Special Needs Trust Considerations

Special needs trusts allow families to provide financial resources for individuals with disabilities without disqualifying them from essential government benefits. The structure of these trusts is highly technical, and errors in drafting or administration can result in benefit termination and significant financial harm. This guide explains the two primary types of special needs trusts, their requirements, and their proper use.

Government Benefit Asset Limits

Understanding why special needs trusts exist requires understanding government benefit eligibility rules.

Supplemental Security Income (SSI)

SSI provides monthly cash payments to individuals who are aged, blind, or disabled and have limited income and resources. For 2024:

• Individual resource limit: $2,000
• Couple resource limit: $3,000
• Maximum monthly benefit: $943 (individual) or $1,415 (couple)

Resources counted toward these limits include cash, bank accounts, stocks, bonds, and most property. An inheritance received directly by an SSI recipient would count as a resource and, if over $2,000, would terminate benefits.

Medicaid

Medicaid provides healthcare coverage, including services often critical for individuals with disabilities:

• Personal care attendants
• Home and community-based services
• Long-term care
• Prescription medications
• Specialized therapies

Medicaid eligibility rules vary by state but generally align with SSI asset limits for disabled individuals. Losing Medicaid can mean losing access to care that costs tens of thousands of dollars annually.

The Special Needs Trust Solution

A properly drafted special needs trust holds assets for the benefit of a disabled individual without those assets counting toward benefit eligibility limits. The trust supplements government benefits rather than replacing them.

First-Party Special Needs Trusts

First-party special needs trusts (also called self-settled or d4A trusts, after the authorizing statute) are funded with the disabled individual's own assets.

When First-Party Trusts Are Used

Common situations requiring first-party trusts:

• Personal injury settlement awarded to a disabled person
• Inheritance received directly by a disabled individual
• Divorce settlement or other legal award
• Retroactive Social Security disability payments

Requirements for First-Party Trusts

Federal law under 42 U.S.C. § 1396p(d)(4)(A) establishes strict requirements:

Age Requirement: The trust must be established before the beneficiary reaches age 65.

Disability Requirement: The beneficiary must meet Social Security's definition of disability.

Establishment: The trust must be established by a parent, grandparent, legal guardian, or court. The disabled individual cannot establish their own first-party trust (though they can petition a court to do so).

Irrevocability: The trust must be irrevocable.

Sole Benefit: Trust assets must be used for the sole benefit of the disabled beneficiary during their lifetime.

Medicaid Payback: Upon the beneficiary's death, any remaining trust assets must first reimburse Medicaid for benefits paid during the beneficiary's lifetime.

Medicaid Payback Provision

The payback requirement is the defining characteristic of first-party trusts. When the beneficiary dies:

1. The state Medicaid agency files a claim against the trust
2. The trust must reimburse Medicaid for all medical assistance paid
3. Only remaining assets after Medicaid reimbursement pass to other beneficiaries

This payback can consume the entire trust. If Medicaid provided $400,000 in lifetime benefits and the trust holds $350,000 at death, no assets remain for other beneficiaries.

Pooled Trusts as an Alternative

Individuals over age 65 or those who prefer professional management may use pooled trusts under 42 U.S.C. § 1396p(d)(4)(C):

• Managed by nonprofit organizations
• Individual accounts within a larger pooled fund
• Lower minimum contributions (often $5,000 to $10,000)
• Professional trustees handle administration
• Upon death, remaining funds may stay in the pool for other beneficiaries

Pooled trusts still require Medicaid payback, but the payback may be satisfied from the pool rather than individual accounts in some states.

Third-Party Special Needs Trusts

Third-party special needs trusts are funded with assets belonging to someone other than the disabled beneficiary, typically parents or grandparents.

Key Advantages

No Medicaid Payback: Because the assets never belonged to the beneficiary, there is no requirement to reimburse Medicaid at death. Remaining assets can pass to siblings, other family members, or charity.

No Age Limit: Third-party trusts can be established at any time, regardless of the beneficiary's age.

Greater Flexibility: The trust grantor has more control over terms, successor beneficiaries, and distribution standards.

Lifetime or Testamentary: Third-party trusts can be created during the grantor's life or through a will.

Establishing Third-Party Trusts

Parents and grandparents should establish third-party special needs trusts as part of their estate planning. Key considerations:

Standalone Trust vs. Subtrust: A special needs trust can be a separate document or a subtrust within a revocable living trust.

Trustee Selection: Choose a trustee who understands both fiduciary duties and government benefit rules. Options include:

• Family members with appropriate knowledge
• Professional trustees (banks, trust companies)
• Pooled trust organizations
• Co-trustees combining family involvement with professional expertise

Funding During Life vs. At Death: Some parents fund third-party trusts during their lifetimes through gifts. Others leave the trust unfunded until death, when it receives assets through the will or beneficiary designations.

