First-Party Special Needs Trust vs. Third-Party Supplemental Needs Trust: The Complete Guide to Protecting Your Loved One's Future

If you're reading this article, chances are you're facing one of life's most important questions: "What happens to my spcial needs child (or loved one) when I'm no longer here to care for them?"

Or perhaps you're asking youself: "How can I make sure they're taken care of without losing government benefits they desperately need?"

These questions keep parents, grandparents, and family members awake at night. The good news? With the right planning, you can protect your loved one's future, preserve their benefits, and give yourself peace of mind.

As an attorney with nearly thirty years of experience helping families navigate these exact situations, I've seen firsthand how the right trust can transform a family's future. I've also seen the heartbreak when families don't plan properly or don't understand the critical differences between trust types.

This comprehensive guide will walk you through everything you need to know about special needs trusts and supplemental needs trusts. By the time you finish reading, you'll understand which trust is right for your situation, how to protect government benefits, and what steps to take next.

Understanding the Basics: What Are Special Needs Trusts?

Before we dive into the differences, let's start with what these trusts actually do.

A special needs trust (sometimes called a supplemental needs trust) is a legal tool designed to hold money and assets for someone with disabilities without disqualifying them from important government benefits like Medicaid and Supplemental Security Income (SSI).

Think of it this way: these government programs have strict income and asset limits. If your loved one receives an inheritance or a legal settlement and suddenly has too much money in their name, they could lose their benefits overnight. A properly structured special needs trust prevents this from happening.

The trust holds the money, and a trustee manages it for your loved one's benefit, paying for things that improve their quality of life without replacing the basic support that government benefits provide.

Why This Matters So Much

Government benefits aren't just about monthly checks. Medicaid, for example, often covers essential medical care, therapy, equipment, and services that private insurance won't touch. Losing Medicaid could mean losing access to care that your loved one depends on for their health and wellbeing.

SSI provides monthly income to help with basic living expenses. For many individuals with disabilities, these benefits form the foundation of their financial security.

That's why getting the trust structure right is absolutely critical.

The Two Main Types: First-Party vs. Third-Party Trusts

Here's where things get important. Not all special needs trusts are created equal. The two main types are:

1. First-Party Special Needs Trusts (also called self-settled trusts)

2. Third-Party Supplemental Needs Trusts

The difference between them might seem technical at first, but it has huge practical implications for your family.

First-Party Special Needs Trusts: When Your Loved One Already Has Money

A first-party special needs trust is used when the person with disabilities already has money or assets in their own name.

When You Need a First-Party Trust

These situations come up more often than you might think:

• Personal injury settlements: Your child is injured in an accident and receives a settlement of several hundred thousand dollars

• Inheritance received directly: A well-meaning relative leaves money directly to your special needs child in their will

• Back pay from Social Security: Your loved one receives a lump sum of disability back pay

• Divorce settlements: Assets awarded in a divorce that belong to the person with disabilities

• Life insurance proceeds: When your loved one is named as a direct beneficiary

Real-World Example: Sarah's Story

Sarah, age 32, has autism and receives SSI and Medicaid. She was a passenger in a car involved in an accident caused by a distracted driver. She received a settlement worth $400,000 from the insurance company.

If Sarah received that money directly, she would lose her SSI and Medicaid immediately. She would have to spend down nearly all of that money on her own care before qualifying for benefits again.

Instead, her family worked with an attorney to establish a first-party special needs trust. The settlement money went into the trust. Sarah kept her benefits and now the trust pays for things that make her life better: a specialized computer, therapy not covered by Medicaid, recreational activities and more.

The Federal Law Behind First-Party Trusts

Legal Authority: 42 U.S.C. § 1396p(d)(4)(A). This federal statute authorizes first-party special needs trusts and sets requirements they must meet to protect Medicaid eligibility. The law was later amended by the 21st Century Cares Act in 2016.

