First-Party vs Third-Party Special Needs Trusts – Understanding Your Options

A single unexpected check can complicate years of careful planning. When someone receiving Supplemental Security Income or SSI-related Apple Health coverage inherits money, receives a personal injury settlement, or gets a retroactive disability payment, those funds may affect eligibility if they become countable resources. For SSI and certain SSI-related Apple Health programs, the applicable resource limit for one person is $2,000, although other Apple Health programs use different eligibility rules. In the right circumstances, a first-party special needs trust can help preserve eligibility while allowing the funds to be used for the beneficiary’s benefit.

Special needs trusts come in two basic varieties, and the difference determines who can set one up, how it can be funded, and what happens to money left in the trust when the beneficiary dies. Sorting out which type fits a given situation is a common question for Washington families during estate planning, and getting it wrong can put the benefits the trust was meant to protect at risk.

What Makes a Trust a “Special Needs” Trust?

A special needs trust, sometimes called a supplemental needs trust, is designed to hold and manage assets for a person with a disability while helping preserve eligibility for needs-based benefits when the trust meets the applicable federal and Washington requirements. The trustee can generally use trust funds for the beneficiary’s benefit without simply handing the assets to the beneficiary, but the effect of a distribution can depend on what the trust pays for and which benefit program is involved. The rules are especially important when the beneficiary receives SSI or SSI-related Apple Health coverage. 

First-Party Special Needs Trusts – Funded With the Beneficiary’s Own Assets

A first-party special needs trust (also called a self-settled trust) is funded with money or property that already belongs to the person with the disability. Common sources include a personal injury settlement, an inheritance received outright in the beneficiary’s own name, a divorce settlement, or accumulated SSI back-payments.

Because the beneficiary technically owned these assets before the trust existed, federal law imposes stricter conditions. An individual first-party trust must be created for a beneficiary who is disabled and under 65 when the trust is established, and it may be established by a parent, grandparent, legal guardian, court, or the beneficiary themselves, as permitted under federal law. In Washington, the Health Care Authority’s rules for these self-settled trusts spell out how the state evaluates them for Medicaid eligibility.

An individual first-party special needs trust must include a Medicaid payback provision under federal law. When the beneficiary dies, the state may recover from the remaining trust assets up to the amount of Medicaid assistance paid on the beneficiary’s behalf. Pooled first-party trusts have a related but somewhat different rule: amounts remaining in the beneficiary’s account may be retained by the pooled trust for other beneficiaries, while amounts not retained must be paid to the state to the extent required by federal law. Washington’s rules address both types of self-settled trusts.

Third-Party Special Needs Trusts – Funded by Someone Else

A third-party special needs trust holds assets that never belonged to the beneficiary. Parents, grandparents, siblings, or friends fund it with their own money, often as part of a will, a life insurance policy, or a living trust set up well before it’s ever needed. Because the beneficiary never owned the funds, there’s no Medicaid payback requirement. Whatever remains in the trust when the beneficiary dies can go to other family members, a charity, or wherever the person who created the trust directed. It can be created immediately through a living trust or built into a will as a testamentary trust that only takes effect after the grantor’s death.

Washington’s Medicaid rules generally provide that an irrevocable third-party trust is not counted as an available resource when the beneficiary does not have the power to access or control the trust assets or distributions. Families often use third-party trusts because they generally do not require Medicaid payback, and because the trust can be incorporated into broader estate-planning arrangements when the trust terms and applicable law permit. 

Key Differences at a Glance

The basic distinction comes down to whose money goes into the trust and what rules apply to those assets. But there are also important differences in age requirements, who can establish the trust, and what happens to the remaining funds.

• Funding source. First-party trusts hold the beneficiary’s own money; third-party trusts hold someone else’s.
• Medicaid payback. An individual first-party trust requires a Medicaid payback provision; pooled first-party trusts follow a related federal payback structure. Third-party trusts generally do not require Medicaid payback.
• Age limit. An individual first-party trust generally must be established while the beneficiary is under 65. A qualifying pooled trust established under federal law does not have the same federal age restriction as an individual first-party trust, although other statutory requirements apply. Third-party trusts have no comparable federal age restriction.
• Who can establish it. Federal law permits an individual first-party trust to be established by the beneficiary, a parent, grandparent, legal guardian, or court, provided the other requirements are met. Pooled first-party trusts have their own statutory requirements under federal law. Third-party trusts can generally be created by another person for the benefit of the individual with a disability.
• Remainder beneficiaries. Individual first-party trust assets are subject to Medicaid recovery at the beneficiary’s death. Pooled first-party trusts have specific rules governing amounts retained by the pooled trust and amounts subject to state recovery. Third-party trust assets generally pass according to the trust’s terms without a Medicaid payback requirement.

What Type of Special Needs Trust Do I Need?

The right structure depends on where the money comes from and how much control the beneficiary will have over it. First-party and third-party trusts can also be structured in different ways, so families should consider more than just who funds the trust.

