can afford to pay for them. Many of these Sales Strategy Planning for Special Needs programs, however, are extremely limited in the types and amounts of services they offer and may not be sufficient to address a family member s many daily life care needs, including medications, education and training needs, living accommodations, home modifications for daily mobility, implementation and maintenance of adaptive equipment, specialized computers, and other aids for independent function, for example. Clients are often concerned about effectively supplementing what the government provides through Medicaid and Social Security Income (SSI) to ensure that their special needs family member can maintain an acceptable standard of living through lifetime. Eligibility for government benefits can be inadvertently jeopardized if personal assets and/or income exceed a mere $2,000. This means that any income, such as child support payments pursuant to a divorce decree for example, or even assets a child receives such as gifts or inheritance from parents or other well-intentioned family members will compromise continued eligibility if proper planning does not take place. It is important to emphasize that clients may want to preserve access to government entitlements because without eligibility for these benefits, specific programs exclusively available through the government and that address a family member s unique needs currently or in the future may not be available outside of Medicaid. 1 Advanced Markets Sales Strategy Planning for Special Needs John Hancock Life Insurance Company (U.S.A.) (John Hancock) John Hancock Life Insurance Company of New York (John Hancock) 1

2 SPECIAL NEEDS TRUSTS (SNT) A properly drafted Special Needs Trust can be designed to round out the government benefits by providing for care and services not covered by those benefits. 2 Accordingly, SNTs endeavor to ensure that any distribution from the trust does not disqualify the special needs individual from receiving ongoing government support. However, the SNT can be specifically tailored to address the ongoing care of a special needs family member without regard to government benefits if the special needs person will not need or qualify for government benefits based on the disability. Nonetheless, many SNTs are often drafted so that if needs change, the trust will not prevent the beneficiary from qualifying for government benefits in the future. Generally, there are two types of SNTs, referred to as First-Party Special Needs Trust and Third-Party Special Needs Trusts, and they can be funded with a variety of different assets, including life insurance. 3 They are each described briefly below and should be drafted by an attorney familiar with special needs planning. TYPES OF SPECIAL NEEDS TRUSTS First-Party SNT 4 A special needs individual is permitted to transfer his personally owned assets on a tax-free basis to a First-Party Special Needs Trust without being disqualified for SSI or Medicaid eligibility. 5 However, the special needs person cannot create the trust and must be age 65 or younger when the trust is established. 6 Instead, the creator of the trust must be the special needs person s parent, grandparent, legal guardian or court. The primary benefit of a First-Party Special Needs Trust is that the personally owned assets transferred on a tax-free basis to the trust will be disregarded for purposes of Medicaid eligibility. However, in exchange for this benefit, First- Party SNTs are required to provide a provision to reimburse the State s Medicaid agency from the trust balance upon the beneficiary s death for payments it made on behalf of the beneficiary. 7 Third-Party SNT Alternatively, or in addition to establishing a First-Party SNT, a Third-Party SNT (also referred to as a Supplemental Needs Trust) can be established. However, the Third-Party SNT must be created by and funded with the assets of a person other than the person with special needs. Unlike the First-Party Trust, there is no age limit on the creation or funding of the trust and no Medicaid payback requirement at death. The Third-Party SNT can also be used as an estate planning vehicle so that other family members can make gifts directly to the trust to benefit the special needs family member at any time without jeopardizing his ongoing eligibility for government benefits. At death, a residual beneficiary of the trust may be designated to receive the balance of the trust assets, if any. In this way, the terms of the Third-Party SNT can be structured to benefit both the special needs child and a client s other children provided the trust states that the special needs child is to be the preferred lifetime beneficiary of the trust without regard to the interests of the other beneficiaries. The Third-Party