The Complete Guide to Special Needs Trusts

For people with disabilities, there’s a delicate balance between income and asset limits to qualify for certain government benefits like Supplemental Social Security (SSI) and Medicaid. Fortunately, special needs trusts are designed to offer financial security without reducing or eliminating those benefits.

While there are benefits to these types of trusts, they can be complex and costly. Therefore, they may not be suitable for every situation. Here’s what you need to know, so you can determine if a special needs trust may be right for you and your family.

Two Main Types of Special Needs Trusts

There are two main types of special needs trusts: first-party and third-party. The key differences between the two are who funds the trust and whether Medicaid can recover some or all of the assets at death.

If the disabled individual provides the funding, it’s a first-party trust. First-party trusts can be subject to Medicaid estate recovery. In this process, Medicaid seeks to recover some medical costs from the trust after death.

On the other hand, if the funding comes from a relative or other party, it’s a third-party trust. Third-party trusts aren’t subject to Medicaid estate recovery.

#1: First-Party Trusts

If a disabled person has supplemental income or assets but wants to retain their government benefits, a first-party trust may be the right fit.

This type of trust is funded by the disabled individual, typically from the following sources:

  • Inheritance
  • Retirement plans or life insurance policies
  • Personal injury or workers’ compensation settlements

There are two common scenarios where this trust type may be useful.

  1. When an individual with existing assets suffers a disabling accident or illness, qualifying them for government assistance, but their existing asset and property levels are too high to qualify. They can transfer their existing assets to a first-party special needs trust to meet the government’s asset-based eligibility tests.
  2. When a disabled individual receives additional income or assets. In this scenario, a disabled individual already receiving government assistance comes into additional assets, either through inheritance or other means, and may set up a first-party special needs trust to maintain assistance eligibility.

#2: Third-Party Trusts

Meanwhile, a relative or third party may set up a third-party special needs trust on behalf of a someone else. This allows the relative to contribute assets to the special needs trust on behalf of their disabled loved one while protecting their eligibility for government assistance.

Often, third-party trusts are outlined in a person’s estate plan. Notably, these third-party trusts aren’t subject to Medicaid estate recovery. Instead, they simply pass on to the next beneficiary at the death of the disabled individual.

Benefits of Special Needs Trusts

The primary benefit of a special needs trust is the ability to maintain eligibility for government benefits while accessing additional financial resources.

Most importantly, it allows people with disabilities to maintain their SSI and Medicaid benefits. In addition, third-party trusts can be beneficial as the assets aren’t subject to Medicaid recovery after the beneficiary’s death.

How Special Needs Trusts Work

At their core, trusts are legal documents, which a legal expert should draft and review. To get started, you may want to consult your family attorney. If you don’t have one, the Special Needs Alliance, a national alliance of attorneys for special needs planning, or the Academy of Special Needs Planners may be helpful places to start.

In addition, consider working with a financial planner like Milestone Asset Management Group to understand how a special needs trust will impact the rest of your financial plan.

When establishing this type of trust, there are three primary rules to keep in mind:

  1. All disbursements must be for the benefit of the disabled individual. To maintain eligibility, disbursements must be used solely for the benefit of the disabled individual.
  2. All disbursements must be payable to a third party. Notably, disbursements cannot go directly to the individual. Instead, they must go directly to the vendor or provider for goods and services.
  3. You must keep adequate records. Lastly, thorough recordkeeping of disbursements and transactions is critical as the Social Security Administration or Medicaid Office can request copies of your records.

Spending Rules

It’s a common misconception that you can only use special needs trusts to cover medical services or other disability-related services. The reality is that you can use them for many things, from personal items to vacations and recreational activities.

However, using a special needs trust to cover things like food, rent, mortgage, or other shelter costs could reduce benefits. The purpose of SSI is to cover those expenses. Therefore, outside funds can affect your benefit calculation.

According to the CPT Institute, there are three essential questions to ask with each disbursement.

  1. Does my distribution request harm my physical or mental safety?
  2. Is my request in my long-term interest?
  3. Will this expense jeopardize my eligibility for government benefits?

These questions can help ensure your distributions won’t jeopardize government benefits.

How Much Does It Cost?

Lastly, cost is a key consideration when determining if a special needs trust makes sense for you. According to CNBC, the cost of setting up these trusts varies by geographic location. Yet in general, adding one to your estate plan can increase the total cost by $2,000 to $6,000.

Nevertheless, a special needs trust could be well worth the cost depending on your situation. Indeed, it can provide ongoing financial security for you or your loved ones while ensuring they maintain their benefit eligibility.

A Trusted Advisor Can Help You Understand Special Needs Trusts

Providing financial security for a loved one with a disability is possible—it may just take extra intention and strategy. A trusted financial advisor can help you better understand how a special needs trust may fit into your financial plan or if there are better alternatives to meet your needs.

At Milestone Asset Management Group, we offer our clients the peace of mind that comes from working with a trusted and experienced financial advisor. We specialize in helping our clients plan for a healthy and secure retirement while handling all of their tax planning, preparation, and estate planning needs in-house.

If you’d like to speak with a member of our team about your financial planning needs, please schedule a complimentary phone call.