Search
Menu

Special Needs Trust

Updated: January 6, 2023

For many with a serious disability, health insurance is a major consideration and it becomes crucial to get coverage under Medicaid for many reasons.

  • They may need Supplemental Security Income for everyday care and living expenses, as well as vocational rehabilitation and/or subsidized housing.
  • They may need medical treatment and services for the rest of their lives, often very expensive.
  • They may never hold a job that offers health insurance.
A special needs trust is a way to assure your beneficiary is still eligible for any or all of these programs and has access to assets to pay for things not covered by those benefits. Because the trust is able to provide for their needs and has the same protections all irrevocable trusts have, they can be useful even if they do not require any of these programs. A special needs trust is a type of discretionary trust that is specific for beneficiaries with long-term physical disabilities, psychological conditions, and/or cognitive deficits, especially those that will prevent them from managing their own finances. It can be referred to as a supplemental needs trust and allows beneficiaries needing extensive medical treatments, specialized equipment, assisted living facilities, and various other services for life to qualify for need-based benefits that have income limits. Special needs trusts are predominantly created by parents for their children. Most of these trusts are testamentary trusts and are created and funded by your assets after you and your spouse have died. Less commonly, this type of trust can be created and used while you are still alive (living trust). A living special needs trust is preferable if others are going to contribute to the trust. Anyone but the beneficiary can donate assets to it, even those without any family relationship. Assets that can be added to the trust include:
  • Non-monetary assets, such as real estate, stocks, collections, a business, patents, or jewelry and other personal items; and
  • Funds in your will, a living trust, or pay on death funds like bank accounts, annuities, retirement accounts, certificates of deposit, money markets, a life insurance settlement, or a settlement on behalf of your disabled beneficiary.
    • If you transfer a retirement savings account while you’re alive, the amount transferred is considered a withdrawal.
    • For pre-tax accounts like a 401(k) or traditional IRA, you would owe income tax on the entire account balance when it’s used to fund the trust.
It is possible for multiple trusts to be created for a particular beneficiary. Special needs trusts have many features in common with any trust.
  • The assets go to your beneficiary upon your or your surviving spouse’s death.
  • It can only be used by the trustee for the needs of the beneficiary;
  • You can determine how, when, and why the assets are used.
  • The assets are protected from estate taxes, creditors or lawsuits, unless it’s apparent that the trust was created solely for this purpose.
  • Distributions from money earned by trust investments are taxed as income.