Under 42 U.S.C. § 1396p(d)(4)(A), a first-party special needs trust must meet specific requirements:

Critical Requirements for First-Party Trusts

Age Limit: The person with disabilities must be under age 65 when the trust is established. This is a hard and fast rule. If your loved one is 65 or older, you generally cannot use a first-party trust (though pooled trusts may still be an option).

Disability Requirement: The beneficiary must meet Social Security's definition of disability under 42 U.S.C. § 1382c(a)(3). This means they have a physical or mental impairment expected to last at least 12 months or result in death, and the impairment prevents substantial gainful activity.

Who Can Create It: Thanks to the 21st Century Cures Act (2016), which amended the original statute, the trust can now be established by:

• The disabled individual themselves

• A parent

• A grandparent

• A legal guardian

• A court

Before 2016, the disabled person could not establish their own trust. This change was significant because it gave adults with disabilities more control over their own financial planning.

The Medicaid Payback Requirement: What You Must Know

Here's the part that surprises many families: when the beneficiary of a first-party special needs trust passes away, any money remaining in the trust must first be used to pay back the state for Medicaid benefits the person received during their lifetime.

This is called the "Medicaid payback provision," and it's not optional. It's written right into the federal law at 42 U.S.C. § 1396p(d)(4)(A).

How the Payback Works: Michael's Example

Michael has cerebral palsy and received a $500,000 settlement at age 25, which went into a first-party special needs trust. Over his lifetime, he received approximately $800,000 in Medicaid benefits for medicalcare, therapy and attendant services.

When Michael passed away at age 58, there was $200,000 remaining in his trust. Before any of that money could go to his siblings (the remainder beneficiaries named in the trust), the entire $200,000 had to be paid to the state Medicaid agency to partially reimburse them for the benefits Michael received.

His siblings received nothing from the trust, but they understood this was the trade-off that allowed Michael to receive quality care throughout his life while preserving the settlement money for his needs.

This payback requirement is often difficult for families to accept emotionally, but it's important to understand the rationale: the trust used the person's own money to qualify for Medicaid. The government is essentially saying, "We'll let you keep your benefits while you're alive, but we get reimbursed when you pass away."

Third-Party Supplemental Needs Trusts: Planning for the Future

Now let's talk about the other type of trust, and this is the one most families want to know about when they're doing estate planning.

A third-party supplemental needs trust is funded with someone else's money, not the beneficiary's own assets. This is the trust you create as a parent, grandparent, or other family member to plan for your special needs loved one's future.

When You Need a Third-Party Trust

You would use a third-party supplemental needs trust in situations like:

• Estate planning: You want to leave money to your special needs child in your will without disqualifying them from benefits

• Lifetime gifts: You want to give money during your lifetime to help your child

• Life insurance proceeds: You want your life insurance to benefit your child

• Family gifts: Grandparents or other relatives want to leave money for your child

Real-World Example: The Martin Family

Robert and Maria Martin have three children. Their youngest, Elena, has Down syndrome and receives SSI and Medicaid. Robert and Maria have worked hard and built an estate worth $1.2 million, including their home, retirement accounts and life insurance.

They want to treat all three children fairly, but they know if they leave Elena's share directly to her, she'll lose her government benefits. Instead, they establish a third-party supplemental needs trust in their estate plan.

When they pass away, Elena's share goes into the trust. A trustee (her older brother, with a corporate trustee as a backup) manages the money for Elena's lifetime, paying for entertainment, vacations, a better living situation and other things that make her life more enjoyable.

Elena keeps her SSI and Medicaid because the money is in the trust, not in her name. And here's the key difference: when Elena eventually passes away, whatever is left in the trust goes to her siblings' children (her nieces and nephews), not back to the government. The family wealth stays in the family.

The Legal Foundation of Third-Party Trusts

Third-party supplemental needs trusts aren't explicitly authorized by a specific federal statute the way first-party trusts are. Instead, they're recognized under general trust law and by guidance from the Social Security Administration.

