Special Needs Planning in Alabama: A Deep Dive into Important Concepts
WHAT IS SPECIAL NEEDS PLANNING?
Special needs planning is a distinct area of law that focuses on optimizing the quality of life for someone, often a spouse, child, or grandchild, who has health conditions or impairments. Special needs planning is often considered a sub-specialty of estate planning, but is likely more accurately a subspecialty or a part of elder law, since both the National Academy of Elder Law Attorneys and the National Elder Law Foundation have strong and robust special needs law divisions.
Over the past decade, special needs law has progressed and changed perhaps more than any other area of law in America. Before the disability rights movement took hold, individuals with special needs were often disinherited altogether in estate plans and readily stripped of their freedom and autonomy through court proceedings without much thought. Additionally, before just a few years ago, guardians, courts, and attorneys were presumed to always know what was best for individuals with special needs.
Thankfully, the law has moved beyond this downward-looking, paternalistic framework and moved toward what is known as “person-centered planning.”
Person-centered planning seeks to empower an individual with special needs to make and communicate decisions about their own well-being while also providing them assistance in areas in which they are unable to manage their affairs. Instead of beginning the analysis by asking what the person cannot do, person-centered planning begins by asking what the person can do, while also considering the person’s weak areas in which they might need assistance. Accordingly, a special needs law attorney might begin a consultation with a family who has a loved one with special needs by asking the individual with special needs or the family member present at the meeting to tell the attorney about the person with special needs, such as their strengths, weaknesses, character, and hobbies.
One of the most exciting aspects of person-centered planning is its opportunities to customize a specific plan particularly tailored to meet each individual’s needs. For example, an individual might be able to obtain employment, but may be unable to remember to balance their checkbook or pay taxes. Perhaps an individual can handle routine financial transactions like paying for groceries, but needs checks and balances of sorts for more major transactions and detecting potential fraud. Or consider the example of a beneficiary with more severe limitations, who might be incapable of handling their own financial affairs, but is more than capable of determining where they want to live or which doctor they want to see. The ability to customize plans based on each individual’s strengths, weaknesses, capacity, needs, and desires, is the heart of person-centered planning.
Another major component of special needs planning is maximizing government benefits for the individual. This often involves structuring one’s assets and estate plan so as to preserve any means-tested government benefits that might be lost if the individual with special needs were to receive an inheritance from family members or friends. Specific examples of these types of benefits and strategies to preserve them are discussed later in this guide. Special needs planning can involve a number of objectives and considerations, including:
- Allowing appropriate personal autonomy
- Maximizing government benefits
- Health insurance planning
- Job, social, and communal planning
- Minimizing taxes
- Planning for adulthood
- Planning for improvement or deterioration
- Planning for death
- Coordination with your overall estate plan
GOVERNMENT BENEFITS
Who is “disabled”? And who decides?
As many families who have a family member with special needs know, there is no real definition of the person has or does not have “special needs.” Additionally, having special needs is not synonymous with being “disabled.” Nonetheless, in order for a person to avail themselves of many of the benefits discussed in this guide, a person must meet the Social Security Administration’s definition of “disabled.” The SSA defines a person as “disabled” if they are unable to do “any substantial gainful activity” due to a physical or mental impairment which has lasted or is expected to last for a continuous period of at least 12 months, or is expected to result in death. The SSA has a different, more nebulous definition of “disabled” for applicants who are children. A child is considered “disabled” by the SSA if they have an impairment resulting in “marked and severe functional limitations.” The SSA allows for appeals if an applicant is rejected for disability status. While obtaining a disability ruling from the SSA can allow a person to obtain many government benefits that they otherwise could not receive, special needs planning can positively impact many families, whether or not one or more of their family members has been declared “disabled” by the SSA.
Health insurance
Most Americans are now aware that a child may remain insured under their parent’s private health insurance plan until they are 26 years old. Upon attaining age 26, a person with special needs must usually obtain health insurance through other means, such as through a private health insurance plan, Medicaid, or, in very rare instances, Medicare. Obtaining private insurance can be difficult for individuals with disabilities who are unable to obtain full-time employment, which generally carries health insurance coverage. If a person can obtain health insurance through a health insurance program, they will usually get the coverage.
Even though an individual may not use the exchange market created under the Patient Protection & Affordable Care Act, it can still be difficult to obtain health insurance through an exchange because, even though federal law provides subsidies to help pay for some or all of the plan’s premiums, an uninsured but very much valid federal law requires that a person must not have a household income below the poverty line in order to receive a premium subsidy for private health insurance.
In states that have not expanded Medicaid coverage under the Patient Protection & Affordable Care Act, such as Alabama, this results in a “coverage gap” for people too poor under this unintended rule to obtain a subsidy but fail to meet the categorical guidelines for Medicaid eligibility (discussed later in this guide). This can be remedied if the beneficiary is declared “disabled” by the SSA, which is why the disability determination is often so crucial in special needs planning.
Social Security Income and the Doors it Opens
Social Security Income (“SSI”) is a tax-free cash benefit given to individuals who are blind, disabled, or at least 65 years old. It is designed to cover the basic needs of people who cannot afford these two life necessities, although in many parts of the country, even the maximum SSI amount does not even cover housing costs. As of 2024, the maximum SSI benefit is $943 per month for an individual.
The more income a person has, the more SSI will be reduced. That means that recipients receive a smaller amount of SSI if there is an income “in kind.” In other words, the person’s SSI benefit is reduced when the income is received in the form of items that are deemed income such as income from interest and dividends as well as gifts received by friends. Earned income such as wages or self-employment income also reduces a person’s SSI benefit — “dollar for dollar,” while earned income reduces a person’s benefit by 50 cents for every dollar after the first $65 a person earns.
