Understanding the Differences Between Special Needs Trusts and Supplemental Needs Trusts

"Special Needs Trusts" and "Supplemental Needs Trusts" are terms to describe trusts designed to provide benefits to a person in a way that will preserve the public benefits that he or she is entitled to receive. These types of trusts are most commonly created when a person has some sort of special needs or disability.  The person who benefits from the trust is called the beneficiary.

In New Jersey, Pennsylvania and Florida, the terms "Special Needs Trusts" and "Supplemental Needs Trusts" are often used interchangeably, although they should not be as it often results in serious problems.  I personally try to use the term "Special Needs Trust" as a way to refer to a First Party Special Needs Trust (i.e. the money used to fund the trust belongs to the special needs person). I try to use the term "Supplemental Needs Trust" to refer to a Third Party Special Needs Trust (i.e. the money used to fund the trust belongs to someone other than the Special Needs Person).

Both a First Party Special Needs Trust and a Third Party Supplemental Needs Trust are intended to protect different public benefits. Most disabled individuals and special needs individuals receive Supplemental Security Income (SSI), Medicaid, vocational rehabilitation, subsidized housing and food stamps.  The most important rule for all First Party Special Needs Trusts and Third Party Supplemental Needs Trusts is that the trust may not pay cash to the beneficiary and it may not pay to or for the benefit of the beneficiary for any medical needs covered by Medicaid, food, shelter, or any asset which could be converted into food or shelter.

A First Party Special Needs Trust and a Third Party Supplemental Needs Trust allow the beneficiary to continue to receive government benefits, but also have money for clothing, education, travel, cable and cell service, electronics, furniture, personal care, medical care not covered by Medicaid, and many other items that make life worth living. 

Key features of a Third Party Supplemental Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the Special Needs Person as the trustee sees fit.  If the trustee has complete discretion whether to make distributions for the beneficiary, the trust principal and income will usually not be counted as available to the beneficiary for purposes of obtaining government benefits.

2.  Established using funds of someone other than the Special Needs Person
A Supplemental Needs Trust is most common when a parent, grandparent or other relative wants to leave money for the benefit of a Special Needs Person.  Care must be taken to avoid giving that person money outright, otherwise he or she risks losing public benefits.  The Supplemental Needs Trust is a way for third parties to provide a Special Needs Person access to money in a way that will not cause them to lose their benefits.

3.  No government payback upon the death of beneficiary is required
After the Special Needs beneficiary passes away, Medicaid does not require reimbursement for the funds it expended during the lifetime of the beneficiary if the trust is funded DIRECTLY with the money of someone other than the beneficiary.  Please note that if a parent leaves money to a child and then the child sets up a trust, that will be considered a First Party Special Needs Trust, and not a Third Party Supplemental Needs Trust.  The key difference is that the third party must set up the trust AND fund it to qualify as a Third Party Supplemental Needs Trust.

4.  A Supplemental Needs Trust can have more than one Beneficiary
While there are substantial restrictions on how the Special Needs Person can receive money, because the trust fund is not comprised of funds of the Special Needs Person, there are few guidelines on how the rest of the Supplemental Needs Trust can be administered. Accordingly, the sole benefit rule that applies to First Party Special Needs Trusts does not apply to Third Party Supplemental Needs Trusts.  As government benefits are available only to those with financial need, the most important rule is that the beneficiary should never be entitled to the money in the trust.

5.  Taxation of Third Party Supplemental Needs Trusts
A Third Party Supplemental Needs Trust can be established as a Grantor Trust while the Grantor is alive, a Qualified Disability Trust or a complex trust.  If the trust is set up as a Grantor Trust, income generated by the trust will be allocated to the Grantor (or Creator) of the Trust during his or her lifetime.   If the trust is taxed as a complex trust, the trust will pick up most of the tax consequences in these types of trusts. Designing the trust as a Qualified Disability Trust may offer a small tax break, but it offers less privacy.  Often privacy is better than saving a few dollars in taxes as it can reduce confusion by government officials looking into the benefits and income of the Special Needs Person.  When fewer people question the validity of the trust, that saves legal fees and aggravation.

