Third-Party Special Needs Trust
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SPECIAL NEEDS PLANNING
Third-Party Special Needs Trusts in Kentucky
If you have a child, grandchild or sibling with a disability, the most consequential decision in your estate plan is how you leave them anything at all. Leaving money to them directly, however generous the intention, can cost them the benefits they depend on and force the family to spend the entire inheritance restoring eligibility.
A third-party special needs trust is the answer, and it is a considerably better instrument than the first-party version. Because the money never belonged to the person with the disability, there is no Medicaid payback on their death, no age restriction, and you decide where anything remaining goes.
This is planning that has to be done by the person giving the money, in their own will or trust, while they are alive to do it. It cannot be arranged afterwards by the family.
Every relative planning to leave something should know about this. Call (502) 348-2108 for a free consultation.
What a Third-Party Trust Is
A third-party special needs trust holds assets that have never belonged to the person with the disability. It is typically created by a parent or grandparent, either within their will so that it comes into existence at death, or as a standalone trust that can also receive gifts and life insurance during life.
Its terms allow the trustee to use the funds for the beneficiary benefit in ways that supplement rather than replace public benefits. Because the beneficiary has no right to demand distributions, and never owned the assets, the trust is not treated as an available resource for Supplemental Security Income or Medicaid.
Kentucky trust law supports this directly. KRS 386B.5-020(8) provides that certain trusts, including special needs trusts and trusts described in the federal Medicaid provisions, are not treated as having been settled by the beneficiary for spendthrift purposes.
Why It Is Better Than the Alternatives
Families who understand only that they should not leave money directly sometimes reach for solutions that are worse than the problem.
Disinheriting, and the handshake arrangement
The most common workaround is to leave nothing to the child with a disability and instead leave a larger share to a sibling, with an understanding that they will look after them. It is well intentioned and it fails regularly. The sibling money is exposed to their divorce, their creditors and their own death, they may have needs of their own, and the arrangement is unenforceable. We have seen it go wrong often enough to advise against it every time.
Compared with a first-party trust
A first-party trust, funded with the beneficiary own money after a direct inheritance, must include a provision repaying the state for medical assistance on their death before anything passes to family. A third-party trust has no such requirement. Whatever remains goes where you direct it, typically to siblings or grandchildren. The difference over a lifetime of benefits can be very substantial, and it is available simply by planning ahead rather than leaving money directly. See first-party special needs trusts.
There is also no age condition. A first-party trust must be established before the beneficiary turns sixty-five. A third-party trust can be created for a beneficiary of any age.
How It Is Set Up
Inside your will, or as a standalone trust
A testamentary version comes into existence at your death. A standalone trust exists now and can receive gifts, life insurance and contributions from other relatives during your lifetime.
Funded by whatever you choose
A share of your estate, a life insurance policy naming the trust as beneficiary, retirement account proceeds where appropriate, or lifetime gifts.
A trustee who understands benefits
A family member, a professional trustee, or a combination. The trustee needs to understand how distributions affect eligibility, because that is where well-meant generosity does damage.
Distribution standards drafted with care
The beneficiary must not have the right to demand money. The trustee holds discretion, exercised for supplemental purposes.
Remainder beneficiaries you choose
You direct where anything left goes on the beneficiary death, typically to their siblings or to grandchildren. No payback to the state applies.
Coordination with the rest of the family
Grandparents and other relatives should name the trust rather than the individual in their own plans. One relative leaving money directly can undo everything.
The Conversation Nobody Has
The most frequent way a carefully built plan fails is that another relative did not know about it.
A grandparent leaves a share of their estate to each grandchild by name, including the one with a disability. An aunt names nieces and nephews equally on a life insurance policy. A parent updates a beneficiary designation without thinking about it. Each of these delivers money directly to the person with the disability, and each can trigger a loss of benefits and force the creation of a first-party trust with a mandatory payback.
The fix is straightforward and it is a conversation rather than a document. Once a third-party trust exists, every relative who intends to leave anything should name the trust rather than the individual, in their wills and on their beneficiary forms.
We encourage families to circulate that information plainly, because it costs nothing and it is the single most effective protective step available. It is also the step families most often skip out of awkwardness about discussing money and disability at the same time.
What the Trust Can Provide
The point is a fuller life, not merely a maintained eligibility status.
01
Housing support, handled carefully
Payments for shelter can reduce Supplemental Security Income, so housing needs deliberate structuring. It is often one of the most valuable things the trust does and one of the most technical.
02
Education, therapy and equipment
Tuition, training, therapies, assistive technology and equipment that public programmes will not fund.
03
Transport
A vehicle, adaptations, insurance and running costs. Consistently among the most useful expenditures for families.
