Planning for Special Needs Trusts: 3 Key Questions



Families with special needs children or adults must contend with a significant challenge: how to provide their loved ones with the resources to maintain quality of life for the long term. Although there’s no simple solution, special needs trusts have numerous advantages that can help provide economic security for beneficiaries and reassurance for families.

In particular, funds held in special needs trusts are exceptions to the asset eligibility rules for means-tested benefits such as supplemental security income (SSI) and Medicaid. Nonetheless, such trusts are governed by complex provisions you and your clients may want to take into consideration. To get to the heart of the planning issues involved, you should be able to answer the following key questions.

1) Who Was the Initial Owner of the Assets?

The initial ownership of assets determines whether a special needs trust is a first-party or third-party trust. The same beneficiary can hold a first-party trust and one or more third-party trusts, and there is no cap on aggregate value. Other features to keep in mind include:

  • First-party trusts are funded with assets initially owned by a beneficiary who meets the Social Security Act’s definition of disability. These trusts are irrevocable and must be established before the beneficiary turns 65.

  • First-party trusts are subject to the Medicaid payback rule, so trustees should consult with an attorney before the trust purchases a house. The payback rule allows the state Medicaid agency to use the house’s value to recover Medicaid benefits provided to a deceased beneficiary.

  • Third-party trusts are funded with assets initially owned by someone other than the beneficiary. They may be created for an adult older than 65. Although the beneficiary’s disability is usually already established, a bequest can include a provision to create this type of trust in the event of a subsequent disability diagnosis. This planning flexibility is not offered by a first-party trust.

  • The SECURE Act may change planning decisions, so consulting an attorney regarding the life expectancy payout from the trust is recommended. Under the SECURE Act, disabled individuals (according to the Internal Revenue Code’s definition) may still receive the life expectancy payout as the life beneficiary of a conduit trust or accumulation trust. Remainder beneficiaries are subject to the 10-year payout rule set by the SECURE Act.

2) What Happens to the Assets After the Beneficiary Dies?

After the beneficiary dies, assets in a first-party special needs trust must be used to repay the state’s Medicaid agency for the amount of benefits received. As discussed above, this requirement is known as the Medicaid payback rule. For third-party special needs trusts, federal law does not require repayment to Medicaid. Accordingly, a third-party trust can have remainder beneficiaries.

3) How Do the Assets Affect Eligibility for SSI and Medicaid?

Arguably, the most important issue to understand is how a beneficiary’s assets affect eligibility for SSI and Medicaid, which are separate but linked federal programs. In most states, a beneficiary who is eligible for SSI is also eligible for Medicaid. (The 11 states with separate eligibility rules are Connecticut, Hawaii, Illinois, Indiana, Minnesota, Missouri, New Hampshire, North Dakota, Ohio, Oklahoma, and Virginia.) Consequently, distributions that affect eligibility for SSI can affect eligibility for Medicaid.

The standards governing how distributions from a special needs trust affect eligibility for SSI and Medicaid can be summarized as follows:

  • Trust distributions must “supplement but not supplant” benefits that the trust’s beneficiary receives from federal programs. Supplemental distributions cannot be used for in-kind support and maintenance. The Social Security Administration’s regulations define in-kind support and maintenance as food and shelter, including items such as rent, food, mortgages, property taxes, heating fuel, gas, electricity, water, sewer, and garbage removal.

  • Distributions for in-kind support and maintenance can result in a one-third reduction in the SSI benefit or a reduction based on the presumed maximum value. Of course, your client may consider a reduced SSI benefit acceptable if the distributions improve the beneficiary’s quality of life. Many clients, however, will appreciate careful planning that avoids the elimination of SSI eligibility.

Comprehensive Trust Solutions

As we’ve seen, first- and third-party special needs trusts are effective planning tools for long-term financial security. And, fortunately, families do not need to make a choice among these vehicles, though an attorney should be consulted on how they fit into the overall estate plan. The following comprehensive trust solutions can be useful:

  • Trusts in combination. If an individual has assets that disqualify him or her for SSI or Medicaid, a first-party trust is an obvious choice, as long as family members and trustees are aware of the rules for in-kind support and maintenance and Medicaid payback. But these rules should not prevent a third-party trust being established for the same beneficiary.

  • Multiple third-party trusts. Suppose the family members do not own disqualifying assets and different generations want to create third-party trusts. In this scenario, the same beneficiary can have more than one third-party trust.

Easing the Path Forward

As we’ve seen, special needs trusts can be part of a meaningful planning solution for your clients. By educating families about their choices, you’ll give them the tools they need to make confident decisions. This empowerment can lead to a clear road map for the secure future of special needs children and adults.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.