SSA Guidance: POMS SI 01120.203

The Social Security Administration's Program Operations Manual System ("POMS"), provides detailed guidance on when trust assets are counted for SSI eligibility purposes. A properly drafted third-party trust that gives the beneficiary no control over the assets is not counted.

The key is that the beneficiary cannot have direct access to the trust assets or the ability to demand distributions. The trustee must have complete discretion over whether and when to make distributions.

Why Third-Party Trusts Are Different: No Medicaid Payback

Here's the game-changer: because a third-party trust is funded with someone else's money (not the beneficiary's own assets), there is no requirement to pay back Medicaid when the beneficiary dies.

You, as the person creating the trust, get to decide what happens to any remaining money. Most families choose to have it pass to their other children, grandchildren, or other loved ones.

This is a fundamental difference that makes third-party trusts much more attractive for estate planning purposes.

Side-by-Side Comparision: First-Party vs. Third-Party Trusts

Pooled Special Needs Trusts: A Third Option

There's actually a third type of special needs trust worth knowing about: the pooled trust.

Pooled trusts are authorized under 42 U.S.C. § 1396p(d)(4)(C) and offer a unique solution for some families.

How Pooled Trusts Work

A pooled trust is managed by a nonprofit organization. Multiple beneficiaries have individual accounts within the trust, but the organization pools the assets together for investment purposes.

The key advantages:

• No age limit: Unlike first-party trusts, a pooled trust can be established for someone over age 65

• Professional management: The nonprofit handles all the administration and trustee duties

• Lower cost option: For smaller amounts of money, it may be more cost-effective than setting up an individual trust

The trade-off: Like first-party trusts, pooled trusts may require Medicaid payback. However, the trust document can allow the nonprofit to retain a percentage of remaining funds for the benefit of other trust beneficiaries, which some families find appealing.

When a Pooled Trust Makes Sense: James's Situation

James is 69 years old and receives SSI and Mediciad. His brother passed away and left him $75,000. Because James is over 65, he cannot establish a traditional first-party special needs trust.

However, he can join a pooled trust. The nonprofit manages his account, uses the money to enhance his quality of life, and James keeps his benefits. When James passes away, after any Medicaid payback, a portion of the remaining funds stays with the pooled trust to help other beneficiaries with disabilites.

What Can Trust Money Be Used For?

One of the most common questions families ask is: "If the money is in the trust, what can it actually pay for?"

The short answer is: the trust can pay for virtually anything that supplements, but doesn't replace, government benefits.

Things a Special Needs Trust Can Pay For:

• Medical and dental care not covered by Medicaid or insurance

• Therapy, rehabilitation, and specialized equipment

• Education and tutoring

• Personal care attendants beyond what Medicaid covers

• Entertainment, hobbies, and recreational activities

• Vacations and travel

• Electronic equipment (computers, tablets, phones)

• Vehicle and vehicle modifications

• Furniture and household goods

• Clothing beyond basic necessities

• Professional services (legal, accounting, care management)

• Burial and funeral expenses

What to Be Careful About

The trust should generally not pay for:

• Food and shelter directly: These can reduce SSI benefits dollar-for-dollar. However, the trust can pay for furniture, improvements, and property taxes on a home the beneficiary lives in.

• Cash to the beneficiary: Giving cash directly can disqualify benefits. The trustee should pay vendors directly.

A knowledgeable trustee and experienced attorney can help navigate these rules to maximize what the trust can do for your loved one.

Who Should Be the Trustee?

Choosing the right trustee is one of the most important decisions you'll make.

The trustee is responsible for:

• Managing and investing trust assets

• Making distribution decisions

• Keeping detailed records

• Filing tax returns

• Ensuring the trust doesn't jeopardize government benefits

Your Trustee Options

Family member or friend: Many families choose a sibling, adult child, or trusted friend. This can work well if the person is financially responsible, organized, and willing to learn the rules.

