Special Needs Trusts and Financial Aid: FAFSA Rules

Takeaways

• Special needs trusts (SNTs) can complicate the Free Application for Federal Student Aid (FAFSA). While most trusts must be reported as an asset, SNTs are different because the beneficiary (the student) generally cannot access the money freely.

• In general, FAFSA instructions require applicants to report the current value of trust funds that are considered an asset of the student or a FAFSA “contributor” (such as a parent), even if the trust limits access — unless the trust’s restrictions were imposed by a court order.

• An SNT set up solely for a sibling with a disability is generally not treated as a reportable asset of the student applying for aid or the student’s parent(s). This helps avoid penalizing a student simply because their sibling is the beneficiary of an SNT.

Of all the stress-inducing steps in the college application process, the financial aid application may be the most confusing. Although schools tout how easy it is to apply for financial aid, anyone who has filled out a Free Application for Federal Student Aid (FAFSA) knows that there is nothing simple about the application process.

Adding a special needs trust (SNT) complicates things further because the regulations governing federal financial aid do not adequately distinguish SNTs from other types of trusts.

Because financial aid rules can vary by school, families should confirm trust reporting requirements with the school’s financial aid office and a special needs planning professional.

Defining the SNT: Why It Confuses Financial Aid Forms

The core issue is the student’s access to funds. FAFSA generally asks for financial information from the student and from one or more contributors (such as a parent) and treats many trust funds as reportable assets depending on whose asset they are considered.

If the student’s parents have a revocable trust, the assets in it generally still belong to the parents. These assets are typically reported as a parent (contributor) asset on the FAFSA, unless the student already has a right to income or principal, in which case some funds may be reported as a student asset.

If the student is the beneficiary of an irrevocable trust, the portion of the funds that can be spent on the student is usually counted as the student’s asset for FAFSA purposes.

However, a special needs trust is not a “typical” trust. A properly drafted SNT established by a third party for the benefit of a person with special needs (called a third-party special needs trust) does not allow the beneficiary to withdraw trust funds at will. Instead, the trustee of the SNT has the discretion to make payments for the beneficiary’s needs, often to provide supplemental financial support for quality-of-life expenses. In almost all cases, there is no requirement that the trustee spend the funds unless they think that it is appropriate to do so.

A person with special needs can place their own funds into a first-party SNT with similar restrictions. Doing so allows the person with special needs to reduce their assets and qualify for important government assistance programs.

When Is an SNT an Asset?

Since the beneficiary cannot access the funds in a special needs trust, it seems illogical that the trust should be treated as the student’s asset for FAFSA purposes.

However, the Application and Verification Guide in the U.S. Department of Education’s Federal Student Aid Handbook states that when “the settlor of a trust has voluntarily placed restrictions on its use, then the beneficiary should report its present value as an asset.” Although some special needs planners disagree, many interpret this language to mean that the value of a special needs trust must be reported in certain situations. Exactly how a trust should be reported can depend on how the trust is structured and who is considered to own or control the funds.

One significant exception applies when the funds are restricted by court order. In that case, federal guidance indicates the funds are not listed as an asset on the FAFSA. Put differently, the exception generally applies only when the trust’s restrictions are imposed by a court order — not when a family voluntarily creates the trust and later has it reviewed or approved as part of another proceeding.

Most special needs trusts are not created by court order. However, a court may establish an SNT for a variety of reasons, and courts often do so when a child is the recipient of a large personal injury settlement.

Therefore, if the trust’s restrictions on access to the funds were imposed by a court order, federal guidance allows the student to exclude those trust assets from the FAFSA.

As mentioned above, FAFSA typically requires the student to report their own assets and, in many cases, assets of one or more contributors (such as a parent). So when a student without a disability applies to college but their sibling with a disability has a special needs trust, does the trust need to be reported as an asset of the student or a contributor?

Again, the answer is not always clear-cut, but in general it appears that a special needs trust set up solely for a sibling would not be treated as a reportable asset of the student applicant or the student’s contributors, because the funds can be used only for the sibling who is the beneficiary.

Some colleges also require the College Scholarship Service (CSS) Profile or other school-specific financial aid forms, which may ask different questions about trusts than the FAFSA, so families should confirm reporting requirements with the school’s financial aid office.

What to Gather Before You File

Before you start the FAFSA (and any school-specific financial aid forms), gather a few documents so you can answer trust questions accurately and confirm whether any exceptions apply.

These materials can help you (and your advisor) determine whether the trust is treated as a student asset, a parent (contributor) asset, or potentially excluded because of a court-ordered restriction.

• Trust document: Shows who the beneficiary is, who controls distributions, and whether the beneficiary has any right to access funds.
• Court order, if any: May support an exception if a court imposed the restriction on access to the funds.
• Most recent statement: Helps you report current values when reporting is required.
• Whether distributions are required or discretionary: Required distributions can be treated differently than purely discretionary support.

The rules governing federal financial aid are difficult enough without having to factor in their relationship to special needs planning. If you or a loved one is applying for financial aid, consult a special needs planning professional before filling out a FAFSA; you may find that you have options you didn’t realize were available.

Additional Reading

• What to Do When Your Child Receiving Supplemental Security Income (SSI) Is Turning 18

• Building an Estate Plan for Adult Children With Disabilities

• Do I Still Qualify for Medicaid and SSI If I Have an SNT?

• A Comparison of Special Needs Trusts and ABLE Accounts

• Medicaid Coverage for Working People With Disabilities