What’s the Difference Between a First-Party and Third-Party Special Needs Trust?

Special Needs Trusts (SNTs) are essential tools for protecting the financial future of individuals with disabilities while preserving their eligibility for important government benefits like Medicaid and Supplemental Security Income (SSI). These trusts allow funds to be set aside for the benefit of a person with special needs without disqualifying them from receiving public assistance.

However, not all Special Needs Trusts are created equally. The two primary types – first-party and third-party trusts – serve similar purposes but differ in how they are funded, who can establish them, and how the remaining assets are handled after the beneficiary’s death. Understanding these differences is crucial when planning for the long-term care and financial security of a loved one with special needs.

What Is a Special Needs Trust?

A Special Needs Trust is a legal arrangement that holds and manages assets for the benefit of an individual with disabilities. The funds in the trust can be used to cover expenses not typically paid for by government benefits, such as medical care, personal services, transportation, and entertainment.

The trust ensures that the beneficiary can enjoy a higher quality of life while maintaining their eligibility for programs that have strict income and asset limits, such as Medicaid.

First-Party Special Needs Trust

A First-Party Special Needs Trust is funded with assets that belong to the individual with disabilities. This type of trust is often used when the individual inherits money, receives a personal injury settlement, or has assets in their name that could disqualify them from public benefits.

Key Features of a First Party SNT:

• Who Funds It: The trust is funded with the beneficiary’s own assets.

• Who Can Establish It: It must be created by the beneficiary (if competent), a parent, grandparent, legal guardian, or a court.

• Purpose: Protects the beneficiary’s assets while maintaining eligibility for Medicaid or SSI.

• Medicaid Payback Requirement: After the beneficiary’s death, any remaining funds must first be used to reimburse Medicaid for the cost of care provided during the beneficiary’s lifetime.

• Age Limit – The beneficiary/settlor must be under the age of 65 years of age when the trust is established and funded. In some states, transfers to such trusts may be made after age 65, but not in Pennsylvania.
  

Example: Sarah, a 25-year-old woman with cerebral palsy, receives a $200,000 settlement from a personal injury case. To avoid losing her Medicaid benefits, she places the funds into a First-Party Special Needs Trust. After Sarah’s passing, the remaining funds in the trust are used to pay back Medicaid before being distributed to her family.

Third-Party Special Needs Trust

A Third-Party Special Needs Trust is funded with assets that belong to someone other than the beneficiary, typically a parent, grandparent, or other family members. This trust is used to provide for the needs of a loved one with disabilities without affecting their eligibility for public benefits. Key Features of a Third-Party SNT:

• Who Funds It: Funded with assets from family members, friends, or other third parties.

• Who Can Establish It: Can be created by anyone except the beneficiary.

• Purpose: Protects assets intended to enhance the quality of life for the individual with special needs.

• No Medicaid Payback: After the beneficiary’s death, the remaining funds can pass to other family members or designated heirs without the obligation to reimburse Medicaid.
  

Example: John and Lisa set up a third-party Special Needs Trust for their daughter, Emily, who has Down syndrome. They contribute to the trust through their will and life insurance policies. After Emily’s death, the remaining funds pass to her siblings, as specified in the trust.

Key Differences Between First-Party and Third-Party Trusts

Source of Funding:

• First-Party Trusts are funded with the beneficiary’s own assets.

• Third-Party Trusts are funded with assets from others.
  

Medicaid Payback:

• First-party trusts must repay Medicaid for services provided.

• Third-party trusts do not have a payback requirement.
  

Establishment:

• First-party trusts must be created by the beneficiary, parent, grandparent, guardian, or court.

• Third-party trusts can be established by anyone (except the beneficiary).
  

Estate Planning Flexibility:

• Third-party trusts allow families to pass down remaining assets to other heirs.

• First-party trusts leave fewer options for asset distribution after the beneficiary’s death.
  

Which Trust Is Right for You?

The decision between a first-party and third-party Special Needs Trust depends on your unique situation. If the individual with special needs already owns assets or is receiving a settlement, a first-party trust may be necessary to preserve their benefits. On the other hand, if family members wish to provide for their loved one, a third-party trust offers greater flexibility and ensures more control over how remaining assets are distributed.

In many cases, families choose to establish both types of trusts to provide comprehensive financial protection. For example, parents might fund a third-party trust for future care, while a first-party trust safeguards any unexpected inheritances or settlements.

Consult a Certified Elder Law Attorney who is a member of the Special Needs Alliance

Special Needs Trusts are highly specialized and must comply with complex state and federal regulations. Working with an elder law attorney familiar with Pennsylvania’s Medicaid and trust laws is essential to ensure that the trust is properly drafted and structured to achieve your goals.

By taking proactive steps now, you can provide long-term security and enhance the quality of life for your loved one with special needs—while protecting their access to vital public benefits. Anderson Elder Law is here to help.