Special Needs Trusts FAQ

Though the trustee owns the assets, they do so subject to a strict “fiduciary duty" obligating them to manage the trust assets responsibly, productively, and for the benefit of the trust beneficiary.

A special needs trust (SNT) is a specialized trust that sets aside funds for a beneficiary with a disability. The goal is to strengthen the financial security and enhance the quality of life for a person with disabilities --  without disqualifying them for need-based government benefits.

What Is a Special Needs Trust?

Importantly, SNTs are meant to supplement—not replace—government benefits provided to beneficiaries with a disability. For this reason, they are also known as “supplemental needs trusts." SNTs supplement needs that are not covered by Supplemental Security Income (SSI)* and Medicaid.

Because eligibility for these public benefits is need-based, an individual with a disability whose total assets and/or monthly income are too high could be disqualified. If you simply leave assets to a loved one with a disability in a will or arrange for them to receive direct disbursements from a trust, you may unintentionally disqualify them from these benefit programs by “over providing."

A well-formed SNT solves this problem in two ways. First, because the trust assets are owned by the trustee, they are not counted when calculating the beneficiary's initial eligibility for government benefits. Even though the trustee is obligated to maintain and use the trust assets for the benefit of your loved one with a disability, the trust terms must make it crystal clear that the trustee holds absolute discretion over how this is achieved.

Second, unlike in most trusts, an SNT beneficiary does not—and cannot—receive direct disbursements from the trust. This protects the beneficiary's ongoing eligibility by ensuring that their assets and income never exceed the disqualifying threshold.

*Note: Supplemental Security Income (SSI) is distinct from Social Security (SS).

Are All Special Needs Trusts the Same? Not Quite.

SNTs come in two flavors: first party and third party. Both ensure that trust assets benefit a beneficiary without giving them direct access to the funds. However, first- and third-party SNTs also feature a few important distinctions.

First-Party Special Needs Trusts

• Who funds the assets? A first-party SNT can be created by a parent, grandparent, legal guardian, or a court. However, the trust assets originally belong to the person with a disability.
• Is there an age restriction? Yes. The beneficiary must be under 65 years old.
• Can the trust terms be changed? No. First-party SNTs must be “irrevocable." Once an irrevocable trust is created, its terms cannot be changed. For more on this, see Irrevocable Living Trusts.
• What happens to the remaining funds? Once the beneficiary passes away, first-party SNTs are subject to a “payback" requirement. This means that when the beneficiary dies, any Medicaid benefits received from the government must be reimbursed. Once the payback is satisfied, the remaining funds can be distributed according to the trust instructions.

First-party SNTs are sometimes also known as “self-settled SNTs" or “Medicaid payback trusts." They may be referred to as “(d)(4)(A)" or “(d)(4)(C)" trusts in reference to sections in the federal statute authorizing this kind of trust as well.

Third-Party Special Needs Trusts

• Who funds the assets? In a third-party SNT, the grantor and beneficiary are different people. In other words, the assets in a third-party SNT are provided by someone other than the beneficiary (hence the name).
• Is there an age restriction? No. The beneficiary can be a person with a disability of any age.
• What happens to remaining funds? A third-party SNT is not subject to a government “payback" requirement. Funds remaining when the beneficiary dies can be freely distributed according to the trust instructions.
• Can the trust terms be changed? A third-party SNT can be revocable or irrevocable. If the trust is revocable, the grantor reserves the power to change the trust terms down the road. For more on this, see the differences between revocable and irrevocable trusts.

When Are First- and Third-Party Special Needs Trusts Used?

Both kinds of SNTs accomplish the same goal of ensuring that an individual with a disability benefits from trust assets without being disqualified from need-based government programs. Both arrangements are typically set up by family members who are concerned for the long-term wellbeing of a loved one with a disability. Again, the key difference is who provides the funds.

A third-party SNT is straightforward. In this kind of SNT, a third-party grantor funds the trust. Before and after the trust is formed, the funds never belong to the beneficiary.

By contrast, the funds in a first-party SNT always belong to the beneficiary before being transferred to the trust. This situation may arise, for example, if an individual with a disability receives a large inheritance or personal injury settlement. The sudden windfall might disqualify them from their government benefits. To avoid this, the assets are set aside in an SNT.

There is an added benefit. Remember that a first-party SNT is always irrevocable. If the beneficiary is ever sued or comes into debt, the first party SNT funds cannot be touched because the beneficiary does not own or control them. By contrast, a third-party SNT is only sometimes irrevocable. In general, a revocable trust generally does not shield trust assets from creditors and court judgments.

How Does a Beneficiary Receive Funds?

How does the beneficiary reap the benefits of the trust? Simple. The trustee uses the trust assets to purchase necessities for the beneficiary.

Remember, an SNT beneficiary cannot (1) control the trust assets or (2) receive direct distributions because this compromises their eligibility for need-based government benefits. Therefore, the SNT trustee is given full discretion to buy services and products that supplement the beneficiary's government benefits.

This might include personal care attendants, vacations, home furnishings, uncovered medical expenses, education, vehicles, physical therapy, and even recreation. The beneficiary holds no sway over the “what, where, when, and how" of these purchases.

As in all trusts, the trustee is constrained by their fiduciary duty to manage the funds for the benefit of the beneficiary. Needless to say, it is essential that the trustee of an SNT be a person who will honor their duty. A breach of fiduciary duty can lead to serious legal consequences.

What is a Pooled Special Needs Trust?

A pooled SNT combines (“pools") assets from multiple SNTs to be managed and invested by a specialized nonprofit organization. The beneficiary of each SNT gets a separate account and their own professional trustee chosen by the nonprofit. These trustees purchase things to supplement the beneficiary's living arrangements, just like a trustee appointed by the individual's family would.

What is the benefit of a pooled SNT? By combining the resources of many beneficiaries, pooled trusts can reduce fees and improve the collective pool's investment potential. They may also be useful if you simply cannot find a suitable trustee elsewhere.

When the beneficiary dies, the remaining funds are distributed according to the trust agreement. In some cases, those funds may be distributed to the nonprofit to further the organization's charitable mission. However, note that remaining funds may still be subject to government “payback" requirements. These rules vary from state to state.

Do I Need a Lawyer to Set Up a Special Needs Trust?

In many cases, an inheritance through a will may not ensure the long-term security of a family member with special needs. An SNT can help ensure your loved one is well-cared for in years to come.

It is possible to create an effective SNT using reputable do-it-yourself guides and forms. That said, these trusts can be complex, and the governing law varies from state to state. If you do not feel confident handling your special needs planning alone, it is best to seek legal advice from a local estate planning attorney.

Remember, a poorly drafted trust document can lead to serious consequences and undermine your good intentions. Therefore, even if you take the do-it-yourself route, it is still a good idea to have an attorney review your work.