There are three basic types of special needs trusts: first-party special needs trusts, third-party special needs trusts, and pooled trusts. All three varieties of special needs trusts manage resources for a person with disabilities so that person can benefit from those resources without affecting eligibility for public benefits like Supplemental Security Income (SSI) and Medicaid. First-party special needs trusts and pooled trusts hold property that belong to the person with special needs, while third-party special needs trusts hold property that never belonged to the person with special needs.
Third-party special needs trusts are set up by a donor – the person who contributes the funds to the trust, typically a parent or other family member – and provide several advantages over the other two types of trusts. These trusts are typically part of a parent’s estate plan, but can be set up by anyone other than the person with special needs. They are designed to accumulate money and other property that can help a disabled family member while the parent is living and to manage the person’s inheritance when the parent dies.
Third-party special needs trusts can be the beneficiaries of life insurance policies, can own real estate or investments, and can even receive benefits from retirement accounts (although this process is very complicated and not typically recommended unless there aren’t other assets available to fund the beneficiary’s inheritance). There is no limit to the size of the trust fund and the funds can be used for almost anything a beneficiary needs to supplement government benefits. Upon the beneficiary’s death, the assets in a third-party special needs trust can pass to the donor’s other relatives or anywhere else.
This last factor is one of the key advantages of a third-party special needs trust: because the funds in the trust never belonged to the beneficiary, the government is not entitled to reimbursement for Medicaid payments made on behalf of the beneficiary upon the beneficiary’s death. First-party and pooled trusts, on the other hand, do require government reimbursement. Third-party trust allows a careful donor to benefit the family member with special needs while potentially saving funds for others in the family who don’t have the same needs.
First-party special needs trusts can only be established by the beneficiary’s parent, grandparent, guardian, or a court. Another limitation of first-party trusts is that the beneficiary must be younger than 65 years old. In some states, first-party trusts must also be monitored by a court. Third-party trusts do not have an age requirement and almost never have to be monitored by a court, especially while the donor is still alive. In addition, while the donor is alive, funds in the trust usually generate income tax for the donor, not for the beneficiary, avoiding the complication of having to file income tax returns for an otherwise non-taxable beneficiary and then explain them to the Social Security Administration.
Although a third-party special needs trust has many advantages, it is not always a viable option for families of people with special needs. One of the major drawbacks of a third-party trust is its absolute inability to hold funds belonging to the person with special needs. So if the trust beneficiary receives an inheritance that wasn’t directed into the special needs trust to begin with or if she settles a personal injury case, the funds have to be placed in either a first-party trust or a pooled trust, since even one dollar of a beneficiary’s own money could taint an entire third-party trust. Despite these restrictions, most people trying to help a family member with special needs should consider whether a third-party special needs trust is right for their particular circumstances.
If you have any questions about special needs planning, please contact our office at 888-597-9685 to schedule a time to speak with attorney Pablo Tagre.