First-Party vs. Third-Party Special Needs Trusts in New Mexico: What Families Need to Know
Planning for a loved one with a disability often involves more than preparing a Will or Power of Attorney. If the person receives or may qualify for needs-based benefits such as Supplemental Security Income (SSI) or Medicaid, receiving an inheritance, settlement, or other significant assets can create complicated eligibility issues.
A special needs trust can allow assets to be used for a person with a disability while helping preserve eligibility for certain public benefits. But not all special needs trusts are the same.
Two of the most common types are first-party special needs trusts and third-party special needs trusts. The difference largely comes down to one question:
Whose money is funding the trust?
That distinction affects who can establish the trust, the beneficiary's age, Medicaid repayment requirements, and what happens to the remaining trust assets after the beneficiary dies.
What Is a First-Party Special Needs Trust?
A first-party special needs trust, sometimes called an SNT1, is a special needs trust funded with assets belonging to the person with a disability.
Congress created the statutory special needs trust exception under 42 U.S.C. § 1396p(d)(4)(A). The exception recognizes that a person with a disability may need to own assets without automatically losing access to important public benefits.
This can be particularly important when a person becomes disabled and receives money through a personal injury settlement, inheritance, or other source. Without appropriate planning, those assets may make the person ineligible for needs-based benefits.
A properly drafted first-party special needs trust can hold those assets while allowing the trustee to use the trust for the beneficiary's supplemental needs.
First-party trusts, however, are subject to significant requirements. Both federal law and New Mexico Medicaid rules contain specific requirements governing these trusts.
Who Can Have a First-Party Special Needs Trust?
Generally, a first-party special needs trust must meet several requirements.
1. The beneficiary must be under age 65 when the trust is established
The individual must be under age 65 when the first-party special needs trust is established.
Assets added to the trust after the beneficiary turns 65 can present additional Medicaid transfer-of-assets issues, so timing matters.
2. The beneficiary must meet the applicable definition of disability
For purposes of the federal special needs trust rules, the beneficiary must be a disabled individual under the applicable Social Security Act definition.
In general terms, Social Security's disability standard focuses on whether the individual has a medically determinable physical or mental impairment that results in significant functional limitations and is expected to result in death or has lasted, or is expected to last, for at least 12 months.
The precise determination of disability is made under the applicable federal program rules.
3. The trust must contain the beneficiary's assets
This is one of the most important distinctions between a first-party and third-party special needs trust.
A first-party trust is funded with the disabled individual's own money.
Common examples include:
A personal injury settlement;
An inheritance received directly by a person with a disability;
Assets the individual already owns;
A judgment or other legal recovery; or
Other assets belonging to the individual.
4. The trust must be established by an authorized person
For trusts established on or after December 13, 2016, federal law permits the individual with a disability to establish the trust themselves. A parent, grandparent, legal guardian, or court may also establish the trust
The Sole-Benefit Requirement
A first-party special needs trust must be established for the sole benefit of the disabled individual.
In practical terms, the trust generally cannot be used as a vehicle to provide gifts or other benefits to the beneficiary's family members or other individuals during the beneficiary's lifetime.
There are limited exceptions for appropriate expenses that benefit the beneficiary, such as reasonable trustee compensation and expenses related to administering the trust. The federal rules and New Mexico regulations provide additional guidance concerning the sole-benefit requirement.
This is one reason the language of a first-party special needs trust matters so much. A trust can be titled a "Special Needs Trust" and still fail to satisfy the requirements if its provisions are inconsistent with the applicable rules.
Medicaid Payback
The biggest difference between a first-party and third-party special needs trust is often what happens after the beneficiary dies.
A qualifying first-party special needs trust must contain provisions requiring repayment to the state Medicaid program, up to the amount of Medicaid assistance provided to the beneficiary, subject to the applicable federal and state rules.
In other words, if a first-party special needs trust has $200,000 remaining when the beneficiary dies and the applicable state Medicaid program has paid $150,000 in qualifying medical assistance, the trust generally must provide for reimbursement of that amount before remaining assets can pass to other beneficiaries.
This is commonly called the Medicaid payback requirement.
The payback provision is one of the primary reasons that a first-party trust should not simply be treated like a conventional family trust. The trust document needs to be drafted with the federal and New Mexico requirements in mind.
The Trustee Has Discretion Over Distributions
A first-party special needs trust should generally be structured as a discretionary trust.
The beneficiary does not have an enforceable right to demand that the trustee distribute trust assets simply because the beneficiary wants the money.
Instead, the trustee has discretion to determine whether a distribution should be made and how trust assets should be used for the beneficiary.
This structure is important because SSI and Medicaid eligibility can be affected when a beneficiary has the ability to control or access trust assets for their own support and maintenance.
Does Medicaid or Social Security Have to Approve a Special Needs Trust?
This is an area where families sometimes receive confusing advice.
There is not a universal federal rule that every first-party special needs trust must receive a formal "approval" from both Social Security and Medicaid before the beneficiary can qualify for benefits.
Instead, the trust must satisfy the applicable requirements, and the relevant benefits agency may review the trust when determining eligibility.
In New Mexico, the Health Care Authority has specific requirements for recognized Medicaid trusts, including requirements concerning the trust's language, sole-benefit provisions, Medicaid reimbursement, identification of the source of trust assets, and reporting of subsequent additions.
For that reason, proper administration is just as important as proper drafting.
