How Do Special Needs Trusts Work — and What Changes Have Been Made?

Most people with disabilities or special needs qualify for government benefits such as Supplemental Security Income (SSI) and Medicaid. Indeed, many of them depend heavily on these benefits for their survival. Government benefits on their own are often insufficient to provide a good quality of life for recipients. At the same time, having other assets or sources of income can jeopardize a disabled person’s eligibility for the benefits they need. For many individuals, a special needs trust (also known as a supplemental needs trust) has been the answer to this dilemma.

What is a special needs trust? Like any trust, it has a grantor (the creator of the trust, also called the settlor or trustmaker); a trustee (person in charge of administering the trust); and a beneficiary (person who benefits from the trust). Beyond these basics, a special needs trust is structured to allow a disabled beneficiary to benefit from the trust without losing eligibility for government benefits.

Types of Special Needs Trusts

There are three basic types of special needs trusts:

• First-party trusts, in which the disabled person’s own funds (such as from a lawsuit settlement or an inheritance) are used to establish the trust. A first-party trust must be irrevocable in order to help the beneficiary qualify for government aid.
• Third-party trusts, in which a third party such as a parent or grandparent uses their own funds to establish a trust for the benefit of the disabled person. A third-party trust may not need to be irrevocable, but creating a third-party revocable trust can lead to unintended tax consequences which the grantor should discuss with the estate planning attorney who creates the trust.
• Pooled trusts, which are established by nonprofit organizations. Trust assets are pooled for management and investment, but each beneficiary has a separate account.

Each variety of special needs trust has its advantages. All special needs trusts keep trust assets out of the control of the beneficiary with a disability. Because the beneficiary cannot directly access the assets in the trust, those assets are not counted when determining the beneficiary’s eligibility for government benefits.

Funds in a special needs trust are typically used for supplemental needs (hence the trust’s other name) that improve the quality of life for the disabled beneficiary. For example, the trust could pay for out-of-pocket medical and dental bills, education, home health care aides, transportation, home furnishings, and even vacations and recreation. As a general rule, trust funds are not used for food, shelter, or things that the beneficiary can convert into cash.

If you are serving as trustee of a loved one’s special needs trust, it is wise to consult with an attorney who is experienced with these types of trusts to make sure that any planned expenditures are permissible under the rules of the trust. You will also want to be diligent about keeping records of disbursements from the trust so that you can prove you have been compliant with the law and prevent the beneficiary from accidentally losing eligibility for needed benefits. Without strict compliance, the very point of a special needs trust — eligibility for aid — is defeated.

How Special Needs Trust Rules Have Changed

Until fairly recently, all special needs trusts had to be established by someone other than the beneficiary of the trust. Even first-party trusts, which are funded with the disabled person’s own assets, had to be set up by someone other than the intended beneficiary of the trust.

Much of the time, it is logical for someone other than the person with a disability to establish a special needs trust. For instance, a child with a severe intellectual disability would not have the legal capacity to create a trust. However, the former rules regarding establishment of special needs trusts failed to take into account the needs of certain adults with disabilities who have the intellectual and legal capacity to create a trust.

Furthermore, many adults with disabilities who could benefit from a special needs trust do not have a third party to create a trust on their behalf. The law as it existed prevented them from establishing a trust using their own assets. If a person did not have a living relative to create a trust for them, they typically had to go through a complicated court process to get a special needs trust established. Otherwise, their only option was to “spend down” their assets in order to become eligible for government benefits.

In 2016, there was a change in federal law regarding special needs trusts. One important aspect of the new law was that it allowed a person with a disability and the legal capacity to create a special needs trust for their own benefit. A first-party trust created by the disabled beneficiary needs to meet the same requirements as a first-party trust established by a relative:

• It must be funded with assets belonging to a disabled person under the age of 65
• It must be created for the benefit of that person
• Upon the death of the beneficiary, any assets remaining in the trust must first be used to repay Medicaid for any assets provided to the beneficiary.

If you have questions about special needs trusts or about establishing a trust for yourself or for another person, please contact Gudorf Law Group to schedule a consultation.