Professional trustee: Banks and trust companies offer professional trustee services. They bring expertise and objectivity but charge ongoing fees (typically 1-2% of assets annually).

Combination approach: Some families use co-trustees, pairing a family member (who knows the beneficiary's needs and preferences) with a professional (who handles investments and compliance).

There's no one right answer. The best choice depends on your family situation, the size of the trust, and who you trust to make good decisions for your loved one.

The Tax Picture: What You Need to Know

Special needs trusts have unique tax considerations.

First-party trusts are typically "grantor trusts" for tax purposes, meaning income is taxed to the beneficiary at their individual rate. Since many beneficiaries have little other income, this often results in lower taxes.

Third-party trusts are usually separate taxpayers. Trust tax rates are harsh - trusts hit the highest federal tax bracket much faster than individuals. This is why many third-party trusts include provisions allowing the trustee to distribute income to the beneficiary (who can often pay tax at a lower rate) when it doesn't jeopardize benefits.

Tax planning for special needs trusts requires expertise. This is another area where working with an experienced attorney is essential.

Common Mistakes Families Make (And How to Avoid Them)

In my three decades of practice, I've seen families make the same mistakes repeatedly. Here's how to avoid them:

Mistake #1: Leaving Money Directly to the Special Needs Person

Without a trust, an inheritance or gift goes directly to your loved one. This can disqualify them from benefits immediately and force them to spend down the money before requalifying.

Solution: Create a third-party supplemental needs trust in your estate plan and name the trust as beneficiary of your will, life insurance, and retirement accounts.

Mistake #2: Trying to "Do It Yourself"

Generic online trust forms don't account for the complex federal and state rules governing special needs trusts. One wrong provision can destroy the trust's protective benefits.

Solution: Work with an attorney who regularly handles special needs planning and understands both Medicaid and SSI rules.

Mistake #3: Forgetting to Update Beneficiary Designations

You create a perfect trust, but forget to change the beneficiary designation on your life insurance or retirement account. When you die, the money goes directly to your special needs child, not to the trust.

Solution: Review and update all beneficiary designations after establishing the trust. Your attorney can provide a checklist of what to update.

Mistake #4: Not Planning for Who Comes After You

You name yourself as trustee, but don't name successor trustees. Or you name your other child without asking if they're willing and able to serve.

Solution: Have honest conversations with potential successor trustees. Consider naming multiple successors and including a professional trustee as a backup option.

Mistake #5: Assuming It's Too Expensive

Many families put off planning because they assume they can't afford it. Meanwhile, without a trust, their loved one could lose benefits worth tens of thousands of dollars per year.

Solution: Have a consultation to understand the actual cost. For most families, proper planning is far less expensive than the benefits that could be lost without it.

What Happens to Your Special Needs Child When You're Gone?

This is the question that haunts every parent of a special needs child.

I've sat across from countless parents in my office, and I can see it in their eyes - the worry about what happens when they're no longer there to advocate, to care, to protect.

A properly structured special needs trust is part of the answer, but it's not the whole answer.

Your complete plan should also address:

• Guardianship: Who will make personal and medical decisions for your child if they can't make those decisions themselves?

• Letter of intent: A detailed document explaining your child's needs, preferences, routines, medical history, and what makes them happy

• Housing: Where will your child live? With siblings? In a group home? Independently with support?

• Care coordination: Who will manage the team of professionals and caregivers your child needs?

The trust ensures there's money to pay for your child's needs. The rest of your plan ensures someone you trust is there to make sure those needs are met.

Your Next Steps: Getting the Right Plan in Place

If you've read this far, you clearly care deeply about protecting your loved one's future. That puts you ahead of many families who put off planning until a crisis forces their hand.

