What is the difference between a special needs trust and a third-party special needs trust? Authorized by federal law, a special needs trust is an irrevocable trust designed specifically to hold assets for a beneficiary so that the funds do not disqualify the recipient from needs-based government benefits.
Several types of special needs trusts are authorized. A third-party special needs trust is created and funded by someone other than the special needs person (the "third party").
For example, a father and mother wish to provide for their child who has schizophrenia. The child is on Medicaid, so creating a typical irrevocable trust for the child disqualifies him or her from these needs-based government benefits.
Instead, the father and mother have their special needs-trust attorney draft a third-party special needs trust. They fund the trust with cash and stocks. The trustee invests these funds and has the discretion to provide care for child. In this case, the child continues to receive Medicaid, but the trust provides the child nutritious food, secure living arrangements and pays for periodic travel to family events.
• Third-party special needs trust funds are secure from a child's creditors. Because the third-party special needs trust owns the assets instead of the child owning them, a properly drafted trust is not available to the beneficiary's creditors. For example, using the facts above, the child has credit card debt and is being pursued by a former landlord for back rent. The trustee can pay these debts but has no obligation to do so.
• Your financial advisor can invest the trust funds. The trustee is free to invest the funds with any advisor; the statute does not make any limitations. Typically, the trustee utilizes the same advisor who holds the grantor's assets. If the wealth advisor is good enough for the father and mother, that advisor is likely good enough for the trust.
For example, continuing with the facts above, the parents place $500,000 into the special needs trust. The trustee, using the trust's tax ID number, opens an account with their wealth advisor. The advisor and trustee invest the funds, and investments are liquidated and moved into a checking account as needed.
• You decide where the remaining funds go at the child's death. At the beneficiary's death, the trust funds pass to whomever you name. The funds are not subject to the beneficiary's creditors, and the beneficiary has no right to give the remainder to someone as part of his or her will.
For example, assume the trust still holds $300,000 when the child passes. The parents had their attorney draft the trust so any remainder goes to their other children. Even though the child may have had outstanding debt, the $300,000 passes to the other children.
• Special needs trusts provide care for your child without penalty. Third-party special needs trusts are no gimmick — federal law specifically authorizes their existence. The government realizes that you want to provide for your special needs loved one, but also don't want to disqualify them from government benefits. Consult with a special needs trust lawyer and see how these valuable tools can work for you.
(Editor's Note: This article originally appeared at Investopedia.com.)
— By Peter Klenk, principal at Klenk Law