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This article explains the difference between third-party and first-party special needs trusts.
Third-Party Special Needs Trusts
Third-party means that anyone other than the beneficiary (your child) can fund the special needs trust. Your child cannot fund the third-party trust. For example, when you hire an attorney to draft your estate planning documents (e.g., wills, maybe a living trust, powers of attorney for healthcare and property, and a special needs trust), your attorney will draft a third-party special needs trust. The inheritance you wish to leave your child with a disability after you die should go into a third-party special needs trust. If a friend or relative wants to give a gift to your child, they should write a check to a third-party special needs trust. If a relative in their will or trust wants to leave a gift to your child, they should leave it to a third-party special needs trust.
The big advantage of a third-party special needs trust is after your child (the beneficiary) dies, any assets remaining in the special needs trust can be distributed to whomever you name as remainder beneficiaries — the descendants of your child with a disability, your other children, a charity, whoever.
Long story short: If possible, you want a third-party special needs trust.
First-Party Special Needs Trusts
First-party means your child, as the beneficiary of the special needs trust, funds the special needs trust. First-party special needs trusts are treated less favorably by law because the government does not like your child “hiding” their own money in a special needs trust and then telling the government, “Now I’m poor, please give me means-tested government benefits like SSI or Medicaid.”
The first-party special needs trust requires a Medicaid payback provision. A Medicaid payback provision states that after your child (the beneficiary) dies, the trust must reimburse all states that paid medical assistance during your child’s lifetime before any of the remaining assets in the trust are distributed to anyone else. For example, imagine your child lived for years in a Medicaid-funded residential program and then died. The Medicaid cost to provide housing for your child would be astronomical. If your child had a first-party special needs trust and died, any remaining assets in the trust would be gobbled up by Medicaid, with likely nothing left for other relatives.
Why would you ever want to use a first-party payback special needs trust? Well,
you may need to resort to using a first-party special needs trust if your child receives any of the following:
For example, imagine your child inherits $50,000 from their grandmother, disqualifying them from receiving SSI. You may need to establish a first-party special needs trust so your child can transfer the $50,000 into the first-party special needs trust. If the special needs trust is properly drafted with a “payback provision,” then the assets in the trust will not be counted as a resource of your child when determining eligibility for SSI.
Tips
First: Use a first-party special needs trust only as a last resort.
You should always steer gifts from you or friends and relatives into a third-party special needs trust. For example, if your child’s grandmother wants in her will to give your child a gift, her will should direct the gift to a third-party special needs trust for your child; the will should not direct the gift to your child individually.
Second: You typically only need to use a first-party special needs trust if your child needs SSI or Medicaid.
Even if your child owns countable assets over $2,000, your child may not need a first-party special needs trust. It depends on whether your child needs means-tested government benefits — benefits like SSI or Medicaid with an asset limitation.
Before you decide on a first-party special needs trust, inventory the benefits your child receives. Are those benefits means-tested with an asset limitation or not? Benefits like Social Security Disability Insurance (SSDI), Childhood Disability Benefits (CDB), or Medicare do not have an asset limitation.
Take your time and inventory your child's benefits. You never want your child to fund a first-party special needs trust hastily. First-party special needs trusts are irrevocable trusts with a Medicaid payback provision. Don’t lock funds in such a trust unless you have to.
Third: When your child is the beneficiary of both a first-party special needs and a third-party special needs trust.
If your child also needs a first-party special needs trust, there should be language in the trusts directing the trustee to spend the money in the first-party special needs trust first, if practical, before using money in the third-party special needs trust. When your child dies, if all the assets in the first-party special needs trust were spent down on behalf of your child, there is nothing left to pay back the government.
Alternatives to a First-Party Special Needs Trust
Since first-party special needs trusts require a Medicaid payback provision and are expensive to draft, you should weigh other options that will reduce your child’s countable resources to qualify for SSI or Medicaid.
Don’t hastily transfer money out of your child’s name. It’s easy to get mad and do something rash when your child owns too much money to qualify for SSI or Medicaid. You were trying to do right by saving for your child’s future, and now you learn your child will be penalized for having money in their name. In that emotional state, some parents just hastily transfer the money from their child’s account to their own account or to another child's account.
Don’t transfer your child’s money until you get advice from a lawyer or a benefits advocate experienced in Social Security and Medicaid law. Suppose your child gives away a resource or sells it for less than it is worth. In that case, Social Security may consider it an “impermissible transfer,” and your child may be ineligible for SSI for up to 36 months, depending on the value of the resource your child transferred. Your attorney or benefits advocate can advise you about strategies other than first-party special needs trusts, such as “spend-down” strategies or transferring money into an ABLE Account.
This article explains the difference between third-party and first-party special needs trusts.