• Individual or pooled. An individual first-party trust holds the beneficiary’s own assets. A pooled first-party trust maintains a separate account for the beneficiary within a larger trust managed by a nonprofit association.
• Third-party planning. A third-party trust holds assets belonging to someone other than the beneficiary. Depending on the circumstances, it can be structured as an individual trust or, where appropriate, through a pooled arrangement.
• Using more than one tool. A family may pair a special needs trust with an ABLE account for certain expenses. Since January 1, 2026, federal law allows individuals whose qualifying disability began before age 46 to satisfy the age requirement for an ABLE account. This expanded the previous age limit, although the disability-onset requirement and other ABLE eligibility rules still apply. Washington updated its ABLE rules to reflect the federal change. An ABLE account does not necessarily replace a special needs trust, and the two tools can sometimes work together depending on the beneficiary’s needs, available assets, and eligibility for means-tested benefits.
• Trustee control. The beneficiary’s ability to access or control trust assets can affect benefits eligibility. Washington rules generally provide that a third-party trust is not an available resource when the beneficiary has no power to access or control the trust assets or distributions. Washington law also places limits on discretionary distributions when a beneficiary serves as trustee under RCW 11.98.200.

Choosing the right trustee is an important part of protecting the trust’s intended purpose and avoiding unnecessary problems with benefits eligibility.

Food Payments and SSI

Since September 30, 2024, the Social Security Administration no longer includes food in its in-kind support and maintenance calculations for SSI. That gives special needs trustees more flexibility when paying directly for groceries, meals, or other food for a beneficiary. Shelter expenses, such as rent and utilities, remain subject to SSI rules and can still affect the beneficiary’s payment. Cash or gift cards for food are also treated differently and may count as income.

Key Takeaways

• A properly structured special needs trust can help preserve eligibility for certain means-tested benefits while providing funds for a beneficiary’s supplemental needs.
• A first-party trust holds the beneficiary’s own assets and, depending on the structure, is subject to Medicaid recovery requirements.
• A third-party trust holds assets belonging to someone else and generally does not require a Medicaid payback provision.
• The right trust depends on the source of the funds, the beneficiary’s circumstances, the trust structure, and the level of control the beneficiary will have.
• Trustee selection matters because a beneficiary’s access to or control over trust assets can affect benefits eligibility. Washington also limits certain discretionary distributions when a beneficiary serves as trustee.
• Since September 30, 2024, SSI no longer includes food in its in-kind support and maintenance calculations, giving trustees more flexibility when paying directly for food while shelter expenses remain subject to SSI rules.

Frequently Asked Questions

Q. Can a first-party special needs trust be converted into a third-party trust?

A. Not simply by changing the trust’s name or amending its terms. Assets that already belong to the beneficiary generally remain subject to the rules that apply to first-party assets, including applicable Medicaid recovery requirements. A trust may also receive assets from third parties, but those assets do not retroactively become third-party assets merely because they are added to the same trust. Washington has specific rules for trusts containing both types of assets, and in some situations, a separate third-party trust may provide a cleaner structure. 

Q. Do third-party special needs trusts need to go through probate?

A. Not necessarily. A third-party trust created during the grantor’s lifetime, such as through a revocable living trust, generally does not require probate merely because it is a special needs trust. A testamentary trust created under a will generally becomes effective through the probate process. The trust’s specific terms and the assets being transferred can affect how the estate is administered.

Q. Can I set up a first-party special needs trust for myself?

A. Yes. Federal law allows an individual with a disability to establish an individual first-party special needs trust for themselves if the federal requirements are met. The beneficiary must generally be under 65 when the individual trust is established, and the trust must meet the other requirements of federal and Washington law.

Q. What happens to a first-party trust if there’s nothing left after the Medicaid payback?

A. If the remaining trust assets are fully used for required Medicaid recovery, there may be nothing left for other beneficiaries. If assets remain after the applicable recovery amount is paid, any remaining funds are distributed according to the trust terms and the rules governing that type of trust.

Q. Is a pooled trust the same as a third-party trust?

A. Not necessarily. “Pooled” describes how the trust is structured and managed, while “first-party” or “third-party” describes whose assets fund it. A pooled first-party trust can hold a beneficiary’s own assets in a separate account within a larger nonprofit-managed trust, while other pooled arrangements may involve third-party funds. The applicable federal and Washington rules depend on the type of pooled trust and the source of the funds.

Get Clarity on Your Family’s Special Needs Trust Options

Deciding between a first-party and third-party special needs trust isn’t a decision to make from a checklist. It depends on the source of the funds, the beneficiary’s age, whether Medicaid has already paid for care, and how the rest of the family’s estate plan is structured. A trust drafted without those details in mind can put SSI or Apple Health coverage at risk at the exact moment a family needs it most.

James A. Jones Attorney At Law has spent more than 20 years working with Tacoma and Pierce County families on trusts built around a loved one’s disability, from a first personal injury settlement to a decades-old family trust that needs updating. You can read more about James’s background or his work in special needs planning before reaching out.

If your family is trying to figure out which type of trust fits your situation, or you’re worried an existing trust wasn’t built correctly, a Washington special needs attorney can walk through the details with you before a decision becomes hard to undo. A free consultation is available to talk through your specific circumstances and lay out the options that make sense for your family.