Third-Party Special Needs Trusts in Pennsylvania: Protecting Benefits and Securing the Future

By: Adam Cohen, Esquire

Mette, Attorneys at Law

Families in Pennsylvania who want to provide for a loved one with disabilities often face a difficult challenge: how to leave financial support without disrupting access to vital public benefits like Supplemental Security Income (SSI) and Medicaid. One of the most effective solutions is establishing a third-party Special Needs Trust (SNT).

Unlike a first-party SNT, which is funded with the beneficiary’s own assets and subject to Medicaid payback, a third-party SNT is supported by parents, grandparents, or other relatives and friends. Properly structured, this type of trust shields assets from being counted as the beneficiary’s resources. This ensures continued eligibility for means-tested benefits while allowing remaining assets, after the beneficiary’s death, to pass to other heirs or charities—a significant advantage in long-term estate planning.

Legal Basis for Third-Party SNTs

Under Pennsylvania and federal law, third-party Special Needs Trusts (SNTs) are fully recognized. Unlike first-party trusts, they are not statutory creations but are permitted under both common law and federal SSI and Medicaid guidelines. These trusts are essential tools for preserving eligibility for:

• Medical Assistance (Pennsylvania Medicaid)
• Medicaid Waiver services
• Supplemental Security Income (SSI)

Because they are not dictated by statute, families creating these trusts have flexibility in:

• Drafting the trust: determining the terms and conditions
• Selecting assets: deciding which resources can be used to fund the trust
• Trustee authority: giving trustees broad powers to administer the trust

Key Requirements for Validity

To avoid being considered a “resource” of the beneficiary, the trust must meet certain conditions:

• It cannot be revoked by the beneficiary (though it may be revoked by someone else).
• Typically, the trust becomes irrevocable after the settlor’s death.
• The beneficiary must not have the right to direct the trustee or demand distributions.
• Trustees should follow guidelines that supplement, not replace, public benefits.
• The beneficiary’s government benefits must always be considered before distributions are made.

When properly drafted and administered, a third-party SNT will not jeopardize the individual’s eligibility for public benefits—either now or in the future.

Why Benefits Matter

Protecting a disabled individual’s eligibility for public benefits is often essential, even when a Special Needs Trust (SNT) will hold significant assets. Many individuals with disabilities cannot work and cannot fully support themselves. Programs like Supplemental Security Income (SSI) provide less than $1,000 per month, making it nearly impossible to live on, even with food assistance and Medicaid.

While those receiving Social Security Disability Insurance (SSDI) are not subject to the same strict income and asset limits as SSI recipients, Medicaid remains a critical factor in both cases. Medicaid coverage ensures access to services that private funds often cannot fully provide, such as:

• Comprehensive medical care and prescription coverage
• Housing assistance and support with daily living needs
• Employment services and work placement programs
• Case management and coordination of care
• Specialized Waiver programs that cover long-term disability services

Because these benefits are so vital, maintaining Medicaid eligibility is crucial. Special Needs Trusts play an essential role in ensuring that individuals with disabilities can continue to receive this support.

Uses for Third-Party SNTs

Third-party Special Needs Trusts can serve families in various ways, depending on their financial goals and the beneficiary’s needs. The following are some of the most common scenarios where these trusts provide significant benefits.

Inheritance Protection

Perhaps the single most common scenario in which third-party SNTs are employed is the area of inheritance protection. As noted above, if an individual receives even a modest inheritance, they will likely lose benefits. While these funds may be placed into a first-party (payback) SNT, enabling the continuation of benefits, this payback defeats the wealth preservation aspect of the planning. Third-party trusts are preferred.

Funding Strategies

Some individuals choose to create trusts that remain empty, waiting for an influx of assets upon the passing of a family member or individual, and then designating the trust to receive the inheritance. Other individuals choose to establish third-party SNTs during their lifetime and begin to fund the trusts. The strategy employed often relates to the individual creating the trust, their goals, and the anticipated needs of the beneficiary.

Funding strategies are detailed briefly below, but are best employed after discussing the plan with an experienced attorney. A comprehensive plan should be in place, with the SNT simply being a component of that overall plan. The plan is as important, if not more important, than the document itself.

Trustee Flexibility

Third-party SNTs afford trustees significant flexibility. Trustees (chosen appropriately) can invest and utilize the funds to meet the settlor’s goals and to accommodate the beneficiary’s evolving needs. Medicaid and SSI cover bare minimums and often leave disabled individuals wanting or needing more services. SNTs can fill in these gaps. The funds within the trust are used to enhance the disabled individual’s life, affording them the opportunities, dignity, and enjoyment of life that they deserve, but which neither they nor public benefits can provide for themselves.

