How Special Needs Trusts Work

If you have a loved one with special needs, you might consider setting up a special needs trust to help support that person financially after you die. How does a special needs trust work? If you leave money directly to a person with special needs, that gift will likely keep that person from qualifying for government benefits. Leaving money to a special needs trust, allows you to improve the quality of life for your loved one, without jeopardizing eligibility for benefits.

Types of Special Needs Trusts

There are three main types of special needs trusts:

• third-party trusts
• first-party trusts, and
• pooled trusts.

This article discusses the typical "third-party" special needs trust, which is designed to help you leave gifts or an inheritance to people with special needs while protecting their eligibility for government benefits. If the person with special needs already owns assets—such as from a personal injury award, retirement plan, life insurance policy, or an unplanned-for inheritance—that person can take steps to protect those assets, but not through the type of trust described here. If the assets already belong to the person with special needs, you can consider "first-party" trusts, which have more restrictive rules. You'll want to work with an experienced special needs trust attorney.

If you don't want to set up your own special needs trust, you can also look into an already existing "pooled trust." Most states have at least one nonprofit organization that operates this type of trust. In a pooled trust, gifts to many beneficiaries are combined, and the trustee of the pooled trust will invest and spend funds for the beneficiaries. Learn more about pooled special needs trusts.

Setting Up a Special Needs Trust

To create a special needs trust, you must first create the trust document. You don't need a lawyer to set up a basic no-frills special needs trust, and having one that you make yourself is often better than not having a trust at all. Special Needs Trusts, by Kevin Urbatsch and Michele Fuller-Urbatsh (Nolo) provides forms and instruction for creating a simple special needs trust, without a lawyer. However, many families will benefit from getting trust tailored to their specific situation. To get a personalized trust, consult a lawyer for help.

In the trust document, the person setting up the trust (usually called the "grantor" or "settlor") places property in the hands of another person to manage the trust (called the "trustee"). Typically, the grantor of a special needs trust names himself or herself as trustee and another trusted person successor trustee. The grantor serves as trustee until he or she dies, becomes incapacitated, or resigns; at that time the successor trustee takes over. Each person who serves as trustee is legally obligated to follow the terms of the trust document to use the property for the benefit of the person with special needs, identified in the trust document (the "beneficiary").

Finalizing and the Initial Funding of the Trust

The trust will take effect when you sign it and have it notarized. Not long after that (when you get the trust's tax identification number from the IRS), you can add a little cash to the trust by opening a bank account with a minimal deposit. At that point the trust is ready to be funded through the wills, living trusts, beneficiary designations, or other estate planning tools of those who want to help support the beneficiary with special needs. (More on this below.)

Who Can Give Property to a Special Needs Trust?

Anyone (except the beneficiary of the trust) can contribute property to a special needs trust. Although these trusts are most often created by parents for their children, you don't need any family relationship to create or give money to a trust for someone. And there is no limit to the number of trusts that may be created for a particular beneficiary.

What Types of Property Can Be Held in the Trust?

Virtually any type of property can be held in a special needs trust, including real estate, stocks, collections, a business, patents, or jewelry. But because the primary purpose of a special needs trust is to use cash money to pay for items that aren't provided by SSI or Medicaid, special needs trusts typically give the trustee authority to sell tangible items (cars or jewelry, for example) to raise cash. In order to decide whether to keep or sell tangible items, the trustee will need a good understanding of the beneficiary's personal needs and basic sound investment rules. Learn more about The Trustee's Job.

How Assets Get Into the Trust

The person who creates a special needs trust often makes the initial transfer of assets into the trust—usually, just a small amount of money. Then, commonly, a parent, grandparent, or other relative leaves property to the trust by:

• leaving it through a will or revocable living trust directly to the trustee of the special needs trust, or
• naming the trustee of the special needs trust as a beneficiary on a designation form that controls what happens to a deposit or brokerage account, retirement plan, or stocks and bonds.

If you're interested in learning more about special needs trust funds, read How to Leave Property to a Special Needs Trust.

The Trustee's Job

After the trust is funded, the trustee role becomes critical. The main job of the trustee is to use trust funds to support the beneficiary without jeopardizing government benefits. In order to do this, the trustee must have a good understanding about how eligibility works—and he or she must be willing to keep up with the law. The trustee also has many other duties, including paying taxes, keeping records, investing trust property, and keeping up to date with the beneficiary's needs. Learn more about The Trustee's Job.

How Trust Assets Can Be Used

Trust assets can be used for almost anything that is not illegal