Key features of a First Party Special Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the special needs person as the trustee sees fit.  However, payments to any one person or entity in excess of $5,000 during a single calendar year requires government approval.

2.  Established using funds of the Special Needs Person
A First Person Special Needs Trust is most commonly created when a person inherits money outside of trust or is awarded money in a personal injury settlement.  Prior to actually receiving the money, the Special Needs Person can create this type of trust to avoid losing their public benefits.

3.  There is a government payback at the death of the Special Needs Person
After the Special Needs beneficiary passes away, the government requires that the First Party Special Needs Trust reimburse Medicaid for expenses it has incurred.  For this reason many trust specialists semi-jokingly recommend that the trustee of a First Party Special Needs Trust try to spend the last dollar of the Trust on the day the Special Needs Person dies.

4.  A First Party Special Needs Trust must be for the sole benefit of the Special Needs Person
The sole benefit rule of a Special Needs Trust is very tricky and many states, including New Jersey, have changed their definition of this term many times over the years.  For example, can payments be made for the care of a pet for a Special Needs Person?  Many New Jersey officials say no, but most will also say yes, if it is a therapy animal. The biggest issue comes up over incidental benefits.  For example, a First Party Special Needs Trust can pay for a Special Needs Person to go to an amusement park, but it shouldn't pay for the ticket of a family member caretaker even that caretaker has no interest in going to the park and is only going to assist the Special Needs Person.

5.  Establishing a First Party Special Needs Trust.
Creation of a First Party Special Needs Trusts is much more complicated than the creation of a Third Party Supplemental Needs Trust. Usually (but not always), a First Party Special Needs Trust must comply with a federal law enacted in 1993. That law requires that most First Party Special Needs Trusts be established by a judge, a court-appointed guardian or the parents or grandparents of the beneficiary with notification being given to the government so that they can appropriately monitor it.(In some cases Social Security regulations may also require a judge to sign off on the creation of trusts).  In addition, the trust must generally be created before the beneficiary turns 65 years of age.

6.  Alternate names of a First Party Special Needs Trust
First Party Special Needs Trusts are frequently referred to as d(4)(A) Trusts because that is the section of the government statute that allows for these trusts.  They are also frequently called self settled special needs trusts.

7.  Taxation of First Party Special Needs Trusts
Because this is a grantor trust for IRS tax purposes, all income earned by the trust is taxable to the Special Needs beneficiary. There is no option to tax the trust itself.  The trust is also includible in the gross estate of the Special Needs Person for estate tax purposes.  However, the trust still need its own separate EIN and must file a federal Form 1041.  (Note: This can be a very simplified form merely advising the IRS that the Grantor/beneficiary will be picking up all the taxable income on their personal income tax return.)

8.  Other Issues with First Party Special Needs Trusts
Income generated inside a properly created 1st Party Special Needs Trust should not affect the beneficiary’s eligibility for government programs.  However, while taxable income is not “countable” income for purposes of Medicaid or other government benefits, government agencies often get a “tracer” report from the IRS about the beneficiary's income, and may issue a notice that benefits will be terminated unless they receive proof that the beneficiary did not have countable income. The trustee must be prepared to explain that although the income was reportable to the IRS as the beneficiary’s income for tax purposes, the beneficiary only received "in-kind” distributions that should not be counted as income for purposes of SSI, Medicaid, or other programs.  In other words, the Trustee will likely have to explain to many different people that the Special Needs Person is being taxed on income that the beneficiary never receives.

Summary

The administration of First Party Special Needs Trusts and Third Party Supplemental Needs Trusts can be somewhat difficult. A special needs trust attorney, familiar with public benefits programs and special needs trust provisions, should always be involved in the preparation of a Special Needs Trust or a Supplemental Needs Trust. While many legal matters can be undertaken without a lawyer, or with a lawyer with a general background, special needs planning is complicated enough to require the services of a specialized practitioner.