SSI is significant for not only the persons who receive SSI, they are categorically eligible for Medicaid. This means that so long as a person is eligible for and is receiving at least one dollar of SSI, they are automatically entitled to enroll in Medicaid. Obtaining that dollar of SSI is even more significant in states like Alabama and others who never expanded Medicaid, since this is quite possibly one of the few ways that an individual can qualify for health insurance in those states. In states that have expanded Medicaid, obtaining SSI is not nearly as valuable because Medicaid is available to people whose household income is less than 138% of the federal poverty line. Additionally, in states that have expanded Medicaid coverage, there is no other avenue for Merit for Medicaid eligibility. In other words, a Medicaid applicant in a Medicaid expansion state can have unlimited assets (for example, cash in a bank account), but if their income is less than 138% of the Federal Poverty line, they can qualify for Medicaid.
One of the least-known implications of obtaining SSI is that it may allow the beneficiary access to food stamps. Federal law does not tie income to a household in single figure. SSI, then, that household is eligible for SNAP also known as food stamps. SNAP benefits are available on a per-household basis. Thus, if a person who is receiving SSI lives with others, the entire household automatically qualifies for food stamps. Being eligible for food stamps does not mean the person automatically receives them. An application must still be filled out, and there are guidelines that the applicant must meet.
If a person who receives SSI and is also the recipient is automatically deemed as a Qualified Medicaid Beneficiary (QMB) who then receives Medicare, Qualified Medicare Beneficiary…
Receive help with the out-of-pocket costs of Medicare such as premiums, co-insurance and co-pays, and deductibles. Qualified Medicare Beneficiaries are automatically eligible for the “Extra Help” program, which reduces the cost of prescription drugs under Medicare Part D.
Other Social Security Benefits
SSI is not the only Social Security benefit available to persons declared “disabled” by the SSA. In fact, SSI is the only Social Security benefit that is means tested, meaning it has strict asset and income requirements. If a person has substantial assets (called “available resources” by the SSA), they will likely not be eligible for SSI, but they may be entitled to other Social Security benefits.
Social Security Disability Insurance is a monthly cash benefit available to individuals who meet the definition of “disabled” according to the SSA and have worked a sufficient amount of time to be “insured” for purposes of SSDI. While the exact calculation to determine whether someone is “insured” for purposes of SSDI is beyond the scope of this guide, it is worth noting that this calculation depends on how long the person worked, how much they earned, how much time working, and their age. Interestingly, being eligible for SSDI has a significant health care benefit. After 24 months of drawing SSDI, an SSDI beneficiary becomes eligible to receive Medicare (not Medicaid).
Another little-known Social Security benefit available to individuals who are declared “disabled” by the SSA is the “childhood disability” benefit, formerly known as the “disabled adult child” benefit. This is available to an adult child (defined as age 18 or older) who can prove a serious functional disability that began before the age of 22. This benefit is available to spouses and widows of a worker or a deceased worker, few are aware of the “disabled adult child” Social Security benefit.
This benefit is available to the children of any age of a worker who is currently drawing Social Security benefits so long as the disabled adult child became disabled before the age of 22. If the parent of the disabled child is drawing a benefit equal to 50% of the worker’s benefit, or if the worker is deceased, that disabled adult child is also an important because it allows for the disabled adult child to receive Medicare (not Medicaid) 25 months after the childhood disability payments begin.
Additionally, if a worker’s spouse is caring for a minor or disabled child (of any age), the worker’s spouse is entitled to a benefit equal to 50% of the worker’s benefit regardless of the spouse’s age. This is significant because if a spouse is not raising a minor or disabled child, the spouse would not be eligible for spousal benefits unless the spouse was age 62 (or 60 if the worker is deceased).
Veterans Benefits
While the law surrounding Veterans benefits is largely considered a separate area of law and is oftentimes reserved for individuals with a condition or impairment sufficient enough to consider applying for Medicaid or a Social Security benefit should also consider applying for benefits from the Veterans Administration if they have served in the U.S. military. A person can receive VA and be entitled to benefits such as SSI, SSDI, and/or Medicare.
Veterans benefits, like SSI, is a monthly, tax-free cash benefit paid out to Veterans who were injured while on active duty or otherwise show service-related disability. In addition to this benefit…
Administration. VA disability compensation is different than SSDI in that Veterans are rated and compensated incrementally in 10% increments, while SSDI benefits are not awarded in increments. Rather, SSDI benefits are “all or nothing.” However, like SSDI benefits, VA disability compensation is not means-tested, so no Veteran can be denied for having too many assets or too much income.
Aside from VA disability compensation, the VA offers other benefits for older Veterans and Veterans with severe medical conditions. These benefits are known as the VA pension, household benefits, and Aid and Attendance. These three benefits have more substantial eligibility requirements than VA disability compensation. While an in-depth discussion of these three benefits is beyond the scope of this guide, it is worth noting that these benefits have (1) an age or medical requirement, (2) a wartime service requirement, and (3) a “net worth” requirement, which has its own highly unique calculation that allows for strategic planning opportunities.
SPECIAL NEEDS TRUSTS
“Special Needs Trusts,” sometimes called “Supplemental Needs Trusts” are trusts designed to maximize the quality of life for a special needs person with basic unmet needs. Conceptually, a special needs trust, whether it is funded by a special needs person or a loved one, acts very much like an agreement between the person or entity creating the trust and a trustee to manage the trust benefits for the benefit of a particular beneficiary or group of beneficiaries. All special needs trusts fall into one of two categories: first-party special needs trusts or third-party special needs trusts. The classification of a special needs trust depends on where the funds come from.
If the trust is funded with money that belongs to the beneficiary themselves, then the trust is a first-party special needs trust. If the trust is funded with assets of someone other than the beneficiary (a “third party”), then the trust is a third-party special needs trust. Vastly different rules apply to these two different types of special needs trusts.
