Have you heard the terms “special” needs trust and “supplemental” needs trust and wondered what the difference is? The simple answer is that there’s no difference.
Whether supplemental or special, these trusts serve the same purpose of helping meet the needs of individuals with disabilities while still permitting them to qualify for vital public benefits programs. But there are different categories of special needs trusts and important differences between them that warrant a longer explanation.
What’s in a Name? Background on Special Needs and Supplemental Needs Trusts
The field of special needs planning began more than three decades ago with the passage of the Omnibus Budget Reconciliation Act (“OBRA”) of 1993, a law that overhauled Medicaid and authorized the creation of a new special needs trust.
Prior to OBRA, a disabled person under the age of 65 who had assets greater than $2,000 was not eligible for means-tested government assistance programs like Medicaid and Supplemental Security Income (SSI). In the government’s eyes, it didn’t matter if the assets came from an injury or medical malpractice award, pre-disability personal savings, or an inheritance. A disabled person had to remain at or below $2,000 in assets to retain public assistance.
As a result of this policy, the families of disabled individuals faced a stark choice. They could provide financial support for a disabled loved one, but doing so often resulted in the loss of their means-tested benefits. Another option was to disinherit the person with special needs and leave the money to another family member, such a sibling, for the disabled person’s benefit — a risky option at best.
However, a third option emerged: the use of a third-party trust that benefited a disabled person but was funded by family members, often a parent. This arrangement kept the trust funds out of the beneficiary’s Medicaid and SSI means testing consideration.
Congress took a negative view of these third-party trusts and attempted to limit their use. But a compromise emerged when OBRA authorized first-party special needs trusts.
Some practitioners called for distinguishing between these new trusts and third-party special needs trusts by calling the former “special needs trusts” and continuing to call the latter trusts “supplemental needs trusts.” This approach never really caught on, though.
Instead, over time, both types of trusts have come under the rubric of special needs trusts and the term "supplemental needs trust" has fallen away. The term "special needs trust" refers to the purpose of the trust — to pay for the beneficiary's unique or special needs. In short, the name is focused more on the beneficiary, while the name "supplemental needs trust" addresses the shortfalls of public benefits programs.
More than 20 years after OBRA was passed, in December 2016, President Obama signed the 21st Century Cures Act into law. Section 5007 of the Act (“Fairness in Medicaid Supplemental Needs Trusts”) further modernized special needs trusts, allowing a person who meets the government’s definition of “disabled,” yet who is also mentally capable, to establish their own first-party special needs trust, rather than relying on a third party to set it up for them.
First-Party vs. Third-Party Special Needs Trusts
Special needs trusts (SNTs) now encompass both traditional third-party trusts and first-party trusts created under OBRA. They can hold many types of assets, including cash, real estate, investments, and life insurance policies.
- Special needs trusts funded with assets belonging to a person other than the disabled beneficiary (such as a parent, grandparent, sibling, or some combination of family and other individuals) are referred to as third-party special needs trusts.
- Special needs trusts funded with assets/income belonging to a disabled individual who is also the trust’s beneficiary are called first-party special needs trusts.
First-Party Special Needs Trust
First-party special needs trusts derive their name from the fact that they hold assets belonging to the beneficiary of the trust (i.e., first-party assets). They’re also known as:
- (d)(4)(A) trusts (referring to the statute)
- Pay-back trusts (referring to the feature that any funds remaining in the trust at the beneficiary’s death must be used to reimburse the state Medicaid agency)
- Self-settled trusts (referring to the fact that these trusts are created with the Medicaid beneficiary's own funds)
First-party SNTs are typically set up by a person with special needs, or on their behalf, who has assets but still wants to qualify for means-tested public assistance (e.g., Medicaid and SSI).
Often, these assets come from a lawsuit settlement or an inheritance. But in order for the trust’s assets to not be counted for Medicaid/SSI purposes, the beneficiary must, by law, be under the age of 65 when the trust is established and funded.
Third-Party Special Needs Trust
Third-party SNTs are set up by the family members of a special needs individual. Like a first-party SNT, the primary intent of a third-party SNT is to provide financial support to somebody with a disability or functional needs while not jeopardizing their means-tested government benefits.
There are two main types of third-party special needs trusts: standalone and testamentary.
- Standalone third-party SNTs are effective as soon as they’re created and eligible to hold assets from more than one third-party source, usually multiple family members and/or family friends, both during the creator’s lifetime and after. Standalone SNTs can provide cost savings because only one trust is created, but it can pool assets from different individual benefactors.
- Testamentary third-party SNTs are created through the estate plan of a third party, taking effect at the time of their death. When the creator passes away, assets specified in their estate plan transfer into the special needs trust. A testamentary SNT can be set up as a dual-purpose trust that allows the creator to keep assets in the trust they need during their lifetime, and then have those assets later transfer to a disabled beneficiary.
Similarities and Differences Between First-Party SNTs and Third-Party SNTs
First-party and third-party special needs trusts serve the same end: to offer supplemental assets to a disabled beneficiary without disqualifying them from Medicaid, Social Security, and other public benefit programs.
These programs usually provide a level of support that only meets a person’s most basic needs. Special needs trusts can therefore help to ensure that beneficiaries have access to more resources and enjoy a higher quality of life.
But while both types of SNTs serve the same goal, there is a major difference between them when it comes to government benefit reimbursement.
- With a first-party SNT, after the beneficiary dies, the state Medicaid agency can collect reimbursement for payments made to them during their lifetime. Sometimes, whatever funds remain in the trust are fully exhausted to meet this demand. Once Medicaid gets their cut, the trust balance can pass to other beneficiaries named in trust documents (so-called “remainder beneficiaries”).
- Third-party SNTs are not subject to Medicaid reimbursement. When the beneficiary dies, all remaining trust assets are eligible to pass to remainder beneficiaries. The government is not entitled to a Medicaid “clawback.”
The reason for this difference is that first-party SNTs are funded with first-party money belonging to the beneficiary, while the assets held in a third-party SNT never belonged to the beneficiary. It’s a legal technicality, but an important one.
Choosing a Trustee for a Special Needs Trust
When setting up a first-party or third-party SNT for a disabled loved one, among the most important decisions is who will serve as trustee, or the party that manages the trust on behalf of the beneficiary.
A trustee can be a person, like a family member or friend, or a professional trust administrator, such as an attorney or a financial institution. More than one party can simultaneously serve as trustee. It’s also a good idea to name a successor trustee to take over for the original trustee(s) when they are no longer able to serve.
Whoever you choose to serve in this rule, choose wisely. The responsibilities of a special needs trust trustee are crucial to maintaining a beneficiary’s public assistance eligibility.
The trustee must understand the trust’s terms and benefit regulations and only pay for expenses that an SNT can cover. The trustee is also responsible for managing trust investments and acting in the best interest of the beneficiary.
For these reasons, a professional trustee might be a prudent choice for administering a special needs trust, or at the very least co-administering it with a family member to ensure full legal compliance.
To discuss these and other legal issues surrounding SNTs, including which type of trust should be used in your situation, consult with your special needs planner.