Editor’s Note: This article was written by Sarah Barnes, Trust Officer. Originally published 10/30/21 and has been updated.

A special needs trust is a legal arrangement that holds and manages assets for a person with a disability or special needs. When properly drafted, funded, and administered, it may help provide supplemental support without causing the beneficiary to lose eligibility for benefits like Supplemental Security Income (SSI) or Medicaid. 

For those with special needs, financial security has another level of complexity due to strict government benefits restrictions. Families who want to support a loved one may hesitate because they fear disrupting benefits. However, a special needs trust can help build wealth and financial security without compromising SSI or Medicaid. A special needs trust allows beneficiaries to use assets for certain expenses without counting towards their income, maintaining benefits eligibility.

Why Direct Gifts or Inheritances Can Create Benefit Problems

SSI and Medicare are needs-based programs with strict financial eligibility rules. If a beneficiary of either program exceeds monthly income or total asset limits, they may lose eligibility. 

Assets that may cause problems include:

• Cash gifts
• Inheritances
• Life insurance proceeds
• Retirement account payouts
• Payable-on-death accounts
• Transfer-on-death accounts

How Does a Special Needs Trust Operate?

A settlor (also called a grantor or trustor) establishes the trust. An appointed trustee manages the assets and determines when they can be used. Under specific circumstances, the beneficiary can use the trust to pay for expenses, but they do not control the assets directly. Instead, the trustee pays vendors, service providers, or other approved expenses according to the trust document and benefit rules.

What Can a Special Needs Trust Pay For?

• Education and tutoring
• Medical, dental, therapy, or rehabilitation expenses not covered elsewhere
• Transportation
• Assistive technology
• Home accessibility changes
• Care management
• Recreation and enrichment
• Travel
• Personal items
• Professional services
• Phone, internet, or subscriptions if allowed by the trust and benefit rules
• Household items, subject to benefit review
• Vehicle purchase or modification, subject to planning review

Permitted expenses depend on the trust document, benefit program, state law, and how the payment is made. Pure cash distributions, food payments, and shelter payments to the beneficiary can disrupt government benefits. The trustee should keep detailed records on how many funds were used and for what purpose.

Quick Comparison: Types of Special Needs Trusts

First-party special needs trust

A first-party special needs trust is funded by the beneficiary’s assets. To set up this trust, the beneficiary must have a disability, be under the age of 65 when the trust is established, and the trust must be irrevocable. When the beneficiary dies, the remaining money goes to repaying Medicaid before going to secondary beneficiaries. 

First-party special needs trusts are often used when a disabled person receives a windfall, such as a legal settlement or 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 is funded with assets that the beneficiary never possessed or had legal interest in. Often, a relative is the one who funds this trust, such as a parent, grandparent, or guardian.

Unlike first-party special needs trusts, the beneficiary does not need to be disabled; they can also be used for someone who struggles to manage their finances. For example, third-party special needs trusts can support those who are dealing with substance abuse or a gambling addiction. These trusts are specifically called a spendthrift trust.

There are two main ways to set up a third-party special needs trust:

• Stand-alone trust: Not part of a will or trust, so the beneficiary can access funds before the grantor’s death. This trust will be effective immediately.
• Testamentary trust: Assets will become available after death, making this trust well suited for estate planning.

One advantage of third-party special needs trusts is that 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 termination of the trust. 

Pooled special needs trust

A pooled special needs trust can be funded with assets belonging to the beneficiary or a third party. However, a non-profit combines assets from several beneficiaries into one pool and acts as a trustee. Each beneficiary has their own account and can track where their assets are going. 

A pooled special needs trust has no age requirement, even if it’s self-funded, so it may be the best choice for those over the age of 65 who want a self-funded trust. 

How to Fund a Special Needs Trust

A special needs trust can be funded through a variety of resources, including:

• Cash
• Investment accounts
• Life insurance
• Inheritances
• Retirement accounts, with tax and legal review
• Legal settlements
• Gifts from family members
• Real estate, only with legal and benefit review
• Business interests or other assets, only with professional review

For more complex funds such as life insurance, annuities, retirement accounts, and payable or transfer-on-death accounts, name the trust as the beneficiary, not the individual, and consult with an attorney. Directly naming the beneficiary on these account types risks their eligibility for means-tested benefits.

Special Needs Trust vs. ABLE Account

An ABLE account is another financial tool for those with disabilities. As opposed to a trust, these accounts operate more like a standard savings or checking account. 

Quick Comparison Guide

Do You Need a Special Needs Trust, an ABLE Account, or Both?

Whether you need a trust, an ABLE account, or both will depend on your personal needs and financial goals.

Consider an ABLE account when:

• The beneficiary needs more flexible day-to-day spending.
• Qualified disability expenses are the main need.
• Account limits and eligibility rules fit the situation.