04
Companionship and support services
Care and support beyond what Medicaid provides, including services that allow the beneficiary to live more independently.
05
An ordinary life
Holidays, hobbies, memberships, technology and the things nobody thinks of as care but which make a life worth living.
If you are drafting a will and have a relative with a disability, raise it with us. It changes the whole structure. (502) 348-2108.
Kentucky Programmes to Plan Around
A trust works alongside the public benefits and services the beneficiary receives, so the plan should be built with those in view.
Supplemental Security Income has a strict resource limit, and it is usually the benefit most at risk from a direct inheritance. Medicaid eligibility frequently follows from it, which is why a modest amount of money arriving in the wrong way can cascade into the loss of health coverage.
Kentucky also operates home and community based services waivers, including Supports for Community Living and the Michelle P. Waiver, which fund services allowing people to live in the community rather than in an institution. Waiting lists and eligibility rules for these programmes are their own subject, and families should not put access at risk inadvertently.
A STABLE Kentucky account under the ABLE programme sits well alongside a third-party trust, giving the beneficiary a pot of money they can manage themselves within annual contribution limits, for a qualifying disability that began before the applicable age, now forty-six. The figures are adjusted annually.
- No Medicaid payback on the beneficiary death
- No age restriction on the beneficiary
- You choose who receives any remainder
- Can be created in your will or as a standalone trust
- Can receive life insurance and gifts from other relatives
- The beneficiary must have no right to demand distributions
- Every relative should name the trust, not the individual
Special Needs Planning in Bardstown and Louisville
Thomas Hamilton has been admitted to the Kentucky bar since 2011 and has concentrated on elder law since 2014. He is a member of the Kentucky Bar Association Elder Law Section and the National Academy of Elder Law Attorneys.
We work with families throughout Nelson, Bullitt, Washington, Marion, Larue, Hardin, Anderson, Spencer and Jefferson counties, from 117 E. Stephen Foster Avenue in Bardstown and the First Trust Centre, 200 S. 5th Street in Louisville.
These conversations often involve more than one generation, and we are glad to meet whoever needs to be there. The initial consultation is free. Schedule a consultation or read more about special needs planning.
Mistakes That Undo the Plan
Leaving money directly to the beneficiary
The mistake the trust exists to prevent. It can cost benefits and forces a first-party trust with a mandatory state payback, wasting much of what you intended to give.
Disinheriting and relying on a sibling
Unenforceable, and exposed to the sibling divorce, creditors and death. It fails often enough that we advise against it without exception.
Not telling the wider family
One grandparent naming the individual rather than the trust can undo everything. Circulate the information.
Forgetting beneficiary designations
Life insurance and retirement accounts pass by designation, not by your will. If the trust is to receive them, the forms have to say so.
Appointing a trustee without benefits knowledge
Generous but uninformed distributions, particularly cash or payments for food and shelter, can reduce the benefits the trust was created to protect.
Waiting
This planning must be done by the person giving the money, while they are able to do it. Once they are gone, the option is gone with them.
FREQUENTLY ASKED QUESTIONS
Common Questions About Third-Party Trusts
Can a trust protect an inheritance for my children?
Yes, and where a child has a disability it is essential. A third-party special needs trust holds the inheritance so it supplements rather than replaces means-tested benefits, and because the money never belonged to the beneficiary there is no requirement to repay the state on their death.
What happens if we just leave money to our son directly?
It can disqualify him from Supplemental Security Income and Medicaid, and the family may then have to establish a first-party trust with a mandatory Medicaid payback provision, or spend the inheritance restoring eligibility. Either way a large part of what you intended to give is lost, and it is entirely avoidable by planning in advance.
Should we disinherit him and leave more to his sister instead?
We advise against it. The money becomes hers legally, exposed to her divorce, her creditors and her own death, and any understanding about looking after her brother is unenforceable. A third-party trust achieves the same intention with none of the risk.
What happens to money left in the trust when he dies?
You decide. Unlike a first-party trust, there is no requirement to repay the state, so any remainder passes to the people you name, usually siblings or grandchildren. This is one of the strongest reasons to plan in advance rather than leave money directly.
Do other relatives need to do anything?
Yes, and this is the step most often missed. Any grandparent, aunt, uncle or other relative intending to leave something should name the trust rather than the individual, both in their wills and on beneficiary designations for life insurance and retirement accounts. One well-meaning direct gift can undo the whole plan.
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Plan It Now, Not Later
This is planning only you can do, and only while you are here to do it. Call attorney Thomas Hamilton at (502) 348-2108 or use the form below.
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117 E. Stephen Foster Avenue, Bardstown, KY 40004