Unique Features of the Special Needs Trust

The primary goal of a special needs trust is to make sure your beneficiary is still able to receive Medicaid benefits for their healthcare and Supplemental Security Income (SSI). Since Medicaid benefits are only available to those with very limited income and resources, too many personal assets could result in your child or dependent having no health insurance at all. For them to qualify for Medicaid, you cannot leave assets directly to them and need to form a special needs trust. It is important to understand which assets do or do not affect eligibility for SSI or Medicaid in order to accomplish this.
  • Owning a house, a car, furnishings, routine personal effects, property essential for self-support, assets used toward an occupational goal, life insurance policies with cash surrender values less than $1,500, and burial insurance policies of any value will not jeopardize eligibility.
  • Many assets including some properties, money, and other countable resources over $2,000 will disqualify your beneficiary from benefits.
    • Countable resources include cash, checking and savings accounts, stocks and bonds, vacation homes, rental properties, or other real estate that is not their primary residence, IRA, 401(k), and other retirement assets, investment accounts, and Uniform Transfer to Minor Accounts.
    • While owning an expensive home or car will not affect their coverage, a gift of only $10,000 in cash would disqualify them. An exception is if they only receive Medicaid (not SSI); the home value may be limited to $500,000 – $750,000 depending on the state they live in.
For the trust to be eligible:
  • It must be shown that the trust is needed to meet any special needs and expenses your beneficiary likely to encounter;
  • The trust does not contain more assets than what appears reasonably necessary to meet your beneficiary’s needs;
  • The beneficiary cannot have any control over the trust; and
  • The trust conforms to state-specific regulations.
    • This may include changes to the trust if the beneficiary moves to a state with different regulations.
    • If that happens it is most likely that the administration of the trust would be guided by the state of origin, while the impact on the benefits would depend on the state where the beneficiary now lives.
The trust must be formed before your beneficiary turns 65 years old (the age when everyone is eligible for Medicare).
  • It can be used without penalty after they turn 65; disabled people on Medicare may still need Medicaid to cover all their medical bills and Supplemental Security Income to maintain their lifestyle.
  • No new assets can be added after they turn 65 without being subject to transfer penalty rules that prohibit getting Medicaid for a certain amount of time.
Beneficiaries must meet the government’s definition of “disabled” when the trust is established and funded. 
  • This may require that the court be involved to determine if the beneficiary is eligible for these benefits.
  • Both minors and adults must have a disability that constitutes a substantial handicap and substantially impairs their ability to provide for their own care or custody.
    • For adults this may include the inability to perform their current job or may only apply if they cannot work at all. Even if they are able to work, they could qualify if their monthly earnings are less than the current amount allowed in their state.
    • In practice, anyone who qualifies for SSI or Medicaid on the basis of disability will meet these requirements.
  • The condition must be on a Social Security Administration list of serious medical conditions that automatically considers them disabled. Common conditions include blindness, developmental disabilities, Down syndrome, organic brain damage, chronic mental illness, physical paralysis (paraplegia), or congenital disabling afflictions such as cerebral palsy or cystic fibrosis.
  • The disability has been present continuously for at least 12 months or is expected to result in their death.
  • The definition does not include partial or short-term disabilities.
  • Your application will be reviewed by your state’s Disability Determination Services before approval.
The trust agreement needs to be carefully worded to make it valid and absolutely clear on the directives and purpose of the trust.
  • It should include contingencies to authorize the trustee to amend the trust to account for changes in the law or the circumstances of the beneficiary, such as moving to a different state with different laws.
  • This ensures that essential government benefits are preserved if SSI or Medicaid alters their rules or if changes need to be made if they challenge the terms of the trust.
There are some important components of a special needs trust to make it valid.
  • The trust document must state that the trust is:
    • Intended to supplement — not supplant, impair or diminish — government benefits or assistance for which the beneficiary may otherwise be eligible; and
    • Not intended as a basic support trust.
  • There must be a clause that bans the trustee from using trust assets to pay for anything that will impair or diminish the beneficiary’s qualification for government benefits.
  • Do not include a “Crummey Clause,” which is an estate tax provision that allows the beneficiary temporary access to distribute assets from the trust.
  • Include the required language regarding payback to Medicaid if a first-party trust.
  • Explain the exception to the Omnibus Budget and Reconciliation Act.
  • Include a copy of the relevant provisions from the United States Code.
For guidance, reference the Social Security Operations Manual and the specific parts in the manual that authorize the creation of the special needs trust.

If it is a living trust, it can be revocable and you can be a trustee and name a successor. If the trust is created at your death, it is best to name a trustee who knows the beneficiary such as a surviving parent, sibling, or other close family member or friend. It is best if the trustee and/or successor trustee is not at significant risk of dying before your beneficiary. The trustee may need additional qualities to care for a disabled beneficiary that may include:

  • Knowledge of your beneficiary’s health, medical condition, and specific needs;
  • A good relationship with and empathy for your beneficiary; and
  • An even greater willingness to serve and get outside help, especially with understanding government rules.

The duties of the trustee are similar to all trusts, but additional responsibilities may include:

  • The authority to sell non-monetary items, such as cars or jewelry, to raise funds for care;
  • Arranging care for your beneficiaries needs and keeping accurate records about their care and their medical status;
  • Keeping up with laws on eligibility for SSI and Medicaid to ensure that the beneficiary continues to receive benefits;
  • Preparing annual reports as required by SSI and Medicaid;
  • Restricting the use of trust funds to goods or services not provided to the beneficiary by government benefits or other public assistance payments and avoiding paying for food, clothing, and shelter; and/or
  • Paying taxes on undistributed investment income. The trust is taxed at one of four tax rates, which are each much higher than those for individual income.

