Special Needs Trusts: An Estate-Planning Strategy for Parents and Grandparents

What to know about first-party vs. third-party Special Needs Trusts, plus other key strategies for parents and grandparents of children living with special needs. 

mother and daughter with special needs

Families who have children or other loved ones living with special needs face unique financial challenges, even if they have a fairly high income.

Consider the story of Joe and Sarah Cooper*, a professional couple in their mid-30s. They have a 7-year-old daughter, Ella, and a 4-year-old son, Josh, who is living with Down syndrome. The Coopers currently are paying for special therapies for Josh that his insurance won’t cover, on top of their normal family expenses. One of the Coopers’ biggest financial concerns, though, is setting aside money for Josh’s care in case they die suddenly in the near future, or for when they pass away later in life.

One important planning tool available to families like the Coopers is a third-party Special Needs Trust, says Allison Bren Ferris, Senior Vice President – National Director of Special Needs Trust Services and Life Management Services for Wells Fargo Private Bank.

Third-party vs. first-party Special Needs Trusts
According to Bren Ferris, a third-party Special Needs Trust (SNT) is quite different from a first-party Special Needs Trust.

  • A first-party SNT is set up using the beneficiary’s own funds—most often from a personal-injury lawsuit settlement—and is subject to strict rules. A third-party SNT, on the other hand, is established with funds from other people, such as parents and grandparents.
  • Typically created as part of a donor’s estate plan, third-party SNTs can be funded with assets such as retirement funds, life insurance, and even real estate, Bren Ferris explains. Many are testamentary—created under a last will and testament and funded at the donor’s death—but family members can also create “stand-alone” third-party SNTs that are intervivos—or funded during the donor’s lifetime. Instead of having multiple trusts set up by different family members, all who wish to can contribute to a single “stand-alone” SNT.

“One of the greatest benefits of a third-party Special Needs Trust is that it sets aside money to help care for an individual who is living with a disability, but doesn’t interfere with their eligibility for government benefits like Medicaid and Supplemental Security Income (SSI),” Bren Ferris says.

In addition, Medicaid doesn’t require a third-party SNT to pay back funds after the individual with special needs passes away. First-party SNTs typically are subject to a Medicaid payback after the beneficiary’s death if he or she received benefits while alive.

More reasons to consider a third-party Special Needs Trust

  • They can impact quality of life. The trust can pay for extras that government programs might not cover, such as supplemental caregiving, emotional support animals, and assistive technology devices.
  • Public benefits won’t be impacted. Funds left outright to an individual living with special needs may impact benefits eligibility; leaving the funds to a third party SNT will protect eligibility.
  • You can fund a trust with life insurance proceeds. This can be a great way for young parents like the Coopers to help provide money for the trust after they die, even if they can’t afford to fund the trust now.
  • Use of your money is protected. Your appointed trustee must approve distributions. The beneficiary or unscrupulous individuals can’t easily use the money for unintended purposes.
  • Your trustee decides how funds are invested. Your trustee will consider the needs of your loved one and will develop an investment strategy, most often with the advice of an investment professional, that aims to preserve principal but keep up with inflation.
  • Leftover trust funds can go to whomever you choose. Since Medicaid and creditors can’t claim third-party SNT funds, you can designate secondary benefactors if the primary beneficiary passes away before the trust is exhausted. For example, the funds could go to your child’s siblings or a favorite charity.

Pooling resources and ABLE accounts
Some families want a professional trustee to oversee their SNT, rather than a family member, says Bren Ferris. However, most professional trustees will only manage fairly large trusts.

But even if your trust is modest, you still have options:

  • Pooled SNTs. In most states, pooled third-party SNTs are administered by nonprofits. Each individual beneficiary maintains a separate share of the funds.
  • ABLE (Achieving a Better Life Experience) accounts. Each individual who meets certain criteria can contribute up to $15,000 yearly (as of 2018) to a tax-advantaged account and use the money for items related to their disability. Subject to certain limitations, benefits eligibility is not impacted. A new development this year: Families can roll 529 college savings plan contributions into ABLE accounts in certain circumstances. For more information, visit the ABLE National Resource Center.

*Names changed to protect privacy

Teri Cettina writes about personal finance and business from Portland, Oregon, and is a frequent contributor to Conversations. Image by iStock

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Wells Fargo & Company and its affiliates do not provide legal advice. Wells Fargo Advisors is not a legal or tax advisor. Please consult your tax or legal advisors to determine how this information may apply to your own situation.

This information is provided for educational and illustrative purposes only.

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