Special Needs Trusts 101: What Type of Trust Should You Choose?
When establishing a Special Needs Trust (also referred to as a “Supplemental Needs Trust”, “Disability Trust,” or SNT) there are three types of trusts you can consider: first-party special needs trusts, third-party special needs trusts, and pooled special needs trusts. We’ve defined these terms in a previous post, but in this article we’ll go deeper on when these types of trusts are used and the benefits and tradeoffs you want to be aware of.
Third-party Special Needs Trusts
When they are used: Generally, when a parent or guardian wishes to establish and fund an SNT for the benefit of a child with a disability, a third-party trust will be used. These trusts are often used to help the beneficiary cover supplemental costs while the grantor/donor is still living or to help manage an inheritance once the donor has died.
How to fund: Third-party SNTs can be funded in a number of ways, including via life insurance policies, real estate holdings, investments and savings from some retirement accounts.
Benefits: Upon the beneficiary's death, the assets in a third-party special needs trust can pass to the grantor's other relatives or anywhere else as so designated by the grantor. This is one of the key advantages of a third-party SNT because the government is not entitled to reimbursement for Medicaid payments made on behalf of the beneficiary upon their death, as is required by a first-party trust. There is also no age limit for establishing a third-party SNT, nor limits on the size of the trust.
Tradeoffs: Third-party trusts cannot hold funds belonging to the individual with a disability. That means, if the beneficiary receives an inheritance that wasn't directed into the SNT or settles a lawsuit and is awarded a payout, the funds have to be placed in a first-party trust. Note: an individual beneficiary can have separate first-party and third-party trusts, but these assets should not be held together in one trust.
First-party Special Needs Trusts
When they are used: When an individual with disabilities has their own assets (or expects to receive assets), a first-party SNT – also referred to as a “self settled” or “(d)(4)(A)” trust – may be appropriate.
How to fund: Assets commonly placed in a first-party SNT include inherited assets (e.g cash, stocks, property, etc.) and/or settlements from a lawsuit (e.g., awards from a medical malpractice personal injury case, divorce alimony, etc.).
Benefits: When you receive an inheritance or settlement payout, these assets often count as a resource and could put an individual at risk for losing public benefits such as Supplemental Security Income (SSI), Social Security Disability Insurance (SSDI), and Medicaid. By directing these assets to a first-party SNT, the individuals can accept these funds while still maintaining benefits eligibility.
Tradeoffs: First-party trusts do have some limitations. The beneficiary must usually have to be under age 65 (note: varies state-to-state) at the time the trust is established and all first-party trusts must be “irrevocable” (i.e. unalterable) after they are established. First-party trusts are also required to reimburse Medicaid after the beneficiary’s death, though remainder beneficiaries may be named if there are still assets in the trust after Medicaid is paid back. Many states may also require first-party trusts to be monitored by the court which often results in more stringent recordkeeping and reporting requirements (which can add to administrative costs).
Pooled Special Needs Trusts
When they are used: Pooled SNTs, which are managed by nonprofit organizations, combine the resources of multiple beneficiaries into one “pooled” trust. Individuals have sub-accounts within the larger trust and receive a proportionate allocation of the trust’s earnings.
How to fund: A pooled SNT may be either a first- or third-party trust. When establishing the trust, a pooled SNT has a master trust agreement which a beneficiary or the trust grantor may use through a joinder agreement. This may save the beneficiary or grantor in legal drafting fees
Benefits: Pooling trust resources can reduce administrative fees, which can be attractive if the funds available for a trust are of a modest size. Also, because a pooled trust accepts contributions from many beneficiaries, the trust may be able to provide additional investment options and management services that a non-pooled SNT might not be able to afford or access otherwise. Additionally, because pooled trusts are administered by nonprofit organizations, beneficiaries often benefit from additional support services such as case management, housing placement, and other programs.
Tradeoffs: Some pooled trusts won’t accept unique assets (e.g. real estate, mineral/oil/gas rights, etc.) so they might not be the best option for beneficiaries who want to include these in their trust. Like first-party trusts, first-party pooled trusts are irrevocable and Medicaid payback may be required (this varies by state). Additionally, most pooled SNTs may retain a portion of any remaining funds, which allow the nonprofit to continue offering services to and advocating for people with disabilities.
So, how do you choose what’s right for you? Ultimately, this decision is first influenced by where the assets are coming from (the beneficiary or a third-party) as there are strict rules about whose assets can be held in which trust. Deciding between a non-pooled trust (first-party or third-party) versus a pooled trust may then be determined by the types of assets or the size of the trust, but your families’ preferences and needs will also come into play. A professional with experience in special needs planning can help you weigh your options and establish a good path forward.