How Third-Party Special Needs Trusts Differ From Other SNTs

Takeaways

• Third-party special needs trusts (SNTs) are funded by someone other than the disabled person (the “donor”). This is their main difference from first-party and pooled SNTs, which hold the disabled person's own funds.

• The primary advantage of a third-party SNT is that the government cannot claim reimbursement from the trust for Medicaid payments after the beneficiary passes away, unlike with other types of SNTs. This allows the remaining funds to be passed on to other relatives.

• These trusts have no age limit for the beneficiary and can hold an unlimited amount of assets contributed by the donor. However, they cannot hold any funds that belong directly to the disabled beneficiary, such as their own inheritance or personal injury settlement.

Special needs trusts (SNTs) come in three main flavors — first-party special needs trusts, third-party special needs trusts, and pooled trusts.

All three trust varieties are designed to manage resources for a person with special needs so that they can still qualify for public benefits like Supplemental Security Income (SSI) and Medicaid.

While first-party special needs trusts and pooled trusts hold funds that belong to the disabled person, third-party SNTs, as the name implies, are funded with assets that never belonged to the trust beneficiary, and they provide several advantages over the other two types of trusts.

Advantages of a Third-Party Special Needs Trust

Third-party special needs trusts are set up by a donor – the person who contributes the funds to the trust. These trusts are typically designed, as part of the donor's estate plan, to receive gifts that can help support a disabled loved one while the donor is still living and to manage an inheritance for the person with special needs when the donor dies.

Third-party SNTs can be the beneficiaries of life insurance policies, own real estate or investments, and 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 their 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 their death, unlike with a first-party or pooled trust. This allows a careful donor to benefit their disasbled loved one while potentially saving funds for other people who don't have the same needs.

While first-party trusts must be established for the benefit of someone who is younger than 65, third-party trusts don't have age limits. In some states, first-party trusts also must be monitored by a court. Third-party trusts almost never have to go through this same process, especially while the donor is still alive.

In addition, while the donor is living, funds in the trust usually generate income tax for the donor, not for the beneficiary. This avoids the complication of having to file income tax returns for an otherwise nontaxable beneficiary and then explain them to the Social Security Administration.

Is a Third-Party Special Needs Trust Right for You?

Although a third-party SNT has many advantages, it may not always be a viable option for people with disabilities or their families.

One of the major drawbacks of a third-party trust is its absolute inability to hold funds belonging to an individual with disabilities. So if the trust beneficiary receives an inheritance that wasn't directed into the special needs trust, to begin with, or if they settle 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.

Even with these restrictions, most people trying to help a loved one with a disability are likely to strongly consider drafting a third-party special needs trust. A special needs professional in your area can help you understand how these trusts may fit into your other estate planning goals.

Related Reading

• Key Documents for Parents of Children With Special Needs

• Study: Autism in Girls May Be Just as Common as in Boys

• Is Autism Considered a Disability?

• Special Needs Planning for Blended Families