There are specific items the trustee can use the funds for that will not interfere with your beneficiary’s Medicaid and SSI benefits. 

  • The trustee can usually pay for anything for your beneficiary needs as long as it is not against public policy, illegal, and does not violate the terms of the trust.
  • Funds can be used to pay for personal care attendants, vacations, home furnishings, computers, out-of-pocket medical and dental expenses, services such as a cell phone, internet, cleaning, or pet care including pet food or veterinarian care, professional fees, transportation, education, recreation, specially-equipped vehicles, uncovered medical equipment, physical rehabilitation, and other permitted expenses. 
  • Any needs already covered by public assistance such as clothing, food, subsidized housing, and vocational rehabilitation that are paid for by the trust will be deducted from their benefits

The trust ends when it is no longer needed, including when the:

  • Beneficiary dies;
  • Trust funds have all been used;
  • Beneficiary no longer requires need-based government benefits that have income limits, such as becoming eligible for Medicare at 65 years old or social security at retirement age; and/or 
  • Beneficiary is no longer eligible for government benefits, such as if the condition improves or they get health insurance from another source.

Special needs trusts can be designated as first-party and third-party depending upon whose assets funds the trust, yours or your beneficiary’s.

First-Party Special Needs Trusts

A first-party or self-settled special needs trust will be needed if a person with a disability inherits money or property outright, receives a court settlement from a lawsuit, gets alimony, or has retirement funds. They may be used when a person without a prior disability owns assets and later become disabled. They may be referred to as Medicaid Payback Trusts, OBRA (Omnibus Budget and Reconciliation Act) ’93 Trusts, and d4A or d4C Trusts.

Although third-party special needs trusts are predominantly created by parents, grandparents or other legal guardians, federal law also authorizes a mentally and legally competent beneficiary to establish an individual first-party trust for themselves without court involvement.

  • The trust must be created properly and adhere to strict government rules before the assets can be used to benefit the person with special needs without jeopardizing eligibility for government benefits.
  • When a minor or mentally incompetent adult will be the beneficiary, the court must approve the establishment and funding of the trust.
  • Once created, the trust is funded with assets that the beneficiary owns or that are or will become legally entitled to. 
  • The trust must specify that the assets be used to pay the total lifetime medical assistance benefits paid by their Medicaid program on their behalf after the beneficiary’s death, even if all of the assets are exhausted. Any assets left after the payout may be distributed to remainder beneficiaries.
  • Individual first-party trusts are authorized under federal law 42 U.S.C. § 1396p(d)(4)(A).

Third-Party Special Needs Trusts

A third-party special needs trust is usually created and funded by you to assure that your loved one with special needs is provided for. Although most likely set up when you are the parent of the beneficiary, you could be their grandparent, sibling, or any other person wishing to provide for them.

  • The most common special needs trusts are testamentary and created in your last will and testament or established as a sub-trust in your living trust to be formed after your death.
  • Unlike a first-party trust, your beneficiary’s remaining assets will not be used to reimburse the government for the Medicaid benefits received by the beneficiary during their lifetime after their death. A clause should be included that outlines the fate of the trust after the beneficiary dies, such as secondary beneficiaries to inherit any remaining funds.

A stand-alone third-party special needs living trust is created by you and used by the beneficiary while you are alive.

  • The trust can be created using cash, investment accounts, or real estate.
  • Other donors can contribute to this trust such as grandparents, siblings, and family friends, either while they are alive or as gifts in a will or trust.
  • The trust can be revocable to allow for changes and additions to the trust. The assets would be freely available to the beneficiary and would they would still be eligible for SSI and medicaid, unless the beneficiary:
    • Exceeds the income limits for SSI or Medicaid need-based benefits; and/or
    • Has the power to revoke or otherwise control the trust. In this case the beneficiary would be considered a trustee and therefore have access to the assets.

Pooled Special Needs Trusts

Pooled special needs trusts are established and administered by a non-profit organization for the benefit of multiple beneficiaries and are not part of an individual or family estate plan

Resources

Close Menu