For example, New Mexico's Medicaid regulations require subsequent additions to a first-party special needs trust to be reported to the Income Support Division caseworker upon application and recertification.
Families should not assume that creating the trust is the end of the process.
What Is a D4C or Pooled Special Needs Trust?
A D4C trust, referring to 42 U.S.C. § 1396p(d)(4)(C), is commonly called a pooled trust.
Instead of creating an individual first-party trust, the beneficiary's assets are placed into a separate account within a trust established and managed by a qualified nonprofit organization. The individual accounts are maintained separately, but the assets can be pooled together for investment and management purposes.
Unlike a traditional D4A first-party trust, there is no federal age restriction for establishing a pooled trust. However, transferring assets into a pooled trust for someone age 65 or older trigger Medicaid transfer penalties.
These trusts are particularly helpful for persons who do not have a family member or trusted person that can serve as trustee of an SNT1.
What Is a Third-Party Special Needs Trust?
A third-party special needs trust, sometimes called an SNT3, works differently.
Instead of being funded with the disabled person's own assets, it is funded with assets belonging to someone else.
For example, parents may establish a third-party special needs trust as part of their estate plan for a child with a disability.
The parents might provide that, when either parent dies, the child's inheritance will pass into the special needs trust rather than directly to the child.
This can help preserve the child's eligibility for needs-based benefits while giving the family much greater flexibility over how the assets are ultimately distributed.
New Mexico Medicaid regulations specifically distinguish third-party trusts as trusts established with assets contributed by someone other than the applicant or recipient, or the recipient's spouse.
How Is a Third-Party Special Needs Trust Different?
There are several important differences.
The money comes from someone other than the beneficiary
The defining characteristic is that the trust is funded with third-party assets.
The disabled beneficiary does not contribute their own money to the trust.
There is generally no age limit
Because the trust is funded with someone else's assets, a third-party special needs trust can be established for a disabled person regardless of whether the beneficiary is 18, 35, 60, or older.
There is no Medicaid payback requirement
A properly structured third-party special needs trust generally does not have the first-party Medicaid payback requirement.
That gives the person establishing the trust substantially more flexibility over what happens to the remaining assets when the disabled beneficiary dies.
For example, a parent could provide that any remaining assets pass to the beneficiary's siblings or other beneficiaries after the disabled beneficiary's death.
The settlor has more flexibility
Because the assets belong to the person establishing the trust, the person creating the trust can generally determine who receives the remaining assets after the beneficiary's death.
This is one of the major advantages of planning ahead with a third-party special needs trust.
The beneficiary should not control the trust
A third-party special needs trust should generally be drafted so that the beneficiary cannot revoke the trust, demand distributions, or otherwise control the trust assets.
The Social Security Administration explains that a trust beneficiary's ability to direct trust assets for their own support and maintenance can cause the trust to be treated as a resource.
This is why trustee selection and the distribution provisions are important parts of special needs planning.
When Is a First-Party Trust Necessary?
If a family is planning ahead, a third-party special needs trust is often the more flexible planning tool.
But families do not always have the opportunity to plan ahead.
For example, imagine a young adult with a disability unexpectedly receives a $500,000 personal injury settlement. The money belongs to the disabled individual. The parents cannot simply create a traditional third-party special needs trust and put the settlement into it.
A first-party special needs trust may instead be necessary to preserve eligibility for needs-based benefits.
The same issue can arise when a person with a disability receives an inheritance directly because the person who created the estate plan did not know that a special needs trust was necessary.
In those situations, special needs planning may need to happen after the assets have already become the disabled person's property.
A Longer Trust Is Not Necessarily a Better Trust
Families sometimes assume that the best special needs trust is the longest, most complicated, or most expensive document they can find.
That is not necessarily the case.
Special needs trusts need to be carefully drafted because they operate at the intersection of trust law, Social Security rules, Medicaid rules, and benefits administration. But adding pages to a trust does not automatically make the trust better.
A well-drafted trust should be comprehensive enough to address the issues that actually matter without creating unnecessary complexity.
An overly complicated trust can make administration more difficult and more expensive. It can also make it harder for a benefits agency to determine whether the trust complies with the applicable rules when the document contains lengthy provisions or conflicting language.
The goal should not be to create the longest possible trust.
The goal is to create a trust that complies with the applicable rules, accomplishes the family's objectives, and can actually be understood and administered by the trustee.
That is particularly important with special needs trusts because drafting the document is only one part of the process. The trustee must also understand how distributions, purchases, recordkeeping, and reporting can affect the beneficiary's public benefits.
Special Needs Planning Should Be Done Before the Money Arrives When Possible
If you have a child, adult family member, or other loved one with a disability who receives or may qualify for SSI, Medicaid, or other means-tested benefits, it is worth considering special needs planning before an inheritance or other assets are transferred.
A properly structured third-party special needs trust can sometimes prevent a family from having to solve a much more complicated first-party trust problem later.
But when assets already belong to the person with a disability, a first-party special needs trust or pooled trust may provide an important planning option.
The right approach depends on the source of the assets, the beneficiary's age and disability status, the benefits involved, and the family's long-term goals.
If you are considering a special needs trust in New Mexico, an attorney familiar with both special needs trust drafting and public-benefits rules can help you evaluate the available options and coordinate the trust with the beneficiary's overall estate and benefits plan.
Disclaimer: This article is provided for informational purposes only and is not intended as legal advice. Reading this article does not create an attorney-client relationship. Because every situation is unique, you should consult with an attorney regarding your specific circumstances.
