(An article from Kiplinger's Retirement Report, March 2004)

A special-needs trust may be the linchpin of a care plan for a disabled spouse or adult child. Such a trust can assure that the person retains critical government health-and-disability benefits yet also has access to additional resources that can make life more fulfilling. A trust can foot the bill so your disabled spouse can bring an aide and join the rest of the family on a cruise without worrying about being a burden. Or enjoy an extended visit with the grandchildren each year.

Thousands of parents face the prospect of leaving a disabled child to the vicissitudes of a complex, impersonal health and welfare system when they die. The same problem confronts couples when a spouse is disabled but likely to outlive the partner who oversees or provides for his or her care.

For most families and couples in this situation, a carefully crafted special-needs trust is the best way to protect the disabled person. The more modest your resources, the more important it is to consider the benefits of this type of trust. A disabled, dependent child or spouse who stands to inherit millions of dollars may need a trust, but not necessarily a special-needs trust. But for a person who may eventually require government help that's based on need, a special-needs trust is often the best choice.

WHAT THE TRUST CAN DO

Assets in a special-needs trust may not be used for support and care. But they can be used to supplement Medicaid health coverage or Social Security benefits and to improve the beneficiary's quality of life. If, for instance, a beneficiary enjoys music, the trust can pay for musical outings or a stereo. The trust can also engage the services of a nurse or aide who steps in when an unpaid family caregiver takes a vacation.

It can pay for medically needed modifications to the beneficiary's home, buy a wheelchair-accessible van, support the beneficiary's education, and pay for vacations and hobbies. It can also be used to provide additional services, such as extra physical therapy, and for a lawyer and accountant who advise the trustee.

In order to work as intended, a special-needs trust usually must be irrevocable. There are two types:

A third-party trust is funded with assets not belonging to the beneficiary and is the trust most commonly used to take care of someone with a disability.

A self-created or self-settled trust is established by the beneficiary of the trust who uses his or her own assets to fund the trust. It's most often used in personal injury settlements.

Under both types, the beneficiary is eligible for Medicaid and other welfare and health benefits. With a self-created trust, the beneficiary's assets are considered part of his or her estate upon death, and any assets remaining in the trust are used to pay for the Medicaid services he or she received. With a third-party trust, the trust's assets don't belong to the beneficiary, and the trustee has complete discretion on how to spend the assets. Medicaid has no claim on the trust after the beneficiary dies.

Parents sometimes believe they should disinherit a disabled child and turn the assets over to another child who would be responsible for caring for his or her sibling. This is a bad idea. For one thing, the sibling isn't legally obligated to use the inherited assets for the disabled person's care. And even if the person is loving and dedicated, death, divorce or legal problems could strip the disabled person of the intended financial resources.

GET EXPERT HELP

Hire a lawyer who has at least several years of experience creating special-needs trusts. Since mistakes can be disastrous for the very person you are trying to protect, find out from prospective candidates how many trusts he or she has drafted and which trust companies the law firm works with. Also ask for references, and specifically ask for permission to speak with families and trustees who are now using the lawyer's trusts. A good place to start your search for a specialist is the Special Needs Alliance, a national organization of disability lawyers who help families with this type of trust. For a list of members, call 877-572-8472 or visit www.specialneedsalliance.com .

The cost of creating a trust depends on where you live, your needs and the beneficiary's situation. Expect to pay about $3,500, which should include the cost of reworking wills and drafting a power of attorney.

Once the trust is established, the trust--not the disabled person--must be named beneficiary of life insurance, IRAs and other assets you intend to use to fund the trust. Make sure this last step is completed and that your lawyer reviews these documents to make sure everything is in order. Other family members may also leave assets to the trust on behalf of the beneficiary.

PICKING THE RIGHT TRUSTEE

It's usually a good idea to divide trust duties between two co-trustees: one who knows and loves the beneficiary, and one--such as a bank or other institution--that will handle the administrative and recordkeeping chores. (Having an institutional trustee or independent trust company involved provides continuity.) It's also quite common for the trustee to hire a separate adviser to invest and manage the trust's assets.

If you name a corporate fiduciary, consider giving the beneficiary's guardian or another trusted individual the right to remove and replace the trustee. "This is going to be a long-term relationship [between the guardian and the trustee], and you don't want it to be an unhappy one," says Kristen Lewis Denzinger, an Atlanta estate lawyer who specializes in disability.

Finally, make sure the trustee who makes the distribution decisions has access to legal advice, so he or she won't run afoul of complex state and federal rules. And include language in the trust that allows the trustee to amend the trust so it complies with any later changes in the laws that could affect the trust or the beneficiary.

If your spouse or child may ultimately require government health care or supplemental Social Security, make sure that relatives and friends don't unknowingly compromise his or her eligibility with gifts or direct bequests. To qualify for Medicaid, for example, a person generally may not have more than $2,000 in assets. Too much income can also close off benefits.

Unfortunately, it's not unusual for well-intentioned relatives to inadvertently sabotage a carefully laid care plan with gifts or bequests to the disabled person. Medicaid or other benefits may get cut off for months, jeopardizing the person's health care and living arrangements.

Recently, the North Dakota Supreme Court ruled that a disabled child was too wealthy for Medicaid because he had access to the funds left to him by his grandparent in a traditional support trust--a type of trust whose assets are specifically for the "care and support" of the beneficiary. The parents' effort to correct the error by having the trustee "pour" the assets into a special-needs trust didn't work either. A special-needs trust doesn't include "care and support" language.

In some cases, a guardian or spouse may be able to ask a court to amend the support trust. That usually requires convincing the judge that the person creating the support trust didn't intend to disqualify the beneficiary from government benefits, says Andrew Hook, an estate and elder-law lawyer in Portsmouth, Va. But it's often hard to make such a case.

If the court denies your request, you may have another option, says Denzinger. You may be able to persuade the court to allow the money to be transferred to a self-created trust. In that case, the beneficiary would once again be eligible for need-based government benefits. This means that if the person is on Medicaid, the state would have the right to collect for its expenses from any remaining funds after the beneficiary's death. But seeking such amendments is expensive and time-consuming, and the judge's decision is never certain.

F ees and costs can quickly erode the assets in a small trust. For trusts under $200,000, take a look at the "pooled trusts" offered by not-for-profit organizations. Assets in the trust are combined, and interest and income are available to each beneficiary on a pro rata basis. In theory, pooling should pare both administrative and investment costs, but check and compare before you go this route. Also determine what will happen to any remaining funds once your beneficiary dies--in some cases, the funds must go into the trust's pool to help other beneficiaries.

Pooled trusts are usually available from groups that cater to specific disabilities, such as the Alzheimer's Association (800-272-3900; www.alz.org) and local and state affiliates of The Arc, a national organization for developmentally disabled people and their families (301-565-3842; www.thearc.org).