Termination Clause in Special Needs Trust

The Social Security Administration has issued new rules, SI 01120.199, related to the early termination of Self Settled Special Needs Trusts created on or after January 1, 2000. Self Settled Special Needs Trusts, also known as First Party Special Needs Trusts established under Section 1917(d)(4)(A) of the Social Security Act. are designed to avoid being counted as a resource that would affect the trust beneficiary's right to receive Supplemental Security Income (SSI) and Medicaid.

Typically, a Self Settled Special Needs Trust does not terminate until the death of the beneficiary. The new rules provide guidance on how beneficiaries of these trusts can still qualify for government benefits in the event the trusts contain an early termination provision.

An early termination provision is a clause that would allow the trust to terminate before the death of the beneficiary. A termination clause is very important to have in a special needs trust in case the trust beneficiary is no longer disabled, becomes ineligible for SSI and Medicaid, or when the trust fund no longer contains sufficient assets to justify its continued administration.

The most common need for an early termination clause comes when a child wins a very large personal injury settlement. Settlement agreements will routinely require that a special needs trust be established. However, if in twenty years the child is fully functioning and not in need of SSI or Medicaid, a special needs trust will be overly restrictive.

A special needs trust with a termination clause will qualify under the new rules if the trust:

1. has a payback provision on the date of the termination. This means that the trust has to pay to the State all amounts remaining in the trust up to an amount equal to the total medical assistance paid on behalf of the beneficiary by the State;
2. only makes payment of the balance remaining directly to the trust beneficiary (reasonable administration expenses and taxes are allowed to be paid to other parties); and
3. gives the decision on whether or not to terminate the trust to a person other than the trust beneficiary.

In the event you have an existing trust that does not meet the termination standards set forth by this new rule, such trusts will be evaluated under Section 1613(e) of the Social Security Act.

SI 01120.199 also apply to Pooled Trusts established under Section 1917(d)(4)(C) of the Social Security Act. SI 01120.199 will take effect October 1, 2010.

Self Settled Special Needs Trusts

There are generally two types of private special needs trusts:

1. 1) Third Part Special Needs Trusts; and
2. 2) Self Settled Special Needs Trusts (also known as First Party Special Needs Trusts or D-4A Trusts).

A person who is receiving (or about to receive) Medicaid and Supplemental Security Income (SSI) may wish to consider establishing a Special Needs Trust just before he or she is about receive a substantial gift, inheritance or personal injury award. By receiving money outright, the person will no longer be eligible to receive SSI and Medicaid.

The Social Security Act (Section 1396p(d)(4)(A)) specifically allows a Special Needs Trust to be created for a person so that the person can continue to qualify for Medicaid and SSI. This particular trust is called a Self Settled Special Needs Trust because it is being funded with the person's own money (as opposed to money given to a trust by a third party).

The prime difference between the terms of a Self Settled Special Needs Trust and a Third Party Special Needs Trust is that when the beneficiary of a Self Settled Special Needs Trusts dies (or the trust terminates), the balance in the trust must pay off any Medicaid liens that have been built up. If there money left in the trust after that, the balance can be paid to the beneficiary's relatives. With a Third Party Special Needs Trust, there is no payback provision necessary.

The reason why a beneficiary of either a Self Settled Special Needs Trust or a Third Party Special Needs Trust can qualify for SSI and Medicaid is because those trusts are limited in what they can pay for. In general, the trust may not pay for food, shelter, electricity, gas or water and it may not pay for anything that can be converted into food, shelter, electricity, gas or water. So cash should almost never be distributed to a beneficiary from the trust. (Note: there are special rules about a trust owning a home)

A Self Settled Special Needs Trust can be created on behalf of the individual who receives the money by the person's guardian, the person's parent or grandparent, or by a court (as often happens in personal injury settlements). The beneficiary must be under the age of 65 when the trust is created and funded and the trust must be for the sole use of the beneficiary.