Regardless of whether the special needs trust is first-party or third-party, one of the chief uses of a special needs trust is to allow a person with special needs to legally get themselves or others who are legally liable for them to qualify for government benefits for which they would otherwise be ineligible due to having too many assets while also retaining the benefit of those assets. Some means-tested government benefits, including Medicaid and SSI in Alabama, require that a beneficiary have no more than $2,000 in “available resources” in order to qualify. While certain resources are explicitly excepted from being considered an “available resource” (for example, a home and vehicle do not count as available resources), cash in a bank account most certainly counts toward a person’s $2,000 limit.
Living with less than $2,000 to your name obviously makes for a very difficult life. What a properly-drafted special needs trust gives the beneficiary the best of both worlds in that it allows the beneficiary to be eligible for government benefits (including those with strict means-testing) but also receive the benefit of the assets in the special needs trust to help support the best life they can live.
Special needs trusts are the key to maintaining eligibility for government benefits while still being cared for by someone in a meaningful way. Therefore, any assets (such as a legal settlement or inheritance) must be carefully handled to avoid creating a disqualifying event for an individual with a special need.
those assets—the trust does. The assets in the trust (which are legally “owned” by the trust rather than the beneficiary themselves) are managed by a trustee who distributes assets in the trust for the benefit of the disabled beneficiary based on certain carefully-designed standards. Typically, special needs trusts are drafted to allow the trustee to distribute money from the trust for the benefit of the beneficiary’s health, education, and maintenance. The wording of this standard is very important and is discussed later in this guide.
First Party Special Needs Trusts
First-party special needs trusts are trusts funded with assets belonging to a person with special needs. These assets are often comprised of settlements or court awards in a lawsuit (such as a vehicular or other accident) or an inheritance. These trusts can accelerate eligibility for government benefits. If a person who is receiving SSI and Medicaid receives an inheritance that results in the person owning more than $2,000, then they will be ineligible for SSI and Medicaid until they spend down that amount to $2,000 in ways that are far from optimal. However, transferring the inherited assets into a first-party special needs trust can allow for that person to become eligible for SSI and Medicaid as soon as the month after the trust is created and funded.
First-party special needs trusts have some unique federal requirements. First, the trust must be funded before the beneficiary turns 65 years old. Once the trust is funded, a trust for a beneficiary who turns 65 can no longer receive any contributions to the trust and the beneficiary must continue to own it as otherwise unaffected by the creation of the trust. Second, if the trust is created by a person who is disabled, it must be created by the beneficiary’s parent, grandparent, or legal guardian, or by a court. Third, the trust must be irrevocable (in other words, the trust cannot be terminated except in very rare instances) and the trust must explicitly reference the federal law that allows such trusts: 42 United States Code Section 1396p(d)(4)(A).
One of the most consequential requirements of a first-party special needs trust is that it must contain what is known as a “Medicaid payback provision.” This is a provision that states that upon the death of the beneficiary, the state Medicaid agency is entitled to reimbursement for all funds it spent on the beneficiary’s care. Notably, this payback amount includes all money spent on the beneficiary’s care since the beneficiary was born regardless of when the first-party special needs trust was created. So if a beneficiary was ever on Medicaid, including during childhood or their young adult years, Medicaid is entitled to recoup all costs it paid for the beneficiary’s care. Given the cost of health care, this amount could obviously be very high, so caution is warranted in creating, designing, funding, and planning around first-party special needs trusts.
What can First-Party Special Needs Trusts Pay For? ("We're Going to Disney World!")
As discussed above, a first-party special needs trust allows the trustee to supplement the benefit of a beneficiary according to a certain standard, which is usually for the beneficiary’s health, education, and maintenance. Additionally, federal regulations require that the trustee’s distributions of trust assets be for the “sole benefit” of the special needs beneficiary. This “sole benefit” requirement was adopted roughly ten years ago and is widely interpreted to mean that the special needs beneficiary must be the “sole benefit” of the distributions.
beneficiary may benefit from the distribution collaterally. The 2018 regulations focused on specific changes for payments from a special needs trust to family members for caregiving, companionship, and travel. As for caregiving and companionship, the new regulations specifically state that family members may receive compensation from the trust for caregiving and companionship and additional expenses related to such service or companionship even if they would otherwise do so free of charge. This is a major departure from the prior rule, which required family members to be “qualified” in order to receive compensation for caregiving. Unfortunately, many Medicaid offices completely miss this benefit because much of the income on the Internet is outdated and does not reflect the more generous rules.
As for travel, the 2018 regulations explicitly allow the trust to pay family members or caregivers of the beneficiary for their travel if the travel with the beneficiary is necessary for the “safety” or “medical well-being” of the trust. The 2018 regulations provide that “parents or caretakers” may be compensated for their travel to assist the beneficiary on vacation. The regulations provide that the example of parents or caretakers accompanying a beneficiary on a cruise ship vacation is acceptable so long as the trust may pay for the ticket to the cruise.
Pooled First-Party Special Needs Trusts
There are two kinds of first-party special needs trusts: “(d)(4)(A)” trusts (also known as “OBRA trusts” or “Zebley” trusts) and “(d)(4)(C)” trusts (also known as pooled trusts). A (d)(4)(C) trust is a trust described under a (d)(4)(C) statute. It is a trust established and maintained by a nonprofit organization. The trustee “pools” all of the plan and the beneficiaries together for asset management and investment purposes but still segregates each beneficiary’s own money for their own respective benefit.
