Special Needs Trusts: Don’t get them mixed up

Posted on: March 23rd, 2015 by Mark R. Friedman

Today I want to talk about the difference between first and third-party special needs trusts.  It’s a bit technical, but if you have a child or other loved one with special needs, it’s very important not to confuse the two.  Virtually all parents I meet and even many lawyers do not understand the difference.  It lies in where the money comes from.

A third-party special needs trust holds money or property from someone else – money from someone other than the beneficiary (the person with disabilities for whom the trust was established).  Inheritance from parents, gifts from family members, and other payments would go into a third-party special needs trust.

A first-party (aka grantor) special needs trust holds money or property owned by the beneficiary.  For example, let’s say that John, who has disabilities, wins a medical malpractice lawsuit.  Any award or settlement from the lawsuit is compensation to John, and he owns the money.  He can direct that the money go into a special needs trust, but the money is coming from him and not someone else.

The reason this is important is that there are different requirements for first and third-party special needs trusts.  To protect trust assets from disqualifying the beneficiary, a first-party special needs trust has to provide that Medicaid will be repaid from any trust remainder when the trust dissolves or the beneficiary dies.  In other words, when the beneficiary dies, a first-party trust must use any money left to repay Medicaid for all the money it spent on the beneficiary before the trust can pay anyone else.  A third-party special needs trust need not repay Medicaid when the beneficiary dies.  The two are also taxed differently and have different requirements on revocation and other aspects, and first-party trusts must comply with Medicaid requirements that vary from state to state.

For all these reasons, you should work with a lawyer who understands the difference when creating a special needs trust.  If your first-party trust doesn’t meet Medicaid or SSI requirements and your loved one loses benefits, then there wasn’t much point in setting up the trust.  If your third-party trust unnecessarily provides for Medicaid payback, then your other heirs may lose out on any inheritance.

This area of the law is very technical, and mistakes can cost big bucks and have an impact on your loved one’s quality of life.  It pays to work with experienced counsel.

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