Parents of children with special needs know that day-to-day life takes careful planning. And so does financial planning, especially when you know your child may not be able to support or care for himself in adulthood when you are gone.

There are lots of parents facing the prospect of planning for adult children who be always be reliant on someone else. According the the 2005 American Community Survey by the U.S. Census Bureau, there are more than 2,274,000 boys and girls age 5 to 15 with one type of disability, and over 600,000 boys and girls age 5 to 15 with two or more types of disabilities. One in 150 individuals are diagnosed with autism, according to Autism Speaks. And one in 733 children is born with Down syndrome, according to the National Down Syndrome Society.

Long-range planning includes appropriate last wills and testaments, conservatorships and guardianships, and letters of intent, all of which should be handled by an attorney. Another important component is life insurance.

For parents of children with special needs, buying life insurance requires the same careful planning as other financial considerations. That's because under current federal law, any inheritance of more than $2,000 can disqualify an individual from federal assistance. For example, Supplemental Security Income (SSI) could be reduced or cancelled for up to three years if a special needs child receives an inheritance or life insurance benefit. Inheritances could also affect eligibility for state assistance programs.

Setting up a "special needs trust" can provide money for living expenses for your child without affecting any other assistance they may receive.

Put simply, a trust is a legal entity that owns assets, be it savings, stocks, property or benefits paid from a life insurance policy. A trustee manages the assets (such as investing them or dispersing them) and is not allowed to personally benefit from the trust.

When the trust is set up properly, the special needs individual does not own the assets in any way, thus maintaining his eligibility for other assistance. But the trust can still benefit the individual and can pay for important expenses such as transporation, home health aides, education, rehabilitation, computer equipment, entertainment and trips, and medical and dental care that is not covered by private policies, Medicare or Medicaid.

In addition, if the trust is paying regularly for food and housing costs, or paying money directly to the special needs beneficiary, the money could be viewed as income and result in a loss of government benefits. These items typically should not be paid by a special needs trust: food, housing, property taxes, home insurance, utilities and direct cash.

Types of special needs trusts

Patrick Smith, vice president of estate and business planning for The Hartford Financial Services, explains that there are three main categories of trusts, depending on the situation of the disabled:

• Third-party settled trust: This is the most commonly used type of trust. It is designed to qualify the individual for government assistance while the trust provides for quality of life, such as travel, a specially equipped van, or home health care or companions. Smith says the wishes funded by the trust "are limited only by the imagination and the funding of the trust."
  
• General support trust: This provides for all general support of the child and disqualifies him for any assistance. Smith recalls a family who opted for a general support trust because they had sufficient assets for the child's lifetime and felt that government assistance should be for people who really need it.
  
• Self-settled trust: This a trust created by the disabled person so they can disperse the funds themselves. This would be used by a person with a physical disability who can manage his own money. However, if the beneficiary also takes government assistance, it may have to be paid back by anything left in the trust after his death.

Common mistakes

According to The Hartford, there are three common mistakes made by parents of children with special needs:

• Mistake 1: Bequeathing assets directly to the child from a parent, grandparent or other relative. This may disqualify them from government benefits and they may not be capable of managing the asset.
• Mistake 2: Naming the child as beneficiary of the life insurance policy, annuity or retirement plan. This also can disqualify them from government benefits.
• Directing the child's inheritance to another family member to manage on behalf of the child. These assets would then be subject to any bankruptcy, divorce or litigation against the assets' owner, or the owner may predecease the child, in which case the assets would be subject to the terms of the owner's will.

Choosing the right life insurance for a special needs trust

Not all types of life insurance may be appropriate for funding a special needs trust, depending on your situation.

• Term life
  Pro: Term life is the most inexpensive was to insure a parent's life. It is a good choice for short-term needs.
  
  Con: It is very possible the parent will outlive the term of the policy, leaving a trust short on funds. If you already have a term policy and need to fund a special needs trust, you could consider converting your term policy to whole life with the same insurer.
  
• Whole life
  Pro: A whole life policy could provide funds for a special needs trust no matter when the parents died. Universal life and variable universal life insurance are also choices.
  
  Con: A variable universal life policy builds up cash value but needs a time horizon in order to weather volatility in the markets. Because the cash value is attached to an equity market, the policyholder needs to be ready to ride ups and down that affect cash value and premium payments.
  
• Survivorship life (also called second-to-die)
  Pro: This type of whole life policy insures the mother and father in one policy and pays out upon the death of the second spouse. It is less expensive than buying two separate life insurance policies on the parents.
  
  Con: At the death of the first spouse, consider whether the surviving spouse will have enough money to live on without a life insurance death benefit. Will they be able to maintain quality of life for themselves and dependent children? Will they be able to keep up the premium payments on the survivorship life policy?

Life insurers recognize the specific challenges

Fortunately, life insurers are becoming experts in special needs planning. Some insurers have established divisions to assist clients who have special needs children. Following are examples.

The Hartford Financial Services
The Hartford's estate and business planning department has produced brochures for clients to better understand the issues involved and who work with financial planners and bankers to educate them on special needs planning. The Hartford's brochure on special needs trusts is available online.

Merrill Lynch
Merrill Lynch Financial Advisors offers a Families of Children With Disabilities program, with trained advisors to help you coordinate your complete financial strategy. There's also a Special Needs Calculator online.

MetLife
MetLife's MetDesk is its Division of Estate Planning for Special Kids. MetDesk offers free personalized assistance in financial planning. Available online are a Special Needs Calculator and MetDesk newsletters.

The end of a special needs trust

According to MetLife, when a special needs trust beneficiary dies, assets leftover in certain types of trusts could be claimed by Medicaid if benefits were paid while the trust was in effect. Medicaid laws and special needs trust laws vary by state. Your local Social Security Administration office has information on the rules where you live.

Trusts can also be structured so that if the beneficiary predeceases his siblings, any leftover money in the trust can be dispersed to the siblings.