The same rules largely apply for (d)(4)(A) trusts and (d)(4)(C) trusts, with a few key exceptions, which is very significant. Real reform under the guide that a (d)(4)(C) trust is the only kind of trust where anyone (except court) can establish the trust on behalf of the beneficiary (and possibly even including the beneficiary too). This is huge! For a beneficiary of any age. But some states require a personal law attorney or pooled trust who transfers assets to a pooled trust under older Medicaid laws that are outdated. Some of these laws require pooled trust accounts to close if a beneficiary is over the age of 65. Roughly 18 states which does not impose a transfer penalty for pooled trust accounts for a person who is 65 years old or older or a pooled trust, making this a viable planning strategy for many disabled seniors who cannot avail themselves of a (d)(4)(A) trust because of the age limit.
Third-Party Special Needs Trusts: Even More Versatile, Even More Planning Opportunities
A third-party special needs trust is a trust created for the benefit of a person with special needs by a family member, grandparent, parent, or other benefactor, and is usually more flexible and more favorable than a first-party special needs trust. The key difference between a third-party and first-party special needs trust is who owns the assets in the trust on the front end. A third-party trust is never legally “owned” by the beneficiary. Just like with first-party special needs trusts, this is very important in income requirements. It is also important in Medicaid payback rules. In a third-party special needs trust, the state is not entitled to be reimbursed for Medicaid benefits upon the death of the beneficiary, not considered owned or third-party, and not used to disqualify the recipient for government benefits such as SSI and Medicaid.
Since third-party special needs trusts are often used to obtain and preserve eligibility for government benefits, it follows that another function of third-party special needs trusts is to supplement (rather than supplant) government benefits. In other words, assets owned by a third-party special needs trust are used to pay for what the government benefits do not pay for, such as additional medical care not covered by Medicaid, money for education, job training, transportation (including a vehicle if the beneficiary is capable of and licensed to drive), vacations, recreational and hobby activities, and more. Whether a third-party (or first-party) special needs trust may pay for housing costs or food for the beneficiary is a very complicated question and one that is best for the trustee or the person seeking to set up a trust to inquire.
While some of the technical requirements for first-party special needs trusts do not apply to third-party special needs trusts, third-party special needs trusts have their own list of traps to be aware of. There are three unique but potentially devastating traps in third-party special needs trust planning that an unwary planner must carefully navigate in order to ensure that the trust will be able to be used for the benefit of the beneficiary and still be able to use trust assets.
The first trap is including the word “support” as an acceptable distribution language in a third-party special needs trust. As discussed previously, most special needs trusts are drafted to include distribution language for the beneficiary’s “health, education, maintenance and support.” However, the major issue is that distribution standard requires the trustee to distribute money from the trust for the beneficiary’s “support.” The reason that the word “support” is avoided by many practitioners is because the IRS holds that such language — “health, education, maintenance, and support” — is what is known as an “ascertainable standard” which can provide some tax and asset protection benefits. Despite the fact that the tax and asset protection benefits are sometimes real while the “health, education, maintenance, and support” distribution standard is simpler, the language directly conflicts with regulations and is therefore one of the most misinformed and careless traps in all of trust planning.
This means any court may harmless enough by simply adding the word “support” to the allowable standard in a trust. Unfortunately, adding the word “support” likely invalidates the entire trust for a beneficiary with special needs. Courts routinely invalidate third-party special needs trusts for including the distribution trust assets for the beneficiary’s “health, education, maintenance, and support” rather than the other more narrowly-tailored language that is not “support,” and thereby ruin all of their expectations in it is an effort “available” to the public at large. Even if the technical legal issues are set aside, if a trust has “available” resources in them considered to be an explicit income, then the amount $2,000 must be reduced if there is considered an “available” resources (this process is known as “spend down”).
Note:
Only a handful of courts will likely invalidate the trust regardless of whether the trust is proper. Most states use the beneficiary’s support needs, which regards the word “support.” Thus, this means the inclusion of “support” is highly dangerous. The language is highly inadvisable and will likely cost the beneficiary overwhelmingly when the distribution purposes are not defined. Most attorneys now omit any reference (including definitions) and be aware of the legal limitations and include the word…
“support” in special needs trusts’ distribution language, which is very dangerous.
The second technical legal landmine in third-party special needs trusts is a failure to state that the trust is an “accumulation trust.” This is important if the trust is a beneficiary of a qualified retirement account such as IRA, 401(k), 403(b), or TSP account (military account). Because these accounts have their own distribution rules, failure to state that the trust is an accumulation trust allows the trustee to distribute to either party, to either the beneficiary (in which case all funds must be withdrawn over a short five- to ten-year period) or to another party (in which case the funds must be distributed to an “eligible designated beneficiary” over the course of their life expectancy).
If it is important that a special needs trust be the beneficiary of a qualified retirement account, then the trust must be an accumulation trust and should be carefully drafted. Otherwise, the trustee may be required to withdraw the entire amount from the qualified retirement account in five years (if the trust is not the designated beneficiary), or ten years (if the trust is the designated beneficiary), which can cause serious tax consequences. In some cases, a failure to plan accordingly for qualified retirement accounts results in a multi-year tax liability in the six figures.
The final technical trap concerns one of the most misunderstood concepts in all of special needs trust planning — whether to accumulate or leave large sums of assets to the beneficiary, either during the beneficiary’s life or after their death. By contrast, leaving large cash amounts in a first-party special needs trust can risk entitling the state Medicaid agency to much of those assets after the trust beneficiary’s death.
Because third-party special needs trusts do not contain a Medicaid payback provision, they are often the most important planning tool for families who want to leave assets to a beneficiary with special needs without leaving money to the government. In many cases, a third-party special needs trust is the only available tool to ensure that the beneficiary is taken care of after the parents’ or other family members’ death. The trust allows the family to earmark money, life insurance, or other funds for the beneficiary without worrying about losing eligibility for important public benefits. If structured and funded correctly, the assets in the trust can then be invested and managed so that the principal lasts for the lifetime of the beneficiary. Upon the death of the beneficiary, the remaining funds can then be left to other family members or other charities or religious organizations, depending on the family’s goals.