Asset Distribution After Death

Upon the disabled beneficiary’s death, any remaining third-party SNT assets do not have tobe used to repay the government for Medicaid or benefits (unlike in first-party trusts). Instead, they can pass to remainder beneficiaries—such as family, trusts, or charities— as the settlor decides.

Integrating a Special Needs Trust into the Estate Plan

A third-party SNT is most effective when it is woven into the family’s overall estate planning strategy. As noted above, an experienced attorney should be consulted to assist in determining who should control the trust, who should fund the trust, how the trust should be funded, and who else should be involved in administering the trust.

Lifetime Funding Options

Creating a lifetime third-party SNT can afford an individual significant flexibility in how the trust is funded. It’s common to designate the SNT as the beneficiary of life insurance policies and investment accounts, ensuring that these assets bypass probate and go directly into the trust.

Retirement Accounts and Tax Benefits

For individuals with significant assets in retirement accounts (such as IRAs and 401(k)s), an SNT can be a great vessel to receive those inherited funds. A special needs trust beneficiary (through the trust) can be treated as an eligible designated beneficiary for income tax purposes, affording a lifetime payout (lifetime RMD stretch) of the retirement assets. This can significantly mitigate the income tax burden that otherwise would be faced by non-disabled individuals who receive these assets.

Types of Assets in a Third-Party SNT

Typically, there is no limit on what a third-party SNT can hold in assets. While it may not be practical for such a trust to own an airplane, yacht, or business interests, it can have these assets in the same manner as any other trust. It is typical for a third-party SNT to hold a house, especially the home where the disabled individual is thriving. Consideration should be given to how that home, and its expenses, will be paid for in the future.

Integration with Advanced Estate Planning

Third-party SNTs can also be integrated into the estate plans of high-net-worth individuals who typically engage in more complex estate and tax planning. For example, SNTs can be used in concert with Charitable Remainder Trusts, Crummey Trusts, and ILITs.

In these situations, a third-party SNT may be employed, like trusts used in wealth planning for non-disabled heirs, with one significant caveat: special consideration must be given to the rights and powers granted to the disabled beneficiary. As noted above, if a beneficiary is granted additional rights or powers, the assets within the trust may jeopardize their benefits (and potentially affect the trust’s viability).

Why a Corporate Trustee Often Makes Sense

Families might consider appointing a relative or friend as trustee. Although this can work in certain situations, the complexity of managing an SNT often makes using a corporate trustee, such as a bank, trust company, or dedicated fiduciary organization, a better option.

Expertise and Oversight

Corporate trustees possess the expertise to invest assets in a manner that strikes a balance between growth and preservation. They can create portfolios that offer both income and long-term growth, tailored to the expected needs. They are experienced in best practices in this field.

Corporate trustees are regulated and must maintain detailed records, file accountings and tax returns, and adhere to fiduciary standards, providing families with added confidence. They also ensure trust distributions are carefully coordinated with SSI and Medicaid guidelines. Trustees typically have internal expertise or connections with legal counsel to make sure payments for food, shelter, or other essentials don’t unintentionally reduce benefits.

Long-Term Stability

A corporate trustee offers stability over decades. This is critically important for beneficiaries who may need support for their entire lifetime. The trustee provides a neutral and professional presence in situations where family dynamics often complicate decision-making. Having a sibling be the barrier between a disabled individual and (what they perceive as) their money will usually result in a strained sibling relationship. While the sibling may have otherwise been the disabled person’s best advocate, their relationship may become unworkable, leaving the disabled person isolated.

Collaboration with Financial Advisors

For families with relationships with investment managers and other financial advisors, it is often possible to draft these trusts to enable a continued relationship with the financial advisory team, which outsources the specific trust administration tasks to a professional trustee. This is often a desirable outcome for many families.

Putting it All Together

Third-party SNTs are among the most powerful estate-planning tools available for individuals wanting to provide for a loved one with disabilities, without jeopardizing critical public benefits. When properly drafted and administered, they allow enhancement of quality of life, protection of assets, and flexibility in how funds are used and passed on after death.

However, they require careful planning, knowledgeable legal counsel, ongoing oversight, and trustee choices that reflect both compassion and competence. For many families, the peace of mind that comes with knowing there is a plan in place outweighs the costs and complexity.

Contact Mette today to speak with an experienced Pennsylvania estate planning attorney about creating a third-party Special Needs Trust that protects your loved one’s future.