Third-Party Special Needs Trusts
Third-party means that anyone other than the beneficiary (your child) can fund the special needs trust. Your child cannot fund the third-party trust. For example, when you hire an attorney to draft your estate planning documents (e.g., wills, maybe a living trust, powers of attorney for healthcare and property, and a special needs trust), your attorney will draft a third-party special needs trust. The inheritance you wish to leave your child with a disability after you die should go into a third-party special needs trust. If a friend or relative wants to give a gift to your child, they should write a check to a third-party special needs trust. If a relative in their will or trust wants to leave a gift to your child, they should leave it to a third-party special needs trust.
The big advantage of a third-party special needs trust is after your child (the beneficiary) dies, any assets remaining in the special needs trust can be distributed to whomever you name as remainder beneficiaries — the descendants of your child with a disability, your other children, a charity, whoever.
Long story short: If possible, you want a third-party special needs trust.
First-Party Special Needs Trusts
First-party means your child, as the beneficiary of the special needs trust, funds the special needs trust. First-party special needs trusts are treated less favorably by law because the government does not like your child “hiding” their own money in a special needs trust and then telling the government, “Now I’m poor, please give me means-tested government benefits like SSI or Medicaid.”
The first-party special needs trust requires a Medicaid payback provision. A Medicaid payback provision states that after your child (the beneficiary) dies, the trust must reimburse all states that paid medical assistance during your child’s lifetime before any of the remaining assets in the trust are distributed to anyone else. For example, imagine your child lived for years in a Medicaid-funded residential program and then died. The Medicaid cost to provide housing for your child would be astronomical. If your child had a first-party special needs trust and died, any remaining assets in the trust would be gobbled up by Medicaid, with likely nothing left for other relatives.
Why would you ever want to use a first-party payback special needs trust? Well,
you may need to resort to using a first-party special needs trust if your child receives any of the following:
- An inheritance from a relative;
- Proceeds from a life insurance policy;
- A personal injury settlement;
- Child support payments under a divorce agreement.
For example, imagine your child inherits $50,000 from their grandmother, disqualifying them from receiving SSI. You may need to establish a first-party special needs trust so your child can transfer the $50,000 into the first-party special needs trust. If the special needs trust is properly drafted with a “payback provision,” then the assets in the trust will not be counted as a resource of your child when determining eligibility for SSI.
Tips
First: Use a first-party special needs trust only as a last resort.
You should always steer gifts from you or friends and relatives into a third-party special needs trust. For example, if your child’s grandmother wants in her will to give your child a gift, her will should direct the gift to a third-party special needs trust for your child; the will should not direct the gift to your child individually.
Second: You typically only need to use a first-party special needs trust if your child needs SSI or Medicaid.
Even if your child owns countable assets over $2,000, your child may not need a first-party special needs trust. It depends on whether your child needs means-tested government benefits — benefits like SSI or Medicaid with an asset limitation.
Before you decide on a first-party special needs trust, inventory the benefits your child receives. Are those benefits means-tested with an asset limitation or not? Benefits like Social Security Disability Insurance (SSDI), Childhood Disability Benefits (CDB), or Medicare do not have an asset limitation.
Take your time and inventory your child's benefits. You never want your child to fund a first-party special needs trust hastily. First-party special needs trusts are irrevocable trusts with a Medicaid payback provision. Don’t lock funds in such a trust unless you have to.
Third: When your child is the beneficiary of both a first-party special needs and a third-party special needs trust.
If your child also needs a first-party special needs trust, there should be language in the trusts directing the trustee to spend the money in the first-party special needs trust first, if practical, before using money in the third-party special needs trust. When your child dies, if all the assets in the first-party special needs trust were spent down on behalf of your child, there is nothing left to pay back the government.
Alternatives to a First-Party Special Needs Trust
Since first-party special needs trusts require a Medicaid payback provision and are expensive to draft, you should weigh other options that will reduce your child’s countable resources to qualify for SSI or Medicaid.
Don’t hastily transfer money out of your child’s name. It’s easy to get mad and do something rash when your child owns too much money to qualify for SSI or Medicaid. You were trying to do right by saving for your child’s future, and now you learn your child will be penalized for having money in their name. In that emotional state, some parents just hastily transfer the money from their child’s account to their own account or to another child's account.
Don’t transfer your child’s money until you get advice from a lawyer or a benefits advocate experienced in Social Security and Medicaid law. Suppose your child gives away a resource or sells it for less than it is worth. In that case, Social Security may consider it an “impermissible transfer,” and your child may be ineligible for SSI for up to 36 months, depending on the value of the resource your child transferred. Your attorney or benefits advocate can advise you about strategies other than first-party special needs trusts, such as “spend-down” strategies or transferring money into an ABLE Account.