UNIQUE TAX PLANNING OPPORTUNITIES IN THE SPECIAL NEEDS CONTEXT
Estate planners helping families with special needs beneficiaries should be familiar with two unique and significant tax planning issues. First, funding a third-party special needs trust can eliminate estate and gift tax liability and allow for significant income tax planning opportunities. Second, federal and state law offer unique…opportunities to minimize taxes for families with a person with special needs. In some cases, families with a special needs beneficiary can decrease the amount of taxes owed by a beneficiary to zero, even if the estate features a tax-sheltered account like an IRA that would sustain a high tax liability if not for smart planning.
A special needs trust, whether first-party or third-party, will likely earn income. Usually, this income is earned by stocks, bonds, mutual funds, and other similar assets in the special needs trust, but they also must be realized by assets such as rental property. What happens to the income generated by assets in the trust and how it is taxed depends on how the trust is drafted. A properly-drafted special needs trust will likely allow the trustee to either distribute any income earned by the trust to the beneficiary — at which point the beneficiary will be taxed on the income — or, alternatively, to retain the income in the trust, which will result in the trust paying the income tax instead of the individual special needs beneficiary.
This brings up three issues: First, what are the tax rates for the trust, and how do they compare to the tax rates if the income is distributed to the beneficiary? Second, if the income is distributed out to the beneficiary, how is the beneficiary taxed on the income? And third, how should the attorney or the trustee decide the “bucket” for the income? (Which one gets taxed better and for how?)We will examine each of these questions in turn.
The first important concept to understand is how the income tax system applies to trusts (and high-income individuals) and how it determines the rates for income that is distributed to the beneficiary. There are two main differences between taxation in the trust and income taxation for the individual beneficiary: the tax rate and the standard deduction. First, the rate of taxation is different. Trust tax rates are compressed, that is, after it surpasses $15,200 in income (as of 2024), it sustains the highest possible tax rate of 37%. By contrast, an individual would not reach $609,350 in order to be taxed at the highest tax rate.
Second, trusts and individuals have different standard deductions. The standard deduction refers to a certain threshold allowed by Congress to be automatically not taxed at all. For individuals, in 2024, this amount is $14,600 for unmarried individuals, and more if filing as head of household. For a trust, however, this figure is irreversible, is fixed at a lower amount, and is $100 for 2024. However, if the trust qualifies as what is known as a “qualified disability trust,” then the maximum standard deduction is $4,700 in 2024. While this increase is large, $4,700 is still considerably less than the $14,600 personal deduction given to individuals. Most estate planners are quite wise to have the bulk of investment income or rental income from trust property paid out to the beneficiary if the beneficiary qualifies for the standard deduction. If done correctly, the beneficiary would likely have no tax liability (or very low) because the income taxes could be completely tax-free (using 2024 figures).
This raises an obvious practical issue: What should the trustee do if the income earned exceeds the $15,200 threshold per year? What should the trustee do if the income would not reach this limit if it’s distributed to the beneficiary? Recall that the trust still earns money even if the plan retains income, and trust tax rates are significantly more aggressive than most income tax rates for individuals. A thoughtfultrustee might consider distributing any income over the $13,900 tax-free threshold to the beneficiary so that the income is subjected to lower tax treatment than it would be if the trustee withheld the income in the trust. But the main question will be how the trustee will actually pay that tax liability. What if the beneficiary is unemployed? Additionally, recall that means-tested government benefits do treat a person as having income for $2,000, recall all available resources. Thus, the beneficiary might not well have enough cash or other assets to actually pay the tax bill.
Smart planning can achieve the best of both worlds by allowing the trust the ability to withhold trust income in excess of the $13,900 threshold and actually pay the beneficiary’s income tax liability from the trust. A special needs trust should contain a provision allowing the trustee to pay the beneficiary’s personal income taxes from the trust assets. This achieves the income tax savings resulting from the lower marginal tax rate of the individual beneficiary’s tax rate but allows the trustee to shield the trust by using the trust while also relieving the beneficiary from actually having to pay it—which may be impossible given government benefits limitations and that the beneficiary have very limited cash on hand.
This withholding strategy can result in thousands of dollars per year in income tax savings for the average middle-class special needs beneficiary once distributions (which is seen as “available” to the beneficiary) reach the $13,900 “safe harbor” threshold for government benefits? This amount is non-negligible and must be properly planned for.
If a special needs trust is in a state like Alabama, the trust pays it on behalf of the beneficiary, the trustee can send a letter to the IRS stating that money distributed from the trust to pay the individual beneficiary’s tax liability was only for tax purposes and not that the beneficiary ever actually came into receipt of the funds.
Using this strategy and careful advice, a thoughtful special needs planner is equipped with the tools to enact one of the following major goals:
(1) minimizing taxes,
(2) relieving the individual beneficiary of having to personally pay income tax that is due, and
(3) preserving all eligibility for government benefits while also having the trust pay for the individual beneficiary’s income tax liability.
Special Opportunities to Save on Taxes for Inherited IRAs
In 2019, Congress dramatically changed the law regarding the taxation of inherited retirement accounts. Before 2019, anyone who inherited an account benefitted from what was often referred to as the “income over life” approach. They could withdraw less, and still cumulatively use the account over their entire life expectancy. These rules enabled individuals who inherited an IRA to invest in more surviving beneficiaries before distributing any amount, often spreading the income tax from the account out over 30 years, allowing the maximum amount saved and benefiting from the entire time horizon.