The costs of creating a Special Needs Trust vary from attorney to attorney, however, hundreds of thousands can be saved by setting up one properly.

Special Needs Planning in NJ - Part 4 of 4

Special Needs Trusts and Supplemental Needs Trusts

In Part IV of this Series, I want to discuss the role of Special Needs Trusts and Supplemental Needs Trusts in estate planning.

"Special Needs Trusts" and "Supplemental Needs Trusts" are terms to describe trusts designed to provide benefits to a person in a way that will preserve the public benefits that he or she is entitled to receive. The person who benefits from the trust is called the beneficiary.

Each special needs trust can be intended to protect different public benefits. Most commonly, special needs trusts are intended to permit Supplemental Security Income (SSI) and Medicaid recipients to receive some additional services or goods. Other common benefits include vocational rehabilitation, subsidized housing and food stamps. The trusts are always created as discretionary trusts, which means that money can only be paid out in the discretion of the trustee. The trustee can NEVER be the special needs person.

There are actually few rules governing Supplemental Needs Trusts (also commonly known as third-party special needs trusts). Since government benefits are available only to those with financial need, the most important rule is that the beneficiary should never be entitled to the money in the trust. If the trustee has complete discretion whether to make distributions for the beneficiary, the trust principal and income will usually not be counted as available to the beneficiary for purposes of obtaining government benefits.

The most important rule for special needs trusts is that the trust may not provide food, shelter, any asset which could be converted into food or shelter (including cash), or any items or services that are available from public benefit programs, to the beneficiary. In other words, the trust can provide for physical therapy, medical treatment, education, entertainment, travel, companionship, clothing, furniture and furnishings (such as a television or computer), and some utilities (like cable television and a telephone, but not electricity, gas or water). Distributions of cash to the special needs person outright are almost never permitted.

There are dozens of different ways to draft a Supplemental Needs Trust. In addition, the administration of a special needs trust can be extremely difficult. A seasoned lawyer, familiar with public benefits programs and special needs trust provisions, should always be involved in preparation of a third-party special needs trust. While many legal matters can be undertaken without a lawyer, or with a lawyer with general background, special needs trusts are complicated enough to require the services of a specialized practitioner.

Sometimes a person may be entitled to public benefits, but he or she has too many assets to qualify for those benefits. This is common for people like accident victims or disabled children who inherit money. In such cases, it is often possible and advisable to place assets into a special needs trust to gain, regain or continue eligibility for government benefits. Because the person is using their own money to fund the trust, there are numerous restrictions regarding how the money can be used.

Self-settled special needs trusts are much more complicated than their third-party equivalents. Usually (but not always), a self-settled special needs trust must comply with a federal law first enacted in 1993. That law requires that most self-settled special needs trusts actually be established by a judge, a court-appointed guardian or the parents or grandparents of the beneficiary (Social Security regulations may limit creation of trusts to the first two categories in most circumstances). In addition most self-settled special needs trusts will have to include a provision repaying state Medicaid agencies for any benefits, payable upon the death of the beneficiary.

In summary, Special Needs Trusts and Supplemental Needs Trusts are both Discretionary Trusts. A Special Needs Trust is established using funds of Special Needs Person. A Supplemental is established using funds of someone other than Special Needs Person. A Special Needs Trust requires that the government be paid back for Medicaid liens upon death of the Special Needs Person There is no government payback upon the death of Special Needs Person in a Supplemental Needs Trust.

Special Needs Trusts and/or Supplemental Needs Trusts are all part of a larger strategy to make sure a special needs person's financial and personal needs are met. For individuals who cannot afford these types of trusts, many charities, like Plan NJ, do have pooled funds to which you can contribute. These pooled funds offer you less control, but it does provide for a means of taking care of your loved one.