Case Teaches Valuable Lesson About Special Needs Trusts and Section 8 Housing Benefits
A recent Massachusetts case illustrates why trustees of special needs trusts have to be very careful before making distributi...Read more
Out of all of the stress-inducing steps in the college application process, the financial aid application may be the most confusing and stressful of all, especially when an applicant can't afford to attend college without aid. Although schools and lenders tout how easy it is to apply for financial aid, anyone who has filled out a Free Application for Federal Student Aid (FAFSA for short) knows that there is nothing simple about the application process. When you add a special needs trust to the mix, things can get even more complicated. Why? Because the regulations governing federal financial aid don't do a very good job of distinguishing special needs trusts from other types of trusts.
The problem boils down to a student's access to trust funds. A student applying for financial aid must reveal not only her own income and assets, but her family's income and assets as well. The FAFSA's instructions make it clear that most trust funds are to be treated as "investments" that must be reported. If the student's parents have created a revocable trust, then, typically, the assets in the trust still belong to the parents (and would be included in the "family" share of a student's financial aid calculation), unless the student already has a right to income or principal from the trust, in which case some of the funds would probably be counted as the student's and would be added to the "student" share. If the student is the beneficiary of an irrevocable trust, then the portion of the trust funds that can be spent on the student are usually considered the student's for purposes of the FAFSA.
However, a special needs trust is not a "typical" trust. A properly drafted special needs trust established by a third party for the benefit of a person with special needs (called a "third-party trust") does not allow the beneficiary to withdraw trust funds at her pleasure. Instead, the trustee of the trust has the discretion to make payments for the beneficiary's needs and, in almost all cases, there is no requirement that the trustee spend the funds unless he thinks that it is appropriate to do so. Likewise, a person with special needs can place her own funds into a "first-party trust" with similar restrictions. Doing so allows the person with special needs to reduce her assets and qualify for important government benefits.
A General Rule With One Big Exception
Because the beneficiary does not have any access to the funds in a special needs trust, it does not seem logical that the funds should be counted as the student's asset on the FAFSA. But the U.S. Department of Education's Federal Student Aid Handbook specifically states that when "the settlor of a trust has voluntarily placed restrictions on its use, then the student should report its present value as an asset." Although some special needs planners disagree, most believe that this language requires an applicant to list the funds in her special needs trust on her FAFSA.
There is one large exception to this rule. If the funds in a special needs trust were restricted by court order, then federal guidelines specifically state that the funds are not to be listed on a FAFSA. While most special needs trusts are not created by court order, a court may establish a special needs trust for a variety of reasons, and courts often do so when a child is the recipient of a large personal injury settlement. Therefore, if a student is the beneficiary of a trust and a court specifically approved the trust terms that restricted access to the funds in the trust, then federal law clearly allows the student to disregard those assets on a financial aid application.
As explained above, in most cases an applicant for financial aid must disclose both her own assets and her family's assets on the FAFSA. So when a child without special needs applies to college and her sibling with special needs has a special needs trust, must the applicant count the funds in the special needs trust as "family" assets? Again, the answer is not clear-cut, but in general it appears that the funds would not be considered "family" assets because they can only be used for the person with special needs. This means that an applicant for financial aid should not be penalized just because her sibling may be the beneficiary of a large special needs trust.
The rules governing federal financial aid are difficult enough on their own without having to factor in their relationship to special needs planning. If you or a loved one is applying for financial aid, consult your special needs planner before filling out a FAFSA; you could be pleasantly surprised by the outcome.