But in 2019 Congress eliminated most of these account tax benefits for a beneficiary who inherited an IRA and declared a new requirement: the deceased account owner’s spouse has to now withdraw the income account up to 10 years. While this might not affect most beneficiaries receiving child accounts, it often dramatically reduces the benefit of investing in a special needs trust for a special needs spouse. A chain of other interests such as accounts during the years in their life in which they are that those monies, and thus subjected to the highest income tax rates, which exacerbates the negative effect of the SECURE Act’s requirement that beneficiaries withdraw all of the funds in the account within 10 years.
But the SECURE Act contains an exception for a beneficiary who is “disabled or chronically ill.” The standard for whether a beneficiary is “disabled or chronically ill” for purposes of the SECURE Act is the same standard used by the Social Security Administration discussed previously in this guide. In cases in which the beneficiary of a retirement account is disabled, the beneficiary may withdraw the funds in the trust over their life expectancy rather than in only 10 years. This can result in tax savings, as the beneficiary will, depending on their life expectancy, be able to withdraw the funds in the account over a longer-spread time than 10 years, which results in the beneficiary paying significantly less in total taxes. It is worth noting that a properly-drafted special needs trust can use the benefits of this exception contained in the SECURE Act in the event that a very disabled beneficiary can inherit or owned it in their individual name. This is of great reason for families with a person with special needs to engage in proactive planning.
ABLE ACCOUNTS: AN ALTERNATIVE OR COMPLIMENT TO A SPECIAL NEEDS TRUST
Perhaps the biggest accomplishment of the disability rights movement in the United States is the new system known as ABLE (Achieving a Better Life Experience) accounts. A special needs families and also the people who help with special needs have the ability to experience these possibly can. One of these new tools is an ABLE Account, which became authorized in 2014 with the passage of the federal Achieving a Better Life Experience Act.
An ABLE account is a revocable savings account that offers tax benefits as well as the ability of a disabled beneficiary to have a customizable amount of personal autonomy over their finances while also maintaining means-tested public benefits such as checks and balances on the beneficiary’s spending eligibility for their protection. A person can have an ABLE account, but they must prove that they have ABLE uses. They must have soon disabled (according to the SSA) before the age of 26. This has expanded as of 2026, now the ABLE rule will allow a person born on or after January 1, 2001 to qualify. A person can be older or younger than 26 but needs to have an ABLE account. On January 26, 2026, this law will change to allow someone to have an ABLE account if they became disabled by the age of 46 rather than 26.
ABLE accounts are easy to create. The person with the disability may manage the account, or a person with “signature authority” according to a certain federal regulation rules may open and manage such an account. The “signature authority” is considered the trustee for the disabled beneficiary and must meet fiduciary and legal obligations to the disabled beneficiary. This concept of who is considered the account owner of the ABLE account is important. Because it is easy to give the beneficiary some amount of autonomy to manage their account. It is their money. The person will still remain the owner of the ABLE and still require a rule of ownership for a person who otherwise will not be able to experience it.
ABLE accounts can allow a person with “signature authority” (like a parent, guardian, or manager, or another account protector) to help monitor the account to prevent potential fraud that may not be detected by the account owner.
ABLE accounts may be paired with True Link cards, which allow a beneficiary the ability to swipe a debit card connected to the ABLE account that is only valid within certain defined parameters. Examples of common parameters used in conjunction with an ABLE account include sending a text alert to a person with signature authority for the account every time the card is used by the account owner and prohibiting the card from being used at all at certain undesirable places such as a liquor store or anywhere online, where the threat of fraud is higher.
Recall that first-party special needs trusts are funded with a beneficiary’s own assets, while third-party special needs trusts are funded with assets of others (often a parent or other family member of the beneficiary). In this spectrum, ABLE Accounts exist somewhere in the middle between first- and third-party special needs trusts. An ABLE Account may be funded with a beneficiary’s own assets or assets from a third party.
Regardless of who contributes to an ABLE Account, no more than $18,000 may be contributed to an ABLE Account each year, subject to one exception. If an ABLE Account owner (recall the beneficiary is considered the owner of the ABLE Account) is employed, the owner may contribute – in addition to the $18,000 per year allowed by law – an amount equal to the lesser of the federal poverty line for a single person (in 2024, this amount is $14,580) or the account owner’s compensation for the year. Using this rule and the rule allowing people or entities other than the account owner to contribute up to the $18,000 per year to an ABLE Account, ABLE Accounts can potentially be funded with up to $32,580 per year as of 2024.
While contributions to ABLE Accounts are not tax-deductible for purposes of federal income tax, many states, including Alabama, offer income tax deductions for state income tax purposes. In Alabama, a person may deduct up to $5,000 per year from their Alabama state taxable income for contributions to an ABLE Account, and married couples may deduct up to $10,000 for contributions to an ABLE Account. ABLE Accounts also feature tax benefits for the account owner (recall that the account owner is the disabled beneficiary). So long as the assets in the ABLE account are used for “Qualified Disability Expenses”, distributions or withdrawals from the ABLE account are not taxable at all. Additionally, if there is any growth in the assets in the account, that growth is completely tax-free. Generally, distributions or withdrawals from the ABLE account for an owner’s health, education, or maintenance qualify as “Qualified Disability Expenses”, making authorized distributions between both first- and third-party special needs trusts and ABLE accounts very similar. However, there is one important exception to this general rule, which is discussed immediately below.
