For those living with disabilities and qualifying for certain government benefits, a special needs trust may be essential in allowing the person to continue to enjoy those benefits. Special needs trusts are important vehicles in special needs planning. They protect assets that can be used to provide on-going care for the disabled person who may not be able to gain income from other means such as employment.
There are two primary types of special needs trusts – first-party trust and third-party trust. When the primary beneficiary (the person with special needs) dies, the remaining assets in the trust will be distributed differently depending on whether it was a first-party or third-party trust.
First-Party Trusts
A first-party trust is funded with the primary beneficiary’s own assets (for example, someone with a disability who receives SSDI benefits inherits money from a family member or receives money from a personal injury settlement). That windfall could disqualify the person from continuing to receive SSDI unless those funds are protected by a special needs trust. A trustee is appointed to manage all the assets in the trust.
Third-Party Trusts
In contrast, a third-party trust is funded with assets from someone other than the primary beneficiary. Typically, parents, grandparents or other relative contribute funds to a third-party trust to provide on-going care and maintenance for someone who is disabled. Placing these funds in a third-party trust to be managed by a trustee prevents the funds from disqualifying the individual from government benefits.
Both types of special needs trusts are designed to terminate when the primary beneficiary dies. The trustee is responsible for dissolving the trust upon that individual’s death. At this point, what happens to the assets left in the trust?
Income Taxes
First, a final tax return must be completed by the trustee and all income taxes must be paid.
Medicaid Recovery
Next, if it is a first-party trust and the primary beneficiary received any Medicaid benefits, those benefits will need to be repaid. Medicaid has a pay-back provision requiring recipients to reimburse the state for all Medicaid expenses incurred throughout the beneficiary’s life.
Since a third-party trust is funded by someone other than the beneficiary, the Medicaid pay-back provision does not apply. Even if the special needs beneficiary received Medicaid services, the state cannot claim reimbursement recovery once the third-party trust is terminated due to death.
Estate Taxes
Rarely will this apply because assets in a third-party trust are not counted towards the beneficiary’s estate for estate tax purposes since they were funded by others. It would only apply to first-party trusts and would need to be higher than the current federal and Maryland state exemption amounts allowed. In 2020, each individual has a federal exemption of $11.58 million. This may be lowered sooner than its expected sunset clause of 2025 if Congress decides to do so. An estate planning attorney can assist in determining whether the exemption is a factor in your first-party special needs trust.
Remainder Beneficiaries
Once all of the above is covered, if there are still assets remaining, the trustee is authorized to distribute them to the named remainder beneficiaries according to the terms of the trust. The trustee will contact beneficiaries and make the necessary arrangements for the distributions. If any of the remainder beneficiaries are minors or have special needs, the trust may contain a flexible distribution provision that allows the trustee to retain the funds for the benefit of those particular beneficiaries under similar terms found in the original special needs trust.
Special needs planning requires not only assessing the needs of the primary beneficiary during his or her lifetime, but also taking into account other aspects of taxation and inheritance goals after death. Contact the attorneys at Stouffer Legal in the Greater Baltimore area knowledgeable in special needs planning for a consultation. You can schedule an appointment by calling us at (443) 470-3599 or emailing us at office@stoufferlegal.com.