SNT can be established as an irrevocable or revocable trust and the trustee is given complete discretion in making distributions to and for the benefit of the special needs child, including the ability to withhold and accumulate income and to maintain maximum flexibility to accommodate changing needs. Alternatively, a client s last will and testament or revocable living trust can provide for the establishment and funding of a Third-Party SNT at death. At the death of the special needs beneficiary, the remainder of an SNT can be paid to other beneficiaries, such as the special needs individual s siblings. In this way, the terms of the SNT can be structured to benefit both the special needs individual and other family members. 2

3 WHERE LIFE INSURANCE FITS IN The SNT can be funded with a variety of different assets, including gifts, retirement and savings accounts, and life insurance, for example. A life insurance policy can be an effective liquidity tool to fund an SNT. The policy can be purchased on the caregiver s life, typically the client, or on another member of the client s family, to replace the loss of services and support due to premature death. Alternatively, life insurance can be used to equalize an inheritance or to create liquidity for the future needs of a special needs child. It also provides cash to fund an SNT over lifetime to enhance and supplement the benefits provided under government programs. Moreover, the policy proceeds are generally received income tax free 8 but may be subject to estate tax, depending on the type and design of the SNT. Finally, the amount of life insurance required can be estimated through the use of Needs Analysis software specific to special needs. Assets Transferred Fund Care Needs or Supplement Government Benefits SNT Special Needs Beneficiary Makes Gifts of Premium Premiums Life Insurance on caregiver Caregiver John Hancock Life Insurance PRACTICAL CONSIDERATIONS WHEN USING AN SNT Coordinating life insurance beneficiary designations When life insurance is part of the SNT, care should be taken to coordinate beneficiary designations properly. The SNT should be named as beneficiary for the intended share of the proceeds that are to benefit the special needs child. Otherwise, a direct payment of the proceeds to the beneficiary will forfeit his or her eligibility for government benefits. Trust assets as part of taxable estate Keep in mind that the Third-Party SNT will be includible in the parents taxable estate 9 unless the trust is properly established during lifetime as an irrevocable trust. In this latter case, transfers to the trust during lifetime require a formal lifetime giving program to maximize the use of lifetime gift tax exemptions and to minimize the amount of gift taxes a client pays. 10 In the course of this planning, if preserving access to government benefits is a priority, it is important that the trust not give the special needs child the right to access the contributions made to the trust through what is referred to as a Crummey power. The mere right to this power, whether exercised or not, will jeopardize a disabled individual s eligibility for government benefits. Furthermore, the trust balance of a First-Party SNT, net of the Medicaid payback, will be included as part of the special needs child s estate at death. The trust balance of a Third-Party SNT, on the other hand, will be included in the taxable estate of the family member who established it if it was not properly established as an irrevocable trust. Note that if there is both a First-Party and a Third-Party SNT established, generally, the gifts should be directed to the Third-Party SNT to avoid being subject to the Medicaid payback required by the First-Party SNT. Making gifts to benefit a Special Needs Child Gifts and Inheritances should be planned for in advance and directed to the appropriate SNT to avoid compromising access to government benefits. Whenever possible, the gifts should be directed to the Third-Party SNT so as to avoid application of the Medicaid payback requirement associated with a First-Party SNT. In addition, funds from a structured settlement should generally be payable to the SNT if continued eligibility for government benefits is desired. 3

