What is a disability trust?

Disability trusts, or qualified disability trusts, are created for the purpose of caring for a disabled person in the event of their caretaker’s death.

Qualified disability trusts offer added benefits for the betterment and protection of the beneficiaries by allowing the trustee to claim a full income tax exemption for trust income. In order for a disability trust to qualify under the the IRS rules, it must meet certain criteria which can be found in 42 U.S.C. section 1396p(c)(2)(B)(iv).

Requirements for a Disability Trust

The first requirement for a trust to be considered a qualified disability trust under IRS law is that all the beneficiaries of the trust must be defined as disabled according to the Commissioner or Social Security’s standards.

In other words, the beneficiaries must fall under the category of legally disabled. The simplest means of ensuring this requirement is met is to verify that each beneficiary is registered for and receiving Social Security assistance for medical and living expenses.

The second requirement is that the trust must be irrevocable. This means that any assets placed into the trust can never be removed by the trustor. Also, the trust can never be canceled or even controlled by the trustor.

Instead, a trustee is in charge of all distributions, investments, and supervision of the disability trust. An irrevocable trust also requires that income tax be paid for the value of all assets deposited into the trust. So, if you deposit $10,000 worth of assets into the trust, either the trustor or the trustee must pay the income taxes for that amount.

The third requirement is that the trust is solely established for the benefit of the disabled beneficiary. In other words, the only person who may receive funds from the trust are the disabled beneficiaries.

Funds may be used for the welfare, education, and comfort of the disabled person. This requirement naturally makes sense given that the trust is designed to provide for a disabled child should anything happen to the child’s parents.

The fourth requirement is that the beneficiaries must be under the age of 65. This provision is listed to prevent trustors from taking advantage of this form of trust for their disabled spouses or parents. The primary beneficiaries and the people who these trusts are intended for are disabled children.

Advantages and Disadvantages of a Disability Trust

The IRS created the disability trust for both the benefit of disabled children and to reward parents of disabled children for properly saving and making preparations for that child’s overall welfare. The IRS made this trust so advantageous by allowing a standard income tax exemption instead of the usual trust income exemption; the difference can be seen in comparing the two amounts in any given year. For instance, in 2015 the annual trust exemption is $300 whereas the exemption for qualified disability trusts is $4,000. The difference allows couples to deposit more assets into the trust, removing it from their estates without the added tax consequences.

The primary disadvantage to this trust is that parents must go through some serious hurdles to establish a disability trust. In order to even be considered, the child must be receiving either SSI, SSDI, or some form of Medicare. While this is par for the course with most parents, some may argue that receiving government aid for a child who is completely provided for is unethical.

Case Studies: Disability Trusts

Case Study 1: The Caretaker’s Legacy

Susan, a single mother, has been caring for her disabled daughter, Emily, for many years. She worries about Emily’s future and wants to ensure that she is well taken care of even after Susan’s passing.

Susan decides to set up a qualified disability trust for Emily. The trust is irrevocable, ensuring that the assets are protected and cannot be accessed by anyone else. She carefully selects a trustee to manage the trust for Emily’s benefit.

Susan passes away, and the disability trust becomes active. Emily, now the sole beneficiary, receives financial support for her medical needs, education, and overall well-being, allowing her to lead a comfortable life even in her mother’s absence.

Case Study 2: Securing a Bright Future

John and Maria have a son, Michael, who has a disability. They have been financially supporting him throughout his life, but they are concerned about his long-term care when they are no longer around.

John and Maria consult with an estate planning attorney who advises them to establish a qualified disability trust for Michael. They carefully fund the trust with assets and make it clear in the trust document that the funds are to be used solely for Michael’s benefit.

Over the years, the disability trust grows, thanks to wise investments made by the trustee. Michael continues to receive support from the trust, allowing him to pursue education and training that cater to his interests and abilities. The trust also provides for his day-to-day needs, ensuring he has a secure and fulfilling life.

Case Study 3: Ensuring Financial Security

David, a single individual, is legally disabled due to a chronic medical condition. He relies on government assistance to meet his basic needs but worries about the uncertainties of the future.

David decides to establish a qualified disability trust for himself. He seeks legal advice and ensures that the trust meets all the requirements set forth by the IRS. By creating this trust, he can safeguard his assets and plan for a stable future.

As David’s trust grows, he becomes less reliant on government aid. The funds from the trust are used to cover medical expenses, home modifications to accommodate his disability, and additional support services. With the financial security provided by the trust, David gains greater independence and control over his life.

Getting Help

If you are considering a qualified disability trust for your child or for more information on disability trusts, contact an estate planning attorney.