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Families often think carefully about how to provide lasting support for a loved one with disabilities without jeopardizing eligibility for public benefits. One tool you may consider is a third party special needs trust. Understanding how this type of trust works, what it can do for you, and how it differs from other trusts can help you feel more confident when you plan for the future.
If you’re wondering how a third party special needs trust can fit into your estate planning approach, we’ll answer the following most common questions:
- What Is a Third Party Special Needs Trust?
- What Are the Main Benefits of a Third Party Special Needs Trust?
- How Do You Fund a Third Party Special Needs Trust?
- Who Should You Choose as Trustee?
- What Can a Third Party Special Needs Trust Pay For?
- How Is a Third Party Special Needs Trust Different from Other Trusts?
- What Are the Steps to Establish a Third Party Special Needs Trust in Texas?
- What Are the Possible Drawbacks to Consider?
What Is a Third Party Special Needs Trust?
A third party special needs trust is a legal arrangement that holds assets for the benefit of a person with a disability. The trust is funded with assets that do not belong to the beneficiary. Instead, the funds come from someone else—commonly parents, grandparents, or other family members.
Because the assets never belonged to your loved one, they are not counted against them when they apply for means-tested government benefits such as Supplemental Security Income (SSI) or Medicaid.
These trusts can be created in two main ways:
- As part of your last will and testament, meaning the trust only takes effect after your death.
- As a standalone living trust, which you can fund during your lifetime.
The distinction between a third party trust and a third party special needs trust is critical. A first party trust holds funds belonging to the beneficiary, such as an inheritance received outright or a personal injury settlement. By contrast, a third party trust holds your funds or assets and never becomes the beneficiary’s property.
What Are the Main Benefits of a Third Party Special Needs Trust?
Setting up a third party special needs trust can give your family several potential benefits:
Preserves Public Benefits Eligibility
Means-tested programs limit how much a person can own. If your loved one receives an inheritance in their own name, it can quickly disqualify them from SSI or Medicaid. With a properly drafted third party trust, assets are not counted as resources.
Flexible Use of Funds
Your trustee can pay for a wide range of items to improve the beneficiary’s quality of life. These may include therapies, assistive technology, travel, education, recreation, and personal care attendants. However, distributions for food or shelter can sometimes reduce SSI payments, so you should discuss these with your advisor.
No Medicaid Payback Requirement
Unlike a first party trust, a third party special needs trust does not require repayment to Medicaid upon the beneficiary’s death. Any funds that remain can pass to other heirs you name.
Control Over Assets
You decide who will serve as trustee. You can also give the trustee detailed instructions about how to spend funds to support your loved one’s well-being.
Continuity of Support
This structure allows you to provide resources that last beyond your lifetime. Your trust can be funded with cash, investments, life insurance proceeds, or real estate.
How Do You Fund a Third Party Special Needs Trust?
A third party trust can be funded in many ways. Some families choose to leave gifts through a will, while others establish and fund the trust while living.
Here are some common methods to fund your trust:
- Gifts During Your Lifetime: You may transfer cash, securities, or property directly into the trust.
- Life Insurance Policies: Naming the trust as the beneficiary of a life insurance policy is a popular way to provide substantial support after your death.
- Retirement Accounts: These can also be used, but you should consult a professional to avoid unintended tax consequences.
In Texas, as in other states, funding the trust properly is critical. The assets must never be placed in the beneficiary’s name. Transfers must be titled in the name of the trust and managed by your chosen trustee.
Who Should You Choose as Trustee?
The trustee plays a central role in managing and distributing funds. You can choose an individual, such as a trusted family member, or a professional trustee, like a bank trust department or a nonprofit organization.
Factors to consider when selecting a trustee:
- Experience and Skill: The trustee will be responsible for investing funds, maintaining records, and complying with legal requirements.
- Availability and Willingness: The role can be time-consuming, so you will want to confirm that the person is prepared to serve.
- Continuity: Consider naming a successor trustee or co-trustees to ensure ongoing management if the primary trustee can no longer serve.
What Can a Third Party Special Needs Trust Pay For?
Funds held in the trust can cover a broad range of expenses to enrich your loved one’s life. However, distributions must be made carefully to avoid affecting SSI eligibility.
Permissible uses often include:
- Educational programs and training
- Medical and dental care not covered by Medicaid
- Transportation, including vehicle purchases
- Recreational activities and vacations
- Personal care attendants or home modifications
- Assistive devices such as wheelchairs or communication tools
Certain distributions that cover food or shelter can reduce SSI payments by up to one-third. Your trustee should understand these rules and plan distributions accordingly.
How Is a Third Party Special Needs Trust Different from Other Trusts?
This type of trust is distinct in several ways:
First Party Special Needs Trust: Funded with the beneficiary’s own assets. When the beneficiary passes away, remaining funds must be used to reimburse Medicaid.
Pooled Special Needs Trust: Managed by a nonprofit organization. Multiple beneficiaries’ funds are pooled for investment purposes, though each beneficiary has a separate account.
Revocable Living Trust: Can hold assets for general inheritance purposes but does not automatically protect eligibility for means-tested benefits.
A third party special needs trust is designed specifically to shield assets from being counted as your loved one’s resources, without requiring Medicaid reimbursement.
What Are the Steps to Establish a Third Party Special Needs Trust in Texas?
If you live in Texas and wish to create a third party special needs trust, here is a general outline of the process:
- Work with an Attorney
Consult a lawyer experienced in special needs planning to draft the trust document. - Select a Trustee
Decide who will manage the trust and carry out distributions. - Determine Funding Sources
Identify which assets you plan to place in the trust, whether during your lifetime or through your estate. - Sign and Execute the Trust
Properly execute the trust document in line with Texas law. - Fund the Trust
Transfer assets into the trust. This step is essential. An unfunded trust will not serve its purpose. - Review Periodically
Circumstances can change over time. Reviewing your trust every few years helps ensure it still meets your family’s goals.
What Are the Possible Drawbacks to Consider?
While a third party special needs trust can be a helpful planning tool, it also requires thoughtful management:
- Administrative Effort: Trustees must keep careful records, file tax returns, and comply with distribution rules.
- Potential Costs: Professional trustees charge fees for managing and distributing funds.
- Restrictions on Spending: Certain expenses can affect SSI payments.
- Family Dynamics: Disagreements among relatives about distributions can occur if expectations are not clearly communicated.
You can help reduce these challenges by providing clear instructions, choosing an experienced trustee, and keeping beneficiaries informed about your plans.
Conclusion
A third party special needs trust can offer a structured, reliable way to care for your loved one with a disability without compromising access to public benefits. You can decide who will oversee funds, how they can be spent, and who receives any remainder when your loved one passes away.
By working with qualified professionals and taking time to think through your options, you can create a trust that gives you peace of mind and supports your family’s needs for years to come.
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Frequently Asked Questions
Most trusts are designed to be irrevocable once funded, meaning you cannot change the terms. However, in some situations, limited changes may be made with court approval or by following provisions built into the trust.
Typically, the beneficiary does not control the trust or have direct access to the funds. This structure is essential to protect eligibility for government benefits.
Unlike first party special needs trusts, a third party trust does not require repayment to Medicaid. You can name other beneficiaries to receive any remaining funds.
Trusts have their own tax identification number and must file annual returns. Distributions may be taxable to the beneficiary, and income earned in the trust may be taxed at trust tax rates. You should discuss tax considerations with your advisor.
Yes. Multiple family members, such as grandparents, aunts, or uncles, can contribute gifts or leave bequests to the trust.