How ABLE Accounts Allow a Beneficiary to Preserve More Money While Also Preserving Eligibility for SSI and Medicaid
Recall from this guide’s earlier discussion that eligibility for SSI is particularly important because if a person receives just one dollar of SSI benefit, then that person is automatically eligible for Medicaid. Recall also that federal regulations allow a person to have only $2,000 in available resources to be eligible for SSI, and that cash is an available resource. Thus, if a person has more than $2,000 in their bank account, they will not receive SSI (and they will not be categorically eligible for Medicaid unless they meet other special exceptions)
Federal law allows ABLE accounts to hold up to $100,000 and still allow the account owner to be eligible for SSI (and thus Medicaid). To illustrate how impactful this is, consider the following hypothetical: if a person has $100,000 in an ABLE account, they can still be eligible for SSI. But if a person has $100,000 in a bank account that is not an ABLE account, they will not be eligible for SSI (and thus Medicaid) until they spend down $98,000 so that they have only $2,000.
How ABLE Accounts Solve the ISM Problem
ABLE accounts can solve another problem related to SSI and Medicaid. Recall that SSI payments are, in theory, supposed to cover housing and food costs. This is important because of the concept known as “in-kind support and maintenance” (“ISM”). Federal regulations hold that if a beneficiary receives food or shelter — or money for food and shelter — whether from another person (such as a parent or grandparent) or a trust (including a special needs trust), then their SSI benefit is reduced by about 33% to account for the fact that the beneficiary is receiving food and shelter from another source. If a person is receiving the maximum monthly SSI benefit of $943 per month, then their SSI benefit could be reduced to roughly $600 (the exact calculation is slightly more complicated but not necessary to understand the concept). ISM includes a situation in which an SSI beneficiary lives with family members, including parents, and those family members are providing housing to the SSI recipient free of charge.
This problem, which I will refer to as the “ISM Problem” below, manifests in two ways. First, an SSI recipient can give someone else (such as another person such as a grandparent) money to receive support for their housing or food. If the SSI recipient receives free or discounted rent from another person or a trust (including a special needs trust), they could receive food or shelter and still be penalized by the SSA. This is a popular approach, since the benefit they now get in food and shelter may be provided by SSI or payment from a third party. The problem is the in-kind support is then imputed and provided by providing a beneficiary food and housing is often much more valuable than the roughly $300 the beneficiary might forgo by accepting the housing or shelter benefit.
However, when a beneficiary receives less than the maximum SSI benefit, which can occur if they earn income — whether through dividends, gifts from others, or their own job, the question of whether to accept housing or food benefits from another person or a trust becomes a much more delicate and precarious analysis. This is because if the beneficiary’s SSI benefit is ever less than one dollar per month, they will lose the automatic Medicaid eligibility available through their status as an SSI beneficiary. This is extremely consequential in states like Alabama which have not expanded Medicaid because without SSI, Medicaid eligibility is very difficult. Thus, when the cost and need for housing and food costs knowingly accept the 33% reduction in SSI or pay rent is a fact-intensive analysis that requires care, attention to detail, and knowledge of the rules.
Interestingly, ABLE accounts provide a helpful solution to the ISM problem. This is because federal regulations allow an ABLE account to pay for food and shelter without it counting as in-kind support. Special needs trusts should be drafted so that money within the special needs trust is moved to the ABLE account and then the ABLE account makes this transfer as a qualified disability expense. This creates a clean method to address the ISM and reduces the risk of losing SSI and Medicaid. Under this unique carve-out.
The Downside of ABLE Accounts: The Return of the Medicaid Payback Provision
At this point, other than the limited amount that can be contributed to them ($18,000 per year and possibly up to $22,580 if the beneficiary earns money through their own employment), ABLE accounts seem to be a tool that nearly everyone should use, considering all of their advantages. But there is one significant drawback to an ABLE account. Like first-party special needs trusts, ABLE accounts require a Medicaid payback provision, meaning that after the death of the beneficiary, Medicaid is entitled to be paid back for the money it spent on the ABLE account owner’s care from the funds remaining in the account.
However, there are two interesting nuances to the Medicaid payback provision that make ABLE accounts different from first-party special needs trusts. First, while the Medicaid payback provision required in first-party special needs trusts must provide for reimbursement of all Medicaid expenditures (from any state’s Medicaid program) made on behalf of the beneficiary during the beneficiary’s entire lifetime, the Medicaid payback provision required for ABLE accounts only applies to services provided after the creation of the ABLE account (after the date the account is opened).
The second difference between the Medicaid payback provisions required for ABLE accounts and the Medicaid payback provisions required for first-party special needs trusts is that each state’s Medicaid agency is merely allowed to seek reimbursement for funds it provided for the beneficiary’s care. In the context of first-party special needs trusts, again, reimbursement to Medicaid must happen (though attorneys will often negotiate reimbursement with regard to multiple state programs). Despite this difference, several state Medicaid agencies still aggressively seek reimbursement and families should not assume that an agency, even if from a non-Medicaid expansion state, is refraining from a claim. The legal expenses resulting from an ABLE account payback situation can be as high as the amount in the account, turning a significant asset when the ABLE account owner is alive, into a liability after death.
Without question, the requirement that ABLE accounts contain a Medicaid payback provision contributes to one reason why, even one and a half years into the law’s existence, only a few individuals have opened them. However, with switched-on estate management and perhaps with legal tools in place such as revocable or irrevocable pooled benefit or special needs trusts, an ABLE account becomes an asset strategically managed to be one of several accounts in a comprehensive financial plan. At the very least, in most instances, an ABLE account is not meant to be the only planning tool used for a beneficiary. For example, an ABLE account is not well-suited for carrying large balances. Instead, these accounts may be best used for amounts of $2,000 or less over longer periods of time, or for spending in amounts of “just over” what an ABLE account owner (or person acting on their behalf) is legally allowed to retain in personal assets— generally a total of $2,000—without affecting public benefits (e.g., Supplemental Security Income or Medicaid). ABLE accounts are also great tools to help those with disabilities learn financial management skills and act as a practical bank account substitute for spending needs. But the Medicaid payback provision required by ABLE accounts should not be ignored by account holders or their families, and great care should be used to plan for holding an account owner’s everyday “spending money.”
