Editor’s Note: This article was written by Sarah Barnes, Trust Officer

When you have a loved one with a disability or functional needs, planning ahead and creating financial security for them is likely a top priority. How can you offer financial support without negatively affecting any means-tested government benefits they’re receiving or may receive in the future? A special needs trust is one sound solution.

What Is a Special Needs Trust?

Because needs-based government benefits have income and asset limits, receiving financial gifts or assets could reduce or eliminate eligibility. That’s where special needs trusts can come in.

Special needs trusts are irrevocable trusts established for the benefit of individuals with a diagnosed physical or mental disability. Establishing this unique type of trust is a popular strategy for those who want to help someone without taking the risk that the person will lose their eligibility for programs that require their income or assets to remain below a certain limit. That’s because money in a special needs trust is meant to be a supplemental resource, meaning it should cover expenses that aren’t already covered by government benefits.

For example, if you have an adult daughter with autism on Supplemental Security Income (SSI) benefits and want to give her money to meet her living expenses, she could be disqualified from receiving needs-based government benefits. Likewise, if you die and leave her your Roth IRA worth hundreds of thousands of dollars (or any amount that exceeds the asset limit), she could no longer receive SSI or Medicaid. But if you put the assets into a special needs trust, she can keep her benefits and receive your financial support for the rest of her life as long as the trust pays for qualifying expenses.

How Does a Special Needs Trust Work?

A special needs trust places the individual's assets under the control of an appointed independent trustee. The trustee has a duty to protect the assets of the trust and to act in the best interest of the beneficiary at all times. While the funds may not be given directly, as there can be no incidents of ownership by the beneficiary, they may be used to pay for expenses not covered by the government benefits being received. For example, education, certain medical expenses, or any other goods or services that benefit the individual can be paid for by the trust. You must ensure money is spent in accordance with IRS guidelines, so hold on to receipts or make a spreadsheet to keep track.

Special needs trusts are authorized and governed by the federal Omnibus Budget and Reconciliation Act (OBRA-93), and may be put in place by any individual–but most commonly a family member, guardian, or friend. It is important that the person who creates the trust or their legal representative word the terms of the trust documents very carefully to ensure its validity and to confirm that the directives and purpose of the document are explicitly clear.

Advantages of a Special Needs Trust

There are several advantages to establishing a special needs trust, with the primary reason typically being protection of the assets of the beneficiary while maintaining their eligibility for governmental support. There are a number of significant government benefits, including SSI, Medicaid and food assistance that are subject to strict asset and income limits. Since the beneficiary has no control over the money or assets in a special needs trust, the contents of the trust are not considered when calculating the individual's total assets.

Meanwhile, the person that creates the trust has some reassurance that the money will be used for its intended purpose. For example, special needs trusts are irrevocable, and their assets generally cannot be seized by creditors or by the winner of a lawsuit.

Types of Special Needs Trusts

There are different types of special needs trusts, with the two most common being a first-party or third-party special needs trust.

First-Party Special Needs Trust

Also referred to as a “self-settled trust,” a first-party special needs trust is funded with the assets and/or income that belong to the beneficiary of the trust. Thanks to a section in the 21st Century Cures Act, as of December 2016, if a person with functional needs is mentally capable, they can set up and fund their own first-party trust. Alternatively, a relative, guardian or court can set up the trust and fund it with the beneficiary's assets.

There are certain requirements that must be met in order to qualify as a first-party special needs trust. To begin with, the beneficiary must have a disability, be under age 65 when the trust is established, and the trust must be irrevocable. Plus, these trusts must typically include a Medicaid repayment provision. This means when a beneficiary dies, any remaining money goes to repaying Medicaid, and if anything is left, it goes to listed secondary beneficiaries. Also, in some states, the assets in the trust aren’t protected from creditors.

Still, a person with functional needs might choose this type of trust if they’ve received a windfall, such as a settlement for medical negligence or an inheritance. It may also be ideal for an individual who has existing assets, becomes disabled, but needs to qualify for means-tested benefits.

Third-Party Special Needs Trust

A third-party special needs trust, also referred to as a “supplemental needs trust,” is funded with assets belonging to a person other than the beneficiary and to which the beneficiary never had possession or legal interest. A real-life example would be the parent, grandparent or guardian opening and funding the trust.

Third-party special needs trusts aren’t only for individuals with disabilities; they can also be used for someone who struggles to manage their finances. For example, they could be used for an individual who is dealing with substance abuse, gambling addiction or anything else that might hinder them from managing their own money. In this case, the trust is called a spendthrift trust.

An advantage of a third-party special needs trust is you can appoint secondary beneficiaries to inherit the remaining funds when the original beneficiary dies, since there are no provisions to pay back Medicaid upon the trust’s termination.

There are two ways you can set up a third-party special needs trust:

• Stand-alone trust: Since it isn’t created as part of a will or trust, the beneficiary can access funds before your death, making this type of trust effective immediately.
• Testamentary trust: This may be more suitable if you’re estate planning and want to leave the trust as an inheritance but don’t want to give the beneficiary access to the trust immediately.

Is Establishing a Special Needs Trust Right for Me?

There’s a lot to consider when it comes to establishing a special needs trust. As with most trusts, you want to factor in things like the complicated regulations, taxes and fees before diving in. That also means considering how it fits into your overall financial plan.

No financial plan is the same–they’re as unique as you and your situation. Speak to a financial advisor for advice on whether a special needs trust is right for you, how to establish a trust, and mitigating the costs and tax implications.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.