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Understanding Special Needs Trust Rules and Regulations

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A typical trust fund is a legal structure that holds assets in an account until the beneficiary of the trust is eligible to receive them. Usually, this happens when the beneficiary reaches a certain age or the grantor — the person who legally established the trust for the benefit of the recipient — has passed away. Unlike a regular trust, a special needs trust (SNT) is bound by different and complex regulations and rules. It’s essential to follow those rules carefully when creating an SNT to avoid interfering with the beneficiary’s ability to receive forms of assistance like Medicaid benefits and Supplemental Security Income (SSI).

There are two main types of SNTs: first-party and third-party. This is an important distinction when setting up an SNT properly because it determines how the trust is drafted and administered. In both cases, however, there are many benefits to setting up a trust for a loved one with special needs. Regardless of the type of SNT trust that a grantor chooses, understanding the rules that apply to SNTs is a top priority. If you’re considering setting up this type of trust get started by learning the basics about what these trusts are and how to manage them.

What Is a Special Needs Trust?

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An SNT, also called a supplemental needs trust, is a legal arrangement that holds and protects assets for a person who’s disabled or living with a chronic illness. An SNT can contain a variety of different assets, such as real estate, bank accounts, investments and bonds.

It’s different from a standard trust in that the structure is set up to preserve the beneficiary’s eligibility to receive publicly granted disability benefits, including Social Security, SSI, Medicaid and Medicare. These public assistance programs are often needs-based, meaning eligibility for them depends on a person’s health conditions but also on their financial situation. Their income and assets — if they exceed certain limits — could affect their eligibility for assistance. This is where an SNT’s biggest benefit is apparent: Assets in an SNT don’t count as income when determining a person with special need’s financial eligibility for assistance programs.  

For example, if a standard trust contains a large sum of cash, that could disqualify a beneficiary with special needs from receiving disability benefits. With an SNT, the beneficiary doesn’t lose their disability benefits. This is because the assets in the trust don’t directly go to the beneficiary in the same way the assets from a normal trust would. Instead, they’re distributed to the SNT itself.

To protect the beneficiary’s public disability benefits, their SNT must be drafted and formalized correctly. Many SNT grantors use an attorney who’s experienced in forming SNTs to assist with the process.

How First-Party and Third-Party Trusts Work

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Of the two types of SNTs, the more common is the third-party SNT. Parents, grandparents, siblings or guardians of loved ones with special needs are typically the grantors who form third-party SNTs. Some beneficiaries receive the funds in these trusts when the grantor of the SNT passes away, while others receive it during their lifetime. The latter allows for the SNT recipient to receive gifts from loved ones during their lifetime without the gifts affecting their eligibility to receive disability benefits. Multiple donors can fund the SNT.

An SNT beneficiary cannot exercise control over the trust if they don’t want their disability benefits to be impacted. Instead, the grantor designates a trustee to manage the SNT. Within the agreement, authorization given to the grantor or trustee allows them to amend the SNT if the beneficiary’s circumstances change or the law changes. This is important to ensure the beneficiary’s government benefits continue uninterrupted.

The trustee’s duties in managing the SNT include taking care of the beneficiary’s needs, record-keeping and paying taxes. The trustee has complete control over the SNT, including spending the money in the trust, which should always and only be done in the beneficiary’s best interest. When the beneficiary of a third-party trust passes away, remaining funds in the trust aren’t used to reimburse the state for any disability benefits the beneficiary received. Instead, the trustee can decide how to use the remaining assets upon the beneficiary’s death.

Setting up a first-party SNT is less common, but it is an option. Before the 2016 Special Needs Trust Fairness Act became law, the only people who could create a first-party SNT were the beneficiary’s parents, grandparents or legal guardians. Courts also had the power to create this type of trust. Since then, however, an SNT beneficiary who’s deemed legally and mentally competent can establish their own SNT. It’s important to note that a first-party SNT can only contain property that the beneficiary legally owns. Additionally, the beneficiary must be under 65 years of age when this type of SNT is established.

A first-party SNT is most commonly created when a person with a disability inherits money or assets or they collect a court settlement. First-party SNTs can be practical when a non-disabled person who owns assets becomes disabled. In that case, establishing a first-party SNT allows them to receive disability benefits without the value of their assets restricting their eligibility.

Once the beneficiary of a first-party SNT dies, remaining assets are used to reimburse the disability programs, such as Medicaid, that provided benefits to the beneficiary during their lifetime. Other beneficiaries named in the trust then receive the remaining balance. If the remaining assets don’t fully cover the reimbursement amount that a disability program is entitled to, the program receives what’s left in the trust account.

What Can a Special Needs Trust Pay For?

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A trustee of a third-party SNT can essentially pay for anything the beneficiary needs with the exception of illegal purchases and purchases that violate the irrevocable trust laws. Typical uses for SNT funds include paying for caregiving, medical and dental services that disability benefits don’t cover, vehicles, education, and vacations. Use of the funds to buy one primary home, one vehicle, furniture, personal items, work-related items, and life and burial insurance are also typically within these trusts’ terms.

Because public disability benefits can cover some of the costs of food and rental housing (and sometimes utilities), using SNT funds to pay for these needs means potentially reducing those benefits. Despite the reduction in disability benefits that occurs when SNT funds go toward paying for housing, many trustees opt to do it anyway. This is because the SSI disability benefits granted for shelter may not be enough to provide for the beneficiary’s housing needs in today’s market.

The trustee cannot give any money in excess of $2,000 directly to the beneficiary. This includes funds in checking and savings accounts, stocks, bonds, vacation homes, real estate outside of the beneficiary’s primary residence, investment accounts and retirement assets. Doing so could lead to ineligibility for disability benefits.

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