Do you have a disabled loved one? You may be torn about whether to leave them assets in your estate plan. You may think it’s best to leave them money outright. But, you know if you do that, they may no longer be eligible for their needs-based government benefits. Someone may have suggested that you look into a special needs trust for that person. Special needs trusts generally allow individuals with disabilities to remain on public benefits, while also having access to additional assets to pay for expenses not covered by those benefits. You may hear other attorneys referring to special needs trusts as supplemental needs trusts. Don’t be confused; they’re the same thing. If properly constructed, special needs trusts (SNTs) allow the beneficiary to remain eligible for Medicaid, SSI and other needs-based benefits programs.
While these trusts can be a very useful tool for the right beneficiary, they can also be confusing and difficult to set up for their loved ones. Many don’t even realize that there is more than one type of special needs trust: third-party special needs trusts and self-settled special needs trusts. It’s important to understand the distinction. These two trust types are treated differently for tax purposes, benefit determination and court involvement.
How do I know if I have a self-settled special needs trust and a third-party SNT?
The first major difference is where the funds come from. As the name suggests, a grantor creates and funds a self-settled special needs trust using the beneficiaries own assets. These funds might come from a personal injury settlement, an inheritance, or winning the lottery but they should be assets that actually belong to the beneficiary. On the other hand, in a third party special needs trust, the funds come from a person other than the beneficiary. For example, a parent or grandparent might set up a third party special needs trust using their own funds for the benefit of a disabled child when doing their estate planning.
This is not as straightforward as it seems though. Sometimes, a loved one will set up a trust using money that actually belongs to their disabled child. For example, if a grandparent leaves a disabled child money in their will outright, that money belongs to the child. Even if the parents are quick to put the money into a special needs trust, that trust is still a self-settled SNT. On the other hand, if the grandparents left that money in a special needs trust for the disabled child, that would be a third-party special needs trust. It’s not about who sets up the trust; it’s about who owned the assets when they went into the trust.
What is the difference between the self-settled SNTs and third-party SNTs?
There are a couple of major differences between self-settled SNTs and third-party SNTs. For one, self-settled special needs trusts must include what is commonly known as a payback provision. The payback provision provides that upon the beneficiary’s death, the state Medicaid agency will be reimbursed for the cost of benefits received by the beneficiary. Third-party SNTs do not require this same provision and should not include pay back language.
Another major difference is that self-settled special needs trust almost always require court supervision. The government entity providing medical care will also likely review the trust. In Arizona specifically, the trustee is also required to give AHCCCS an annual prediction of trust money will be spent. The trustee also has to provide AHCCCS with annual reports on the trust’s assets, income and expenditures. AHCCCs does have the ability to object to the account information but they rarely do.
Limitations for self-settled special needs trusts
In some states, there are also limitations as to what the trustee of a self-settled special needs trust can use the money for. The trusts expenditures must be for the benefit of the person with a disability, not their family or friends. While it can be ok to pay for companionship or caretaking services, even from family and friends, trustees must be careful. If expenditures benefit the family or friend more than the beneficiary, the trustee could be in hot water.
Another difference is what happens to the assets in the trust upon the beneficiary’s death. For a self-settled special needs trust the only expenditures should be for taxes and trust administration. The trustee cannot pay for funeral or burial costs for the beneficiary. The trustee must prepay for burial arrangements while the beneficiary is alive. This is different from a third-party SNT. In third-party SNT’s a grantor can add dispositive provisions as to where the remainder of the assets should go.
So, what now?
Generally, because of the limitations on self-settled SNTs, third-party SNTs are preferred if you can set one up. Sometimes, you have no choice. If a loved one receives a settlement or wins the lottery there is not much you can do. They will receive the money outright. You can save a disabled loved one a lot of hard work and heartache by setting up a third-party special needs trust rather than leaving their inheritance outright. Of course, there are a lot of rules about creating and administering a special needs trust, regardless of the type. Consulting with a capable estate planning attorney, especially one who specializes in special needs planning, is always a good idea.
