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What is a Third Party Funded Special Needs Trust?
Special needs trusts 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 the beneficiary 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 person with special needs, third-party special needs trusts, 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.
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 a family member with special needs while the donor is still living and to manage an inheritance for the person with special needs when the donor dies. Third-party special needs trusts can be the beneficiaries of life insurance policies, can receive investment real estate (beneficiaries will generally be entitled to housing that will not impact governmental benefits, therefore real estate is typically not held in these trusts) or investment accounts and can even receive benefits from retirement accounts (retirement accounts are not typically recommended unless there aren’t other assets available to fund the trust). ACT can work with the families attorney in effort to assist with this type of complex trust. 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 her 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 her death, unlike with a first-party or pooled trust. This allows a careful donor to benefit her family member with special needs while potentially saving funds for other people who don’t have the same needs.
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. But even with these restrictions, most people trying to help a family member with special needs are going to at least need to strongly consider drafting a third-party special needs trust.
Is there Requirements for a Payback for a Third Part Trust?
Perhaps the most dramatic difference between 3rd Party SNTs and self-funded SNTs and Pooled Trusts is the fact there is absolutely no requirement to reimburse the State upon the death of the trust beneficiary. Third parties are therefore free to establish 3rd Party SNTs for trust beneficiaries who receive SSI and Medicaid with no requirement to reimburse the State upon the death of a beneficiary. The freedom that a grantor has to direct the use of trust property upon the death of a trust beneficiary lends itself perfectly to incorporating 3rd Party SNTs into more traditional estate plans.
Language of the Trust
A 3rd Party SNT is established according to the more standard procedures for creating trusts under State law. Under the law of all States, trusts are created as either intervivos trusts or as testamentary trusts. The term ‘intervivos”, is simply a legal term for saying “among the living”, which means the trust is established while the grantor is alive. By contrast, the term “testamentary” means that the trust is created after the grantor’s death through a Last Will and Testament. In those cases, the term, “settelor”, “testator”, “testatrix” or “grantor” are some of the many common terms for identifying the donor who establishes a trust and transfers, or grants, funds to the trust he or she established.
This type of SNT does not have to be irrevocable in order to preserve the eligibility of the SNT beneficiary for means-tested public benefits. However, if the SNT beneficiary has the power to revoke the SNTor demand distribution from the trust the SNT assets would be considered an available resource for Supplemental Security Income (SSI) and Medicaid purposes. The beneficiary’s ability to revoke the SNT or otherwise exercise control over the SNT may render the beneficiary ineligible to receive public benefits that have an income or asset limit. The SNT agreement should authorize the person establishing the third-party SNT and/or the trustee to amend the SNT to address later changes in the law or the circumstances of the beneficiary. Allowing for such limited amendments helps ensure that essential government benefits are preserved if an agency challenges the terms of the SNT.
The most important difference between third-party SNTs and first-party SNTs is what happens to SNT property when the beneficiary dies. Upon the beneficiary’s death, the third-party SNT is not required to use the remaining assets to reimburse any state(s) for the Medicaid benefits received by the beneficiary during his or her lifetime. As a result, this type of SNT is a useful planning tool for people who want to set aside property for a beneficiary with disabilities, preserve essential public benefits during that beneficiary’s lifetime, and remain in full control of where all of the remaining SNT assets will go upon the beneficiary’s death.
Assets That May Be Put in the Trust
Families should always consider placing a portion of personal injury settlements into a first party SNT, since even a very large sum can quickly be dissipated by the needs of an individual with serious disabilities. For third party SNTs, family savings, inheritances and other financial gifts should be considered, each of which can then be invested in stocks and bonds for growth and protection from inflation. Ultimately, there are a number of strategies parents and families should consider:
Insurance – Consider various scenarios in order to sort through the many options.
- Second-to-die, or survivorship, life insurance policies can be a cost-effective SNT funding choice. They’re often less expensive than other options since they don’t pay out until the second member of a married couple passes away. But if the primary breadwinner dies first, funds may be needed immediately to cover the family’s ongoing expenses. If a stay-at-home caregiver is the first parent to go, paying someone to perform those services can be costly. In such cases, individual policies might be more practical. At retirement, though, that dynamic could change, with the income producer playing a larger caregiver role. At that time, it might make sense to convert to a survivorship policy.
- Term life insurance can be another relatively inexpensive path to funding the SNT. Because such policies guarantee payouts during a defined period, they typically cost less. Assuming no significant changes in one’s health, they can be renewed upon expiration, although age and medical conditions often mean steeper premiums.
- Whole life insurance, on the other hand, covers the entire life span and part of each premium is collected in an investment account that grows in value. Premiums are fixed.
- Variable life insurance also provides lifelong coverage, but its cash value fluctuates along with financial markets.
The family residence may be the only home that an individual with special needs has ever known, and preserving that stability for a loved one may be an important goal. But leaving a house in the child’s name can be a big mistake. In addition to affecting means-tested benefits, it may leave the individual open to exploitation. For this reason, leaving such real estate directly to a third party SNT is not a recommended funding tactic. If placing real estate in a Third Party Trust is requested by the donor it’s important to provide the trust with adequate funds to maintain the property for the lifetime of the beneficiary. To address the long-term resource requirements, ACT requires the real estate to be under 20% of the total value of the Trust.
Designating an SNT as the recipient of retirement plans is tricky, and unless carefully managed, good intentions can result in having all the funds distributed to the trust’s beneficiary and taxed during the year of transfer. This could easily disqualify the individual for government benefits and result in unnecessarily high taxes. A notable exception is the designation of military survivor benefits to an SNT.
Because of the retirement difficulties, families are sometimes advised to avoid designating an SNT as the beneficiary of a retirement fund. Instead, they’re encouraged to draw down the retirement account in order to purchase life insurance for the SNT or to leave retirement funds to other heirs.
For additional information and to discuss options feel free to contact us.
Where do you begin?
This can be simple by following these steps and contacting us today.
- First, we’d encourage you to contact us to better learn how to get started identifying a Special Needs Trust and answering questions you may have.
- Then, if you are opening a Third Party Funded Special Needs Trust, you’ll start by contacting an attorney familiar with drafting special needs trusts. ACT works with several attorney’s that may be able to assist you and your family. We are happy to provide you with several options as you begin this important process.
We look forward to hearing from you!