Here's what to do next:

Step 1: Assess Your Situation

Ask yourself:

• Does my loved one currently have assets in their own name? (First-party trust)

• Am I planning for the future and want to leave money to them? (Third-party trust)

• Is my loved one over 65? (May need a pooled trust)

• Do I have an existing estate plan that needs updating?

Step 2: Gather Information

Before meeting with an attorney, collect:

• Documentation of your loved one's disability (for SSI/Medicaid purposes)

• Information about current government benefits they receive

• Details about assets that need to be protected or planned for

• Names of potential trustees and guardians

Step 3: Consult with an Experienced Attorney

Special needs planning is a specialized area. You want an attorney who:

• Regularly handles special needs trusts (not someone who does one every few years)

• Understands both federal and state Medicaid rules

• Stays current on changes in the law (like the 21st Century Cures Act)

• Takes time to understand your family's unique situation

Step 4: Communicate with Your Family

Once you have a plan, make sure key family members understand:

• Why the trust is structured the way it is

• Who the trustees and guardians are

• Where important documents are located

• How to access professional help if needed

Protect Your Loved Ones Future Today

At Roulet Law Firm, P.A. we've spent nearly thirty years helping families just like yours with special needs planning. We understand the emotional weight of these decisions and we're here to help.

Whether you need a first-party special needs trust, a third-party supplemental needs trust, or a comprehensive estate plan that protects your entore family, we can help.

Call us today to schedule your consultation at (941) 909-4644 for our Florida office or at (763) 420-5087 for our Minnesota office. Or you can fill out the contact form on this page and a member of our team will reach out to you to schedule your meeting.

Frequently Asked Questions

Can I create a special needs trust if my child is already receiving benefits?

Absolutely. In fact, this is one of the most common situations. If your child already receives SSI or Medicaid, establishing a third-party trust ensures that any money you leave them won't disqualify them from those benefits.

What if my child receives a settlement but I don't set up a trust?

If the settlement money goes directly to your child, they'll likely lose their benefits immediately. They'll have to spend down almost all the money (keeping only about $2,000 in most states) before they can requalify. A first-party special needs trust prevents this from happening.

Can my special needs child own a home?

Yes, but it's complicated. The home they live in is generally exempt for SSI purposes, but there are income and resource rules to consider. Often, it's better for the trust to own the home and allow your child to live in it rent-free.

What happens if my child's disability improves and they no longer need benefits?

The trust can be structured to allow for this possibility. If your child no longer meets the disability definition and doesn't need government benefits, the trustee may be able to distribute assets more freely or even terminate the trust.

How much does it cost to set up a special needs trust?

Costs vary depending on complexity, but expect to invest several thousand dollars for a properly drafted trust. This may seem expensive, but compare it to the lifetime value of the benefits being protected - often hundreds of thousands of dollars. The investment is usually well worth it.

Can I be the trustee of my own child's special needs trust?

For a third-party trust you create, yes, you can serve as trustee during your lifetime. For a first-party trust using your child's own assets, there are more restrictions, and you'll want legal guidance on whether you can serve.

Final Thoughts: Peace of Mind Is Priceless

I understand the weight you carry as a parent or family member of someone with special needs. The constant worry about the future. The fear of making a mistake that could cost your loved one their security.

You can't control everything, but you can control whether you have a solid plan in place.

A properly structured special needs trust - whether first-party or third-party - isn't just a legal document. It's your promise to your loved one that they'll be taken care of. It's your gift of security, dignity, and quality of life.

The families I work with tell me that once their plan is in place, they sleep better at night. They have peace of mind knowing that even if something happens to them, their child will have the financial resources they need without losing the government benefits they depend on.

That peace of mind is priceless.

Don't wait until a crisis forces your hand. Take action now to protect the person you love.

This article is provided for informational purposes only and does not constitute legal advice. Special needs planning involves complex federal and state laws that change over time. For advice specific to your situation, please consult with a qualified attorney experienced in special needs trusts and estate planning.