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 2007 the annual trust exemption was $300 whereas the exemption for qualified disability trusts was $3,400. 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.
If you are considering a qualified disability trust for your child or for more information on disability trusts, contact an estate planning attorney.