OTHER TOOLS: POWERS OF ATTORNEY, GUARDIANSHIP AND CONSERVATORSHIPS, AND SUPPORTED DECISION MAKING
The final set of tools in the special needs law attorney’s toolbox are powers of attorney, guardianships, conservatorships, and supported decision making. Powers of attorney, guardianships, and conservatorships are much more well-known than all the other tools in the special needs planning toolbox discussed previously in this guide, while supported decision making is one of the least known simply because it is very new.
A power of attorney is one of the most important documents that any American citizen can have. It allows someone to speak, sign, and act for the signer of the document (called the “principal”) if the principal is ever unable to speak, sign, and act for themselves. This may occur if the principal is in an accident or develops a physical or mental impairment that renders them unable to manage their own affairs. Powers of attorney can allow someone to make medical and financial decisions (often called a “medical” power of attorney and a “financial” power of attorney). They can relieve the principal’s health care providers from the need to search both financial and medical powers in one document, although this is uncommon.
If someone is currently cognitively incapable of managing their own affairs, and they have not executed a valid, legal power of attorney, the only way that someone can act for them is by obtaining a guardianship or a conservatorship over the incapacitated person. In cases in which a person lacks capacity to manage their own affairs and they have never executed a power of attorney, a guardianship and/or a conservatorship is often required to do things like manage their assets or obtain health care for them. A guardianship allows a legally-appointed person (called a guardian) to manage the health affairs of the incapacitated person, while a conservatorship allows a legally-appointed person (called a conservator) to manage the financial affairs of the incapacitated person.
Guardianships and conservatorships are proceedings in court. They cut off the incapacitated person’s rights to manage their own affairs and vest those rights in a person appointed by a judge. These proceedings are not sealed from public view or access. Anyone can walk into their local court (usually called a probate court) and look through any entire guardianship and/or conservatorship proceeding. Guardianships and conservatorships are neither fast nor cheap. In some sad situations, guardianships and conservatorships may be contested by another member of the family, leading to a heart-breaking legal fight over who may legally manage the incapacitated person’s health care or finances. These cases are best avoided. The cost of a special needs law attorney to handle one of these cases may be large.
While hard to hear at this point, guardianships and conservatorships are viewed as a “last resort” by special needs attorneys. Sometimes the proceedings are necessary, and they serve the intended purpose, and must be used when they are needed. But they should only be used when no other legal option exists. There is unfortunately a great deal of misinformation (and perhaps malfeasance) regarding powers of attorney, conservatorships and guardianships.
needs have been told by someone who is not a special needs law attorney or read on the Internet that when their child turns 19 (and becomes a legal “adult” in the state of Alabama), they need to obtain a guardianship. This view is incorrect, backward, and harmful. A guardianship and conservatorship should be viewed as a last resort.
As difficult, expensive, and slow as guardianships and conservatorships are, there is good news: they can be avoided with a properly. drafted power of attorney. This raises the issue of whether a person has the requisite legal capacity needed to sign a legal document such as a power of attorney. While the nuances of the requisite legal capacity to sign legal documents are far beyond the scope of this guide, there are 3 important points to know. First, the level of capacity required depends on the task the person is doing. For example, the legal capacity required to make and sign a last will and testament is much higher than the legal capacity required to consent to a certain family member being able to access a person’s medical records otherwise protected by federal law.
Second, whether a person can sign a legal document – no matter the document and no matter what diagnosis a person has or does not have – is a decision for the attorney to make. Each state’s Rules of Professional Conduct, the American Bar Association, and the National Academy of Elder Law Attorneys (which has a significant wing devoted to special needs law study and scholarship) have each made this very clear. While attorneys must make this decision, they are not diagnosticians, and accordingly, the attorney is empowered to refer the client to such a professional if they choose.
Thus, a special needs law attorney will begin their analysis by focusing on what the person with special needs can do rather than what
they cannot do. If a person (whether they have special needs or not) can sign a health care power of attorney, and it is appropriate to do so, it is almost always preferrable to a guardianship. It is much cheaper, faster, and private than a guardianship, and it preserves the person’s autonomy over their affairs in a way a guardianship cannot. The same is true for financial powers of attorney they are almost always preferrable to conservatorships for the same reasons.The third and more powerful point is that just because a person has special needs or is declared “disabled” by the SSA does not necessarily mean that they cannot sign a legal document such as a financial or health care power of attorney. This is one of the most damaging misconceptions that exists in special needs law. Rather, the law holds that the attorney should engage in a specific, fact-intensive analysis to determine what legal capacity a person has. Diagnoses and medical information are relevant, but not dispositive, in this analysis. Thankfully, by reading this, you now know of this harmful misconception, and you may join the author of this guide in the fight against this widespread misinformation.
OTHER TOOLS: POWERS OF ATTORNEY, GUARDSupported Decision-Making IANSHIP AND CONSERVATORSHIPS, AND SUPPORTED DECISION MAKING
While powers of attorney are the most well-known alternative to guardianships and conservatorships, the concept of supported decision-making has rapidly proliferated through the special needs community and through many state legislatures. On August 1, 2023, a new law known as the Colby Act became effective, allowing Alabamians to engage in supported decision-making. Supported decision-making exists somewhere between guardianships and conservatorships on the one hand and powers of attorney on the other.
Thank You for Reading!
On behalf of our law firm, I sincerely hope you found this guide helpful. Feel free to let us know what you think by calling or emailing our office at any time. We hope to see you around!
The information presented herein is for informational purposes only and does not constitute legal advice. However, if you would like our firm’s assistance, please do not hesitate to contact us.
