What's a Special Needs Trust For?

A special needs trust is set up for a person with special needs to supplement any benefits that person may receive from government programs. A properly drafted special needs trust will allow the beneficiary to receive government benefits while still receiving funds from the trust.

There are three main types of special needs trusts, but first it is important to understand how a typical trust works.

How Does a Trust Work?

A trust is really a relationship between three parties:

• a donor, who supplies the funds for the trust;
• a trustee, who agrees to hold and administer the funds according to the donor's wishes; and
• a beneficiary or beneficiaries who receive the benefit of the funds.

Often, but not always, the donor's wishes are spelled out in a document that gives the trustee instructions about how they should use the trust assets.

Trusts have been used for estate planning for a long time, and are highly useful tools for ensuring that a donor's property is administered as they see fit. One of the reasons trusts are so popular is that they usually survive the death of the donor, providing a low-cost way to manage the donor's assets for others when the donor is gone.

So, What Is a Special Needs Trust?

A special needs trust is a trust tailored to a person with special needs that is designed to manage assets for that person's benefit while not compromising access to important government benefits.

There are three main types of special needs trusts: the first-party trust, the third-party trust, and the pooled trust. All three name the person with special needs as the beneficiary.

• A "first-party" special needs trust holds assets that belong to the person with special needs, such as an inheritance or an accident settlement.
• A "third-party" special needs trust holds funds belonging to other people who want to help the person with special needs.
• A pooled trust holds funds from many different beneficiaries with special needs.

Why Are There Different Types of Special Needs Trusts?

The reason there are several different types of trusts has to do with regulations regarding Supplemental Security Income (SSI). SSI is a government program that assists people with low incomes who have special needs.

In order to qualify for SSI, an applicant or beneficiary can have only $2,000 in their own name. If the person has more than $2,000 in their own name, (typically because of excess savings, an inheritance, or an accident settlement), the government allows them to qualify for SSI so long as they place their assets into a first-party special needs trust.  

While the beneficiary is living, the funds in the trust are used for their benefit, and when they die, any assets remaining in the trust are used to reimburse the government for the cost of their medical care.

These trusts are especially useful for beneficiaries who are receiving SSI and come into large amounts of money, because the trust allows the beneficiary to retain their benefits while still being able to use their own funds when necessary.

When to Use a Third-Party Special Needs Trust

The third-party special needs trust is most often used by parents and other family members to assist a person with special needs. These trusts can hold any kind of asset imaginable belonging to the family member or other individual, including a house, stocks and bonds, and other types of investments.

The third-party trust functions like a first-party special needs trust in that the assets held in the trust do not affect an SSI beneficiary's access to benefits and the funds can be used to pay for the beneficiary's supplemental needs beyond those covered by government benefits.

But a third-party special needs trust does not contain the "payback" provision found in first-party trusts. This means that when the beneficiary with special needs dies, any funds remaining in their trust can pass to other family members, or to charity, without having to be used to reimburse the government.

More on Pooled Trusts

A pooled trust is an alternative to the first-party special needs trust. Essentially, a charity sets up this type of trust, which that allow beneficiaries to pool their resources for investment purposes, while still maintaining separate accounts for each beneficiary's needs. When the beneficiary dies, the funds remaining in their account reimburse the government for their care, but a portion also goes toward the nonprofit organization responsible for managing the trust. (Learn more about pooled trusts.)

Special Needs Trusts, Taxes, and Medicaid

Anyone can establish a special needs trust and, if the trust is properly drafted to account for tax planning, in certain situations gifts into the trust could very well reduce the size of the donor's taxable estate.

As if these are not enough reasons to create a trust, seniors who are attempting to qualify for long-term care coverage through Medicaid can transfer their assets into a properly drafted third-party special needs trust for the sole benefit of a person with disabilities -- all without incurring a transfer-of-assets penalty. This permits the elder to qualify for Medicaid and ensures that the person with disabilities is taken care of in the future.

Of course, every person with special needs is different, which means that every special needs trust is going to be different as well. The only way to determine which special needs trust is right for your family is to meet with a qualified special needs planner to discuss your needs.