What is a third-party special needs trust?

If you have a family member with special needs who is receiving government benefits, then you probably understand that you need a special kind of estate plan. A simple mail-merged will from some website is probably not going to be what you need. And just using beneficiary designations on your retirement accounts and giving that money to your child who is receiving government benefits and special needs is a disastrous situation: It may cause them to lose their government benefits.

Types of Special Needs Trusts

The common way that we can create an estate plan to care for that child is by creating what's called a special needs trust. There are three types:

  • First-party
  • Third-party
  • Pooled trust 

Third-Party Special Needs Trusts

A third-party trust is a very common way that my clients like to use to leave money for a child with special needs who's receiving government benefits. It's created by a donor so it's not using your child's assets. It would be you or your family members or others. Leaving money for your child's benefit is usually part of the larger estate plan. We don't just create a third-party special needs trust, we also create a will and may possibly have other trusts involved. We want to make sure we have a comprehensive plan to take care of your child.

The advantage of the third-party trust is that it can own almost any kind of asset. My clients will commonly use a life insurance policy, real estate, or other assets to fund the special needs trust for their child. Another benefit is there's no asset limit. You can put as much money into this third-party trust as you would like for your child. It can be used to supplement the government benefits. So things like food, healthcare, clothing basics that the government provides under the government benefits is not going to be included in your special needs trust, but this allows them to use the money for other things ("luxuries" like transportation, electronics, educational training).

One of the most important parts about third-party special needs trust is it doesn't have to reimburse the government when the trust is terminated. So when your child dies, if you have a first-party special needs trust, then the government may have a right to actually get reimbursed for the benefits that were paid out under that under the time when they were receiving money from that trust. If you have a pooled trust, it's another good way to plan, but then the charity that's administering the pooled trust will be the one who gets the rest of the money.

When we use a third-party special needs trust, this allows you to then pass that money on to someone else. So let's say you have three kids, one of whom has special needs, you can create this third-party special needs trust, and if the child with special needs dies, and there's money left in the trust, the trust can then distribute that money to your other two children, or to your grandchildren or to others that you designate without having to worry about the government getting reimbursed for government benefits.

Another benefit is also that there's no age limit. The age of the beneficiary can be as young or as old as you would like when the trust is set up. There's normally no court review, so you don't have to submit the trust to a court to decide whether it's valid or not. And then finally, the beneficiary is not taxed if they're going to receive money. So if your child is receiving money under the special needs trust and you're still alive or the donor is still alive, then the taxes on any income distributed would be taxed to the donor and not to your child.

One thing you have to be careful of is that this kind of asset can't hold any of your child's assets. So let's say they've inherited money from an aunt or an uncle, or they have proceeds from a lawsuit settlement. They can't then have that money put into the special needs trust. So you do have to be careful, which is why it's important to work with a professional. You want to work with an attorney, with your financial advisor, work with the care manager who knows your child and knows what their needs are and what can be used to help them with a third-party special needs trust.

If you have a child with special needs, and you understand that we need to put together a comprehensive estate plan, and you want to make sure it's done right, let's set up a Legal Strategy Session to discuss where you are in the process and what are the best options for you with your estate planning so that you know whether or not a third-party special needs trust is the best for you and your family.