The Situation
Alan and Betty are both 65 years old and beginning to think seriously about their estate plan. They have two sons:
- Carl, who has special needs and is unable to manage his finances independently. Carl currently receives Supplemental Security Income (SSI) and will likely need to qualify for Medicaid in the future.
- Don, who is married and owns a business.
Alan and Betty’s primary goal is simple and heartfelt: to ensure Carl is cared for the rest of his life without unintentionally disrupting the public benefits he depends on.
The Initial Plan and Why It Creates Problems
Initially, Alan and Betty designated Carl as the transfer-on-death (TOD) beneficiary on certain bank accounts and other assets. Under this approach, those assets would pass directly to Carl upon the death of both parents.
While TOD designations are often useful, this strategy creates serious risks when a beneficiary has special needs.
Pitfall 1: Loss of SSI and Medicaid Benefits
SSI and Medicaid are needs-based programs. Eligibility is determined by strict limits on income and assets.
If Carl were to receive assets outright through a TOD designation:
- Those assets would be considered countable resources
- Carl would likely lose SSI and Medicaid eligibility
- He would be forced to spend down the inheritance before re-qualifying
In short, money meant to help Carl could disqualify him from the very programs designed to protect him.
Pitfall 2: A Court-Supervised Conservatorship
Because Carl cannot manage his own finances, receiving assets in his own name would likely require the appointment of a conservator.
A conservatorship:
- Requires a court proceeding and judicial approval
- Is ongoing, with mandatory reporting to the probate court
- Requires court approval for many expenditures and investment decisions
- Is expensive, time-consuming, and intrusive
What began as a well-intentioned inheritance could quickly turn into a lifetime of court oversight.
What If the Assets Are Left to the Other Child?
Suppose Alan and Betty recognized these risks and decided to name Don as the TOD beneficiary instead, with the understanding that Don would use the money for Carl’s benefit.
While this may seem practical, it introduces a new set of dangers.
Pitfall 3: No Legal Obligation
Once Don inherits the assets, the money is legally his.
- Don has no enforceable legal obligation to use the funds for Carl
- Good intentions are not enforceable in court
If Don changed his mind, passed away, remarried, or became incapacitated, Carl would have no protection.
Pitfall 4: Hidden Tax Traps
Now imagine part of the inheritance includes a traditional IRA or 401(k) worth $200,000.
If Don receives those funds and attempts to divide Carl’s share:
- Withdrawals are taxed at Don’s personal income tax rate
- Carl’s share could be significantly reduced after taxes
- Most inherited retirement accounts must be withdrawn within 10 years
The result is higher taxes, less money available for Carl, and unnecessary complexity.
Pitfall 5: Exposure to Don’s Personal Risks
Even responsible beneficiaries face life risks, including:
- Business failure or bankruptcy
- Divorce
- Lawsuits or creditor claims
Because the assets are in Don’s name, they are fully exposed. Funds intended for Carl could be lost.
The Solution: A Revocable Trust With a Special Needs Trust
A far more effective solution is to create a revocable living trust that includes provisions establishing a Special Needs Trust for Carl.
How This Structure Works
- Alan and Betty create a revocable trust during their lifetimes
- Upon their deaths, assets flow into a Special Needs Trust for Carl
- Don serves as successor trustee, providing oversight without ownership
Why This Approach Works
A properly drafted Special Needs Trust:
- Preserves SSI and Medicaid eligibility
- Allows funds to enhance Carl’s quality of life
- Eliminates the need for a conservatorship
- Protects assets from Don’s personal risks
- Imposes fiduciary duties and legal accountability
- Allows favorable treatment of inherited retirement accounts
- Centralizes tax reporting and planning
The Bottom Line
Without proper planning, even well-intentioned estate plans can disqualify a special needs child from benefits, trigger court involvement, create unnecessary tax burdens, and expose assets to unintended risks.
With thoughtful planning, families can protect benefits, avoid court supervision, reduce taxes, and provide long-term stability and dignity for a loved one with special needs.
If you have a child or loved one with special needs, traditional estate planning tools are often not enough and can do more harm than good if used incorrectly.
A carefully designed revocable trust with a Special Needs Trust can make the difference between uncertainty and security.
If this situation sounds familiar, now is the time to review your plan and ensure it truly protects the people you care about most.