What You Need to Know About Third-Party Special Needs Trusts

Hello, this is Peter Klenk, New Jersey and Pennsylvania trusts and estates attorney here to talk a little bit more about death and taxes, the same stuff we’ve been talking about in the past. But this time, we’re going to talk about third-party special needs trusts. It’s a long title, so let’s break that down. These are really special trusts, and they serve a very good purpose.

“Third-party” means that it’s a trust that somebody’s setting up for a third party, whereas a first-party trust is a trust you set up for yourself — you’re the first party. A third-party trust is a trust you set up for your grandchild, your son, your daughter, a friend, or anybody else. Now, a special needs trust means that this trust is being set up under specific government rules to qualify, so that when you put assets in the trust, they don’t disqualify the person from getting needs-based government benefits. As you know, there are lots of benefits out there that you get because you’ve just earned them, no matter how much money you have. But some benefits require you to be very poor, as they’re needs-based.

Now, this third-party special needs trust is something that you could set up for someone else, and the money in it won’t disqualify them, because it won’t be counted against their assets when they’re calculating their need. And that’s the important part.

How Government Benefits Can Affect Special Needs Trusts

So let’s talk more about these things. Government benefits are vitally important to those who need them. And what you don’t want to do is take any action that would disqualify the person from getting their benefits. I hope you’ve never had to go through this experience yourself or with a loved one you’re caring for: suddenly they can become disqualified, and you have to go through the whole process again to get them requalified. It’s not fun. Or there are situations where you have somebody who’s been taking care of their child their whole life, and then that person dies. It’s up to that parent who’s been doing all the work for all those years to make sure that the child is qualified for their benefits. But suddenly, the child can’t take care of themselves – maybe they have a mental health issue or a disability, but they’re disqualified. So who’s going to step up now to do all that paperwork? You can imagine, it’s very difficult. So these trusts are very important.

Now, a little history goes a long way, right? Let’s go back over time to see how we got to where we are today. So originally, when these programs came into being, they were for poor people, people who didn’t have much money. And to make sure that only poor people were going to qualify, the rules were that if you had over a certain dollar amount, you couldn’t qualify. But they also disqualified you if you had a trust, because if you had a trust set up for you, you must be rich. So why should a rich person who has assets at their disposal get benefits from the government? This led to a lot of problems. Imagine you’re a grandparent, and your grandchild is on government benefits; if you leave them any sort of money, they’re disqualified, and now you’re stuck with not leaving them anything. So people would die, and they would exclude the child or grandchild. Everybody started to realize that was not a good idea. If somebody’s lucky enough to have someone in their life who leaves them money to help make their life better, why would you want to discourage that? If somebody was personally eligible for benefits, but someone else wanted to set up a trust to help them out, why not let them have this little extra luxury of paying for cable, or getting a haircut once in a while? What’s wrong with that? Pretty much everybody agrees — you don’t have much hassle from either side of the political aisle on this one, as it pertains to people completely stuck on government benefits for the rest of their lives. So they made regulations to say that there’s a way to do this correctly, and as long as you follow their rules, then the trust qualifies and the person is not disqualified.

How Does a Third-Party Special Needs Trust Work? 

Back to the third-party special needs trust. “Special needs” infers that the person is disabled, or can’t function right and needs to be on benefits. If they’re on benefits, this trust will then allow them to be taken care of and pay for things that the government doesn’t pay for, which makes their life better. If you’ve listened to my past podcasts, I’ve talked to you about trusts. But I’m going to segue a little bit here so that I can give you a little bit of background in case this is the first podcast of mine you’ve listened to. 

Generally, a trust has three parts. There’s the grantor, or the person who grants the power and creates the trust. Then, there’s the trustee who manages the trust. And lastly, there’s the beneficiary, the person who benefits from the trust. In our system, you can look at a trust as if it’s a person. When you sign that trust, you’ve given birth to it, so to speak. You’re the grantor, while the trustee is somebody who just manages it, and it has a tax ID number. It can buy things, invest money, hire people, pay taxes, all those things. But somebody has to do it because the trust is just a piece of paper. But the trustee you pick, that person or company, is not the owner, they just manage it. So let’s imagine that you say, “I’m going to form a trust, and my grandchild and I picked my son to be the trustee.” But then your son later has some financial trouble or gets sued or divorced. They don’t own the trust, they just work for the trust. So the trust assets are safe from the trustee’s problems. And it’s the same for the beneficiary – the beneficiary simply benefits from this arrangement. They also don’t own what’s in the trust, so if they get in trouble financially, well, this is not their money. But now you can see why them being the beneficiary of a special needs trust doesn’t disqualify them from government benefits, because they don’t own them. They’re just benefiting from the trust. And as long as they only benefit from it, it doesn’t disqualify them from benefits.

Now, you can do this either while you’re alive, in a trust called an inter vivos trust, or you can do it when you’re dead, through your will. It’s totally up to you and what works best for you. Most people set them up in their will – after all, it’s your money, and you want to be able to spend it while you’re alive, but you want your grandchild or child taken care of after you die. In the will, it will say, “when I die, X number of dollars or percentage of my estate goes into a trust for this person’s benefit in this third-party special needs trust.” The trustee then takes over and they start helping the person out. But again, you can do this while you’re alive if there’s a benefit to it. I’ll give you an example. Let’s say you want to set the trust up because there are other people in the family, maybe your parents, who want to leave the child some money, but they don’t want to go through the work of setting up a trust themselves. Well, you could set it up while you’re alive. You could fund it with some money. And then those other people can either contribute money to it every year once you die. But now it’s all set up and ready to go.

Another advantage of a third-party special needs trust is that because it never belonged to the beneficiary, so when they die, whatever’s left in it does not go to pay the government. However, if it’s a first-party special needs trust, meaning one that’s created with the funds from the person who’s going to benefit, that’s different. If the person who needs government benefits sets up a trust and puts the money into it, and they also receive government benefits, when they die, then that money has to go back to the government to pay for the money that was essentially borrowed. However, for a third-party special needs trust, even though the beneficiary has been using government benefits, it’s got nothing to do with this trust. So if they die, the money in the trust can go wherever you want it to go. It can go to charities that provide studies to find a prevention or cure of the disease which the person suffered from, or perhaps it can go back to their siblings. Think about it — if you don’t have enough money to give your other children money while they’re alive and take care of the special needs person, your will might say that everything goes in the trust for the special needs person, but whatever’s left when they die then goes to the other siblings. Nothing wrong with that.

Find Out if a Third-Party Special Needs Trust Is Right for You 

So that is a little summary of a third-party special needs trust. If you’d like to know a little bit more, we have it on our website, you can take a look! If you live in Pennsylvania or New Jersey and you want to talk more about it, you can always call me. But if you’re listening to this and you’re somewhere else, there are plenty of good trust and estate folks out there. If this feels like it’s going to be a good fit for you, you can talk to us and find out more information and how to set one up. They’re good solid documents, they do good for people. They help make sure that people have better lives, enjoy, and have these little extra things that they just can’t afford based on what the government might provide. So if you’ve set one up, good for you.

Be well! Peter Klenk, trust and estates, death and taxes. I look forward to talking to you again in the future.