In this article, we explain the differences between a testamentary special needs trust and a stand-alone special needs trust as well as the pros and cons of each. We answer the questions, “what is a special needs trust?”, “what is a testamentary special needs trust?”, “what is a stand-alone special needs trust?”, “what are the benefits of a stand-alone special needs trust compared to a testamentary special needs trust?”, and “when is a testamentary special needs trust appropriate?”
What is a Special Needs Trust?
A special needs trust is a tool that can be used to benefit a person with a disability. It allows the person with a disability to accumulate assets and earn income without negatively impacting government benefits. Many government benefits are “means-tested” meaning that if the recipient earns more than a certain threshold in income or accumulates more than a certain threshold in assets, the benefits will be reduced or eliminated.
However, income and assets properly transferred to a special needs trust do not count as the trust beneficiary’s income or assets for the purpose of government benefit means testing.
For much more on special needs trusts and how they work, check out our article: Illinois Special Needs Trusts Explained.
What is a Testamentary Special Needs Trust?
A testamentary special needs trust is one that is provided for in a third party’s will or trust. An example is when a parent of an individual with a disability provides in her will that upon her death a special needs trust will be created for her child and that a certain portion of her estate will be transferred to the trust. This can also be accomplished through a revocable living trust. A testamentary special needs trust does not actually come into existence until the death of the third party whose will or trust provides for it.
What is a Stand-Alone Special Needs Trust?
A stand-alone special needs trust is one that is not created as part of a third party’s will or trust and is not contingent upon the death of that third party. It is a separate trust document that is effective immediately.
What are the Benefits of a Stand-Alone Special Needs Trust Compared to a Testamentary Special Needs Trust?
Generally, a stand-alone special needs trust is preferable to a testamentary special needs trust for the following reasons:
- Stand-alone special needs trusts can receive assets from multiple sources: While a testamentary special needs trust is only funded from the assets of the person whose will or trust creates it, a stand-alone special needs trust can receive assets from multiple loved ones who wish to benefit the person with a disability, including that person’s own assets and income. This is a simpler and more cost-effective way to manage the beneficiary’s assets than multiple testamentary trusts.
- A stand-alone special needs trust benefits the beneficiary immediately: A stand-alone special needs trust does not require the beneficiary to wait for the death of the trust’s creator in order to be effective. This means that the beneficiary and other loved ones can begin transferring assets and income to the trust immediately. The beneficiary of a testamentary special needs trust may not have access to the assets intended for the trust until such assets have been distributed to the trust through the probate process, which may take several months.
- A stand-alone special needs trust can be named as a beneficiary on loved one’s accounts: Loved ones can name a stand-alone special needs trust as a beneficiary on life insurance policies and retirement accounts. This is not possible in the case of a testamentary special needs trust.
- A testamentary special needs trust is subject to its creator’s creditors: Assets intended to be part of a testamentary special needs trust must first be used to pay any of its creator’s creditors if the estate does not have enough other assets available to do so. This means that the intended assets may never make it to the individual with a disability. Assets transferred to a stand-alone special needs trust are generally not subject to the debts of the transferor.
When is a Testamentary Special Needs Trust Appropriate?
A testamentary special needs trust may be more appropriate than a stand-alone special needs trust if all of the following are true:
- The beneficiary does not have any income or assets of his or her own: If the beneficiary has any income or assets in his or her own name that would jeopardize government benefits, a stand-alone trust should be created immediately in order to maximize government benefits, rather than waiting for a testamentary trust to be effective.
- Only one third party seeks to transfer assets into the trust: If the beneficiary does not have her own assets and only one loved one seeks to transfer assets into the trust and no one intends to name the trust as a beneficiary of life insurance policies or retirement accounts, the testamentary trust remains an option.
- The person creating the testamentary special needs trust needs to retain the assets intended for the trust for her own use during her lifetime: If the loved one creating the trust does not have assets to immediately set aside for the beneficiary and is unsure whether the assets intended for the trust will be needed for use during his or her lifetime the testamentary trust may be the best option. Again, this is only the best option in the limited situation where there are no other people who may want to give to the trust, including the beneficiary.
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