In a previous post, we went in-depth on first-party special needs trusts, which can be funded using the beneficiary’s assets, including the proceeds from a legal settlement or an inheritance. Today, we’ll discuss the second main form of special needs trusts (SNT): third-party trusts.
How Third-Party Trusts Work
Like all SNTs, third-party special needs trusts are designed to allow people with disabilities to benefit from financial investments, while maintaining their eligibility for means-tested government benefit programs. As most families already know, the hitch with benefit programs like Supplemental Security Income and Medicaid is that people with more than a certain amount of personal assets and income can’t receive them. As a result, individuals and families are forced to sacrifice personal savings in the name of continued government support, benefits that millions of Americans rely on to cover their basic needs.
Special needs trusts provide a work-around for this problem. Instead of depositing money into a personal bank account, the proceeds can be placed in a trust. Trusts are managed and disbursed by someone else, a trustee, but the products and services purchased using the money can only benefit a designated individual, the trust’s beneficiary. This special legal arrangement means that neither the trust’s assets nor any disbursements will be counted toward eligibility evaluations for government benefits. The trick is that the goods and services purchased by the trust can’t overlap with ones usually covered by government assistance.
Key Differences Between First & Third-Party SNTs
The main difference between first-party and third-party trusts is that, while first-party trusts are funded using the beneficiary’s own money, third-party trusts are seeded with money from someone else, a donor. In fact, third-party trusts cannot accept any funds from the person with disabilities.
As a result, third-party trusts are only an option for people who want to help a loved one with special needs, not people with disabilities themselves. Personal funds secured in an injury settlement, along with inheritances that don’t go directly into a third-party trust, need to be placed in a first-party or pooled SNT.
Establishing a third-party special needs trust is a common choice to deal with the complex problem of leaving an inheritance to someone who relies on government benefits. Near the end of their lives, many people write third-party special needs trusts into their estate plans. Life insurance policies, existing investment funds and even real estate assets can all be used to fund a third-party trust. Plus, there’s no limit to how much money can be placed in the trust.
Advantages Of Donor-Funded Supplemental Trusts
Third-party SNTs come with some serious benefits. For one thing, they don’t have beneficiary age limits. First-party trusts, on the other hand, can only be established to benefit people under the age of 65. As an additional advantage, third-party special needs trusts rarely require oversight from the Court system, particularly when the trust’s donor is still alive. In contrast, many states require that first-party trusts are supervised by a Court.
Taxation is also different. During a donor’s lifetime, most third-party special needs trust result in income taxes for the donor, rather than the beneficiary. This cuts down on red tape, since otherwise, beneficiaries would be required to file income tax returns and then explain those tax returns to the Social Security Administration.
No “Payback” Provision
The most critical difference between first- and third-party SNTs, however, is what happens (or can happen) to the money after the trust’s beneficiary dies. When the beneficiary of a first-party trust passes away, the remaining funds in their trust are used to reimburse the government for benefits that were paid out during their lifetime.
Third-party SNTs don’t come with this “payback” provision, because the money never belonged to the beneficiary in the first place. Instead of going to pay the government back, a third-party trust’s assets can be passed on to other relatives, even people who don’t have special needs. This is a huge advantage that, on its own, would make third-party trusts an option to explore further.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).