Parents, grandparents, and relatives often want to leave money to a loved one with disabilities. The goal is simple: provide stability, dignity, and quality of life. The problem is that leaving assets directly to a person who receives means-tested benefits can create benefit issues. A third-party Special Needs Trust is often the planning tool that solves this problem.
Unlike a first-party Special Needs Trust, a third-party SNT is funded with assets that never belonged to the beneficiary. That distinction affects SSI treatment, Medi-Cal recovery, beneficiary designations, tax planning, and who receives remaining trust assets after the beneficiary’s death.
What Is a Third-Party Special Needs Trust?
SSA defines a third-party trust as a trust established with assets belonging to someone other than the trust beneficiary or the beneficiary’s spouse.1 DHCS similarly describes third-party funded SNTs as trusts funded with assets belonging to someone other than the beneficiary and to which the beneficiary never had possession or legal interest.2
Common funding sources include a parent’s living trust, a grandparent’s will, life insurance, investment accounts, real property, and gifts from relatives. The key is that the beneficiary should not receive the assets outright first. Once the assets legally belong to the beneficiary, the planning may shift from third-party trust planning to first-party payback trust planning.
Why Not Leave Assets Directly?
SSI eligibility is resource-sensitive. SSA states that the countable resource limit is $2,000 for an individual and $3,000 for a couple.3 An outright inheritance, beneficiary designation, or gift can push the beneficiary over the limit.
Medi-Cal rules also require current review. DHCS states that beginning January 1, 2026, Medi-Cal again counts assets for many affected categories, including individuals who are 65 or older, have a disability, live in a nursing home, or fall within certain income categories. The 2026 asset limit is listed as $130,000 for one person, plus $65,000 for each additional eligible family member, subject to program-specific rules.4
The purpose of a third-party SNT is to hold assets for the beneficiary’s supplemental needs while avoiding direct ownership or control by the beneficiary. SSA policy provides that if the beneficiary cannot revoke or terminate the trust, and cannot direct the use of the trust assets for support and maintenance, the trust principal is generally not the beneficiary’s SSI resource.5
Why Third-Party Trusts Are Different From First-Party Trusts
A first-party SNT is funded with the beneficiary’s own assets and generally requires a Medicaid payback provision. A third-party SNT is different. DHCS states that third-party trusts are not subject to recovery by DHCS.2
That is one of the major advantages of planning early. The person creating the trust can usually decide who receives any remaining assets after the disabled beneficiary’s death, such as siblings, nieces and nephews, charities, or other family members. By contrast, first-party SNTs generally must repay the State before remainder beneficiaries receive anything.
Standalone SNT or Sub-Trust Inside a Living Trust?
A third-party SNT can be drafted as a standalone trust or as a sub-trust inside a parent’s revocable living trust. Both can work if drafted properly. However, a standalone third-party SNT often provides cleaner administration where multiple people may fund it over time.
For example, a standalone SNT can be named as beneficiary of life insurance, bank accounts, investment accounts, and gifts from relatives. It can also be shared with grandparents or other family members who want to include the beneficiary in their own estate plan. This reduces the risk that one well-intentioned relative leaves money directly to the beneficiary and unintentionally creates a benefits problem.
Retirement Accounts Require Special Planning
IRAs and 401(k)s require careful beneficiary planning. The IRS explains that non-spouse beneficiary options depend in part on whether the beneficiary is an “eligible designated beneficiary.” Disabled and chronically ill individuals are included in that category.6
That does not mean a retirement account should casually name a Special Needs Trust without tax advice. Trust drafting, conduit versus accumulation treatment, applicable multi-beneficiary trust rules, required minimum distributions, income tax brackets, and beneficiary designation language can all change the tax result. For some families, life insurance or after-tax assets may be easier to direct to the SNT than retirement assets. For others, retirement assets can be coordinated, but the drafting must be precise.
What Can the Trustee Pay For?
A trustee should usually pay vendors directly rather than give cash to the beneficiary. SSA policy treats cash paid directly from the trust to the beneficiary as unearned income. Payments for food or shelter can create in-kind support and maintenance. Payments to third parties for items such as education, therapy, transportation, professional fees, uncovered medical services, phone bills, recreation, and entertainment generally may avoid income treatment depending on the item purchased and the facts.7
Common supplemental expenses may include dental care not covered by benefits, therapies, assistive technology, phone and internet service, transportation, recreation, education, clothing, companion care, furniture, and quality-of-life expenses. The trustee should understand the beneficiary’s benefits, keep receipts, document decisions, and coordinate with the beneficiary’s representative payee or benefits advocate when appropriate.
Trustee Selection Matters
The trustee controls the funds. That role should not be treated as honorary. The trustee must understand fiduciary duties, investment management, tax reporting, SSI and Medi-Cal rules, distribution restrictions, accounting, and family dynamics.
Some families choose a trusted family member. Others use a private professional fiduciary, bank, trust company, or nonprofit trustee. In many plans, a family member may serve as trust protector, advisory committee member, or care advocate while a professional trustee handles administration.
Common Mistakes
The most common mistake is leaving assets directly to the beneficiary. Other mistakes include naming the beneficiary individually on life insurance, leaving a retirement account directly to the beneficiary without tax and benefits review, using mandatory distribution language, giving the beneficiary the right to demand distributions, or letting relatives make gifts directly into the beneficiary’s personal bank account.
Another common mistake is waiting too long. A third-party SNT works best when it is created before anyone dies and before beneficiary designations are updated. Planning ahead gives the family time to coordinate the living trust, financial accounts, insurance, retirement assets, and instructions to relatives.
Key Takeaway
A third-party Special Needs Trust is often the most flexible and protective planning tool for parents and relatives of a loved one with disabilities. It can preserve eligibility for SSI and Medi-Cal, provide supplemental support, avoid first-party payback, and allow the family to choose remainder beneficiaries. The key is making sure the beneficiary never receives the assets directly.
Planning for a loved one with disabilities? Visit SdCountyTrusts.com to learn more about Special Needs Trust planning.
Legal Authorities and Sources
- SSA POMS, SI 01120.200, definition of third-party trust.
- California Department of Health Care Services, Special Needs Trust.
- Social Security Administration, Supplemental Security Income (SSI) Resources.
- California Department of Health Care Services, Asset Limit Frequently Asked Questions.
- SSA POMS, SI 01120.200, resource treatment of trusts.
- Internal Revenue Service, Retirement Topics—Beneficiary.
- SSA POMS, SI 01120.200, trust disbursement rules.