4 Ownership of Assets Care should be taken, where applicable, to re-title assets if maintaining eligibility for government benefits is a planning objective. That is, continued joint ownership of property between a parent and his or her special needs child will jeopardize ongoing access to government benefits. Importance of a Letter of Intent Finally, just as important as the financial and funding aspects of caring for a special needs family member is the need for a daily activity plan that can be outlined in a letter of intent in the event of the temporary or permanent absence of a primary caregiver. A daily activity plan should provide a guide to anyone who needs to step in to care for a child s special needs. Siblings and other family members, designated legal guardians, or the courts who are trying to help in the caregiver s absence will require this information. The daily activity plan should include information such as vital statistics, emergency contact information, a disabled child s skills and weaknesses, clothing preferences and needs, behavior, social skills, daily living skills and considerations, as well as the use and need of adaptive equipment. BENEFITS OF AN INSURED SPECIAL NEEDS TRUST Provides the funds to help replace the services of a caregiver. Provides cash to help fund the trust over the lifetime of the special needs individual enhancing and/or supplementing the benefits provided under government programs. The life insurance proceeds are generally received income tax free but may be subject to estate tax, depending on the design of the trust. Depending on the state, the life insurance policy proceeds may not be subject to the claims of creditors. Provides liquidity to equalize an inheritance for the benefit of heirs. The life insurance allows for the completion of funding needs through the death benefit regardless of the performance of other assets in the trust. CONSIDERATIONS WHEN USING AN INSURED SPECIAL NEEDS TRUST If preserving the availability of government benefits for a special needs individual is an objective, extra care should be taken in planning. Please consult your professional legal advisor. If the life insurance is to be owned by the insured, the SNT, rather than the special needs individual, should be named as beneficiary for the intended share of the proceeds. Otherwise, a direct payment of the proceeds to the special needs beneficiary could jeopardize his or her eligibility for government benefits. A revocable Third-Party SNT will be includible in the grantor s taxable estate unless the trust is properly established during lifetime as an irrevocable trust. Transfers to an irrevocable SNT trust are subject to gift taxes. As a result, the client may want to create a giving program to maximize the use of lifetime gift tax exemptions and to minimize gift taxes. Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws, including generation-skipping transfer tax applicable to beneficiaries who are more than one generation removed from the client. Failure to do so could result in adverse tax treatment of trust proceeds. The amount of life insurance protection for which a client qualifies will be subject to medical and financial underwriting requirements. Life insurance policies have charges associated with them such as the cost of insurance and potential surrender charges. Please consult with your tax advisor for more information. 4

5 CASE STUDY: PAIGE AND MARTIN STILLWATER Paige and Martin Stillwater want to ensure that the special needs of their daughter, 10-year-old Emily, will be properly met in the event that anything should happen to Paige, age 48, Preferred Non Smoker and Emily s full time caregiver. Their legal advisors draft a Supplemental Needs Trust 11 that will be used to provide funds to care for Emily based on her life expectancy 12 of 71 years. The Stillwaters assess Emily s long-term needs, taking into account expenses and income from government and non-government sources, as well as the varying time periods for which Emily might require specific items of support. The present value of the expenses are based on a detailed list of current cost items relative to Emily s housing and transportation needs, personal care needs, recreational needs, care assistance, insurance payments and co-payments, therapies, tuition, supplies and housing accommodation required in the future. Each cost is indexed for inflation. Costs to be incurred in the future when Emily is an adult, assuming beginning at her age 22, are also projected. All of these are offset by current and future available income from government benefits, if any. The Stillwaters provide this information to their insurance advisor, who uses JH Solutions software to illustrate the life insurance needed to fund the SNT. The following is a summary of the present value costs and the subsequent life insurance amount calculated. The insurance advisor ran a John Hancock Protection UL, a universal life insurance policy, on Paige s life and the software made an initial projection of $2,062,400 life insurance need. The annual premium on a Protection UL is $13,009. Take a look: ANALYSIS OF NEEDS Present Value Expenses Living Expenses Health and Care Expenses Education and Job Training Expenses Other Expenses Emergency Fund One-Time Fixed Costs Subtotal $1,418,400 $547,200 $252,000 $10,000 $40,000 $2,267,600 Sources of Income Public Benefits Structured Settlement Beneficiary s Income Existing Assets in Trust Exisiting Life Insurance Subtotal $205,200 $205,200 Total Expenses Less Existing Sources of Income New Life Insurance Need $2,267,600 $205,200 $2,062,400 This is a supplemental illustration authorized for distribution only when preceded or accompanied by a basic illustration from the issuer. Benefits and values may not be guaranteed; the assumptions on which they are based are subject to change by the insurer. Actual results may be more or less favorable. Refer to the basic illustration for guaranteed elements and other important information. The example above is hypothetical and intended for illustrative purposes only. By analyzing finances, assessing a loved one s care needs, and creating a Special Needs Trust (SNT) funded with life insurance, a source of money can be created to provide the requisite care. 5

6 1. See the following case regarding the proper use of an SNT and the need to preserve eligibility for government benefits: Social Services vs Saunders, 724 A.2d Also see Grillo v. Petiete et al., (96th Dist. Ct., Tarrant Cty., Texas); and Grillo v. Henry Cause, , (96th Dist. Ct., Tarrant Cty., Texas). See also French v Glorioso 94 S.W.3d 739 (No CV). 2. Trusts should be drafted by an attorney familiar with such matters in order to take into account suitability and the various transfer tax implications as well as eligibility for government benefits. 3. See the following case regarding the proper use of an SNT and the need to preserve eligibility for government benefits: Social Services vs Saunders, 724 A.2d Also see Grillo v. Petiete et al., (96th Dist. Ct., Tarrant Cty., Texas); and Grillo v. Henry Cause, , (96th Dist. Ct., Tarrant Cty., Texas). 4. First-party SNTs can be a d(4)(a) SNT in which the assets are not pooled with other beneficiaries, or established as a pooled d(4)(c) SNT. Both First-party SNTs must be created by an irrevocable inter-vivos trust agreement. 5. See 42 U.S.C Section 1396(P)d(4)(A) and the First-Party Pooled Trust under 42 USC Section 1396(P)d(4)(C). 6. Although the disabled person must be younger than age 65 for the trust to be created, future contributions can be made to the trust after age 65 subject to Medicaid s 5-year look-back rule. 7. If the First-Party SNT is established as a pooled SNT, under 42 U.S.C. 1396p(d)(4)(C), it is a pooled account created and managed by a nonprofit organization. In such a trust, a separate subaccount is maintained for each beneficiary of the trust, but the assets are pooled for investment and management purposes. The account is created for the sole benefit of an individual with a disability by the individual s parent, grandparent, legal guardian, court, or the individual. The trust is funded with the assets of the person with disabilities. The pooled SNT must provide that to the extent funds in the disabled individual s account are not otherwise retained by the pooled d(4)(c) SNT for the benefit of other beneficiaries in the pool, upon the individual s death, the state Medicaid agency must receive the amounts remaining in the subaccount up to the amount paid by the Medicaid program for the individual. 8. Life insurance death benefit proceeds are generally excludable from the beneficiary s gross income for income tax purposes. There are few exceptions such as when a life insurance policy has been transferred for valuable consideration. 9. Or the estate of the family member who creates the trust. 10. Annual exclusion gifts are the annual tax free gifts (currently $13,000) a donor (i.e., mom/dad) can transfer to anyone individually or through the use of a trust, without using their lifetime gift tax free exemption amount ($5M in 2011). To apply the annual exclusion to a gift, it must be considered a present interest gift which allows a beneficiary of a trust the right to immediately withdraw (known as Crummey rights of withdrawal) the gift within a certain period of time. 11. Third-Party SNT. 12. Life expectancy based on 2008 Valuation Basic Tables. This material does not constitute tax, legal or accounting advice, and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Comments on taxation are based on John Hancock s understanding of current tax law, which is subject to change. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors. Insurance policies and/or associated riders and features may not be available in all states. Insurance products are issued by: John Hancock Life Insurance Company (U.S.A.), Boston, MA (not licensed in New York) and John Hancock Life Insurance Company of New York, Valhalla, NY John Hancock. All rights reserved. IM /11 MLINY Policy Form Series: 11PROUL Not for use with the public in Mississippi, Nevada, and Guam.