Permissible Trust Distributions

What a special needs trust can and cannot pay for determines its practical value. The goal is supplementing government benefits, not replacing them.

Generally Permissible Distributions

• Housing costs (rent, mortgage, property taxes, utilities, maintenance)
• Vehicle purchase and maintenance
• Education and vocational training
• Medical and dental care not covered by Medicaid
• Therapies and treatments
• Personal care items
• Entertainment, travel, and recreation
• Furniture and household items
• Technology (computers, tablets, adaptive devices)
• Legal and advocacy services
• Burial and funeral expenses

Distributions Requiring Caution

Cash Payments: Direct cash to the beneficiary counts as income and may reduce or eliminate SSI. Trustees should pay vendors directly rather than providing cash.

Food and Shelter: Payments for food and shelter may trigger SSI's In-Kind Support and Maintenance (ISM) rules, reducing the SSI benefit by up to one-third. The reduction is capped, so this may still be worthwhile for significant housing costs.

Calculating ISM Impact: If the trust pays $1,500 monthly rent and the beneficiary receives $943 monthly SSI, the ISM reduction would be approximately $314 (one-third of $943), leaving $629 in SSI. The beneficiary still receives the housing benefit plus reduced SSI.

Prohibited Distributions

• Payments directly to the beneficiary (use third-party payments instead)
• Distributions that could be characterized as support from a legally obligated party
• Payments for items that would substitute for Medicaid-covered services

Worked Example: The Patterson Family

Robert and Susan Patterson have three children. Their middle child, Michael, age 32, has Down syndrome and receives SSI ($943/month) and Medicaid. The Pattersons have a $1.2 million estate and want to leave $500,000 for Michael's lifetime care while also providing for their other two children.

The Problem with Direct Inheritance

If Michael inherits $500,000 directly:

• His assets exceed the $2,000 SSI limit on day one
• SSI terminates immediately
• Medicaid terminates (after a brief coverage period)
• Michael must spend down $498,000 before benefits resume
• The inheritance meant to last a lifetime could be consumed in a few years paying for care Medicaid would have covered

The Special Needs Trust Solution

The Pattersons' estate plan includes a third-party special needs trust for Michael.

Trust Structure:

Trust Provisions:

• Purely discretionary distributions for supplemental needs
• Explicit prohibition on distributions that would impair benefit eligibility
• Trustee must consider impact on government benefits before any distribution
• Spendthrift provisions protecting assets from creditors
• No Medicaid payback requirement (third-party trust)

Projected Trust Administration

Assuming 5% annual return and 4% annual distribution:

Year 1 Trust Budget: $20,000

Projected 30-Year Outcome:

With conservative investment and controlled distributions:

• Beginning balance: $500,000
• Annual distribution: 4% ($20,000 initially, adjusted for inflation)
• Annual return assumption: 5%
• Projected balance after 30 years: Approximately $450,000 to $550,000

Michael receives supplemental support throughout his life while maintaining full SSI and Medicaid benefits. At Michael's death, any remaining trust assets pass to his siblings without Medicaid payback.

Coordination with Other Planning

The Pattersons also:

• Update beneficiary designations on IRAs to name the special needs trust (not Michael directly)
• Inform grandparents to direct any gifts or bequests to the trust, not Michael
• Purchase a $500,000 second-to-die life insurance policy payable to the trust to ensure funding
• Advise their other children to include similar trust provisions in their own estate plans

Special Needs Trust Checklist

Determining Trust Type

• Identified source of funds (beneficiary's assets vs. third-party assets)
• Confirmed beneficiary meets disability definition
• Evaluated age limitations for first-party trusts
• Considered pooled trust option if appropriate
• Understood Medicaid payback implications

Trust Drafting

• Engaged attorney experienced in special needs planning
• Included required statutory language for first-party trusts
• Made trust purely discretionary (not mandatory distributions)
• Included spendthrift provisions
• Added explicit benefit preservation language
• Named appropriate remainder beneficiaries

Trustee Selection

• Selected trustee knowledgeable about benefit programs
• Named successor trustees
• Considered professional trustee for complex situations
• Established trustee compensation terms
• Provided guidance letter for trustee

Funding

• Determined funding amount appropriate for beneficiary's needs
• Coordinated beneficiary designations on retirement accounts and insurance
• Notified family members to direct gifts to trust
• Considered life insurance to guarantee funding

Government Benefit Coordination

• Verified current SSI and Medicaid eligibility
• Notified Social Security Administration of trust establishment (first-party)
• Provided trust document to benefit agencies as required
• Documented beneficiary's current benefit amounts

Ongoing Administration

• Established record-keeping system for distributions
• Created annual reporting process
• Scheduled regular reviews with benefits specialist
• Documented how each distribution supplements (not replaces) benefits
• Maintained awareness of benefit rule changes