Consider a special needs trust when:

• A parent or grandparent wants to leave a larger inheritance.
• The beneficiary may receive a settlement.
• Life insurance or retirement assets need coordination.
• Professional oversight is needed.
• Long-term estate planning is the priority.

Consider both when:

• The family wants a trust for larger assets and an ABLE account for more routine disability-related expenses.

Choosing the Right Trustee

Special needs trusts are complicated, and choosing your trustee should not be done lightly. The trustee should be organized, communicative, objective, and able to keep detailed records. The trustee should understand, or work with professionals who understand:

• SSI
• Medicaid
• Trust administration
• Tax reporting
• Investment management
• The beneficiary’s day-to-day needs

Families should also name successor trustees.

It’s important to note that a trustee is not always the same as a caregiver or care manager. Who your trustee is will depend on your needs and their experience. 

Common Special Needs Trust Mistakes to Avoid

Special needs trust mistakes are easy to make, and they can be costly. Common mistakes include:

• Leaving assets directly to the beneficiary rather than the trust.
• Naming the beneficiary directly on life insurance or retirement accounts.
• Adding the beneficiary’s own assets to a third-party trust without legal review.
• Choosing a trustee without benefits knowledge.
• Making cash distributions directly to the beneficiary.
• Paying for food or housing without understanding the SSI impact.
• Failing to coordinate the trust with the broader estate plan.
• Not updating the plan after a move, marriage, divorce, death, benefit change, or state-law change.
• Using generic online forms without special needs planning expertise.
• Forgetting to coordinate gifts from grandparents and relatives.
• Assuming an ABLE account replaces a special needs trust in every situation.
• Assuming a trust automatically protects benefits regardless of how it is administered.

When Should You Review a Special Needs Trust?

A special needs trust needs to be reviewed regularly to ensure that all rules are followed. You should review a special needs trust when:

• The beneficiary turns 18
• After a benefit change
• After an inheritance, settlement, or large gift
• When the beneficiary moves to another state
• After a parent, guardian, trustee, or caregiver dies or can no longer serve
• After marriage, divorce, or family changes
• When tax laws or estate plans change
• When family wealth, insurance, retirement accounts, or care needs change
• At least every few years with the advisory team

Is a Special Needs Trust Right for Your Family?

A special needs trust may be appropriate when:

• A loved one receives SSI, Medicaid, housing assistance, or other means-based benefits.
• A parent or grandparent wants to leave an inheritance.
• The beneficiary may receive a legal settlement.
• The family wants professional oversight of assets.
• The family wants to coordinate estate planning, tax planning, insurance, care planning, and benefits planning.

Another tool may be enough when:

• The need is limited to smaller day-to-day disability-related expenses.
• An ABLE account fits the goal.
• The beneficiary does not receive and is not expected to need means-tested benefits.
• The asset amount is small, and a pooled trust may be more practical than a standalone trust.

Whether a special needs trust is right for your family depends on your unique financial situation. It can be a powerful tool, but only when drafted, funded, and administered correctly. Speak with a Wealth Enhancement advisor to understand how a special needs trust may fit into your broader financial, tax, estate, and benefits planning strategy.

Frequently Asked Questions About Special Needs Trusts

Does a special needs trust affect SSI eligibility?

A properly drafted and administered trust may help preserve SSI eligibility, but distributions can still affect benefits depending on how they are made and what they pay for.

Does a special needs trust affect Medicaid eligibility?

A properly structured trust may help preserve Medicaid eligibility, but Medicaid rules vary by state and trust type. First-party trusts often require Medicaid payback.

Can a special needs trust pay cash directly to the beneficiary?

Direct cash payments are generally risky because they may be treated as income or resources. Trustees often pay vendors or service providers directly instead.

What happens to the money when the beneficiary dies?

It depends on the trust type. First-party trusts often include Medicaid payback provisions. Third-party trusts may allow remaining assets to pass to other named beneficiaries if properly constructed.

Can grandparents contribute to a special needs trust?

Yes, but they should coordinate with the family’s legal and financial advisors to make sure gifts or inheritances are directed to the trust correctly, not directly to the beneficiary.

Do I need a special needs trust and an ABLE account?

Many families use both. An ABLE account can help with qualified disability expenses and more flexible day-to-day spending, while a special needs trust can be better suited for larger gifts, inheritances, settlements, or long-term planning.

How often should a special needs trust be reviewed?

Review it after major life, benefit, tax, legal, family, or financial changes. Families should also revisit the plan every few years with their advisory team.

Advisory services offered through Wealth Enhancement Advisory Services, LLC, a registered investment advisor and affiliate of Wealth Enhancement Group.

Content in this material is for general information only and not intended to provide specific advice or provide individualized tax or legal advice. Discuss your specific situation with a qualified tax or legal professional.

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