by: Dawn Badorini, MST

There are various trusts that can be used to provide for a family member who is disabled. A Special Needs Trust (SNT) is generally set up to allow a disabled beneficiary to simultaneously receive benefits from the trust and from one or more public assistance programs.

The two primary sources for benefits for disabled and special needs individuals are Supplemental Security Income (SSI) and Medicaid. SSI provides income and is administered at the federal level while Medicaid provides medical care and is administered by the state. These programs typically only provide the individual with necessities. A SNT can preserve these federal and state benefits while funding travel, entertainment and other expenses that can greatly enhance the quality of life for the disabled individual. The trust should limit the trustee’s ability to make any distributions that could reduce public benefits received by the beneficiary.

The way to distinguish between types of SNTs is by determining who owned the funds that were used to establish the trust. The funds used to form a First Party SNT or Pooled Trust are those belonging to the beneficiary. A Third-Party Trust is established by someone other than the beneficiary using assets that never belonged to the beneficiary. Most SNTs are all irrevocable. An irrevocable trust cannot be revoked or changed. They also offer protection from creditors.

The First Party or Self-Settled SNT is one of the most common. Assets properly titled to the trust will not be counted for SSI or Medicaid purposes. Also, the beneficiary cannot compel the trustee to use the SNT assets for his or her support or maintenance.

The four elements of this type of trust are:

This type of trust is frequently used when a disabled individual receives an influx of assets. This may be from a court mandated settlement or an inheritance. It is also used when the disabled person owns property prior to the onset of the disability.

These trusts are typically grantor trusts for income tax purposes. The income generated by the trust is taxable to the beneficiary. If the trustee obtains a separate taxpayer identification number for the trust, a Form 1041 has to be filed for the trust. However, no tax is paid by the trust. The trust issues a grantor letter to the beneficiary who then reports the income and pays the tax on their individual tax return. This reporting of income by the grantor should not cause a problem with public benefits. Public benefits program administrators should be aware of the difference between income for income tax purposes and for program eligibility

Another type of self-settled trust is the Pooled Trust. A pooled trust has several similarities to the first party trust, but the biggest difference is the pooled trust is administered by a nonprofit organization. Pooled trusts are a good option where the beneficiary has no close friends or family who are able or willing to competently administer the trust. The choice to use a First Party SNT or a Pooled Trust will largely depend on the situation.

Third Party Trusts are most often established by parents or grandparents who wish to gift or leave assets to a disabled beneficiary. Third party trusts are not subject to most of the federal statutory requirements mandated for first party SNTs. Most importantly, there is no Medicaid payback for a third-party trust.

A third-party trust is a separate taxpayer and will file annual federal and state fiduciary income tax returns. To the extent that distributions have been made to the beneficiary, the trust will issue the beneficiary a K-1 and the beneficiary will report the income on their own individual tax return. All other income and capital gains will be taxed at the trust level. Most special needs trusts are permitted a $300 exemption. However, a Qualified Disability Trust receives a full personal exemption ($4,300 for 2020). For a third-party trust to be treated as a qualified disability trust, it must be for the sole benefit of the disabled beneficiary. The beneficiary must also be getting SSI benefits.

Another option in special needs planning is the ABLE account. An ABLE account is a less complicated alternative to special needs trusts. They do not require an attorney to set up and a trustee is not required. Funds held in an ABLE account do not count toward asset limitations for Medicaid or SSI purposes. Like a Section 529 College Plan, growth in an ABLE account is tax free to the extent funds are used for a proper purpose but they are limited to what kind of assets they can hold and how they can invest. There is greater flexibility for which the funds may be used. There is an annual contribution cap limited to the gift tax exemption ($15,000 in 2020). They have the same payback provision as the first party SNT. Any amount left after the owner’s passing must first be paid back to the state as compensation for Medicaid payments made during the owner’s lifetime. An ABLE account is often used in addition to a third-party trust.

The laws surrounding SNTs are extremely complex. With the proper planning, they can be an effective tool for families to ensure a person with disabilities receive the care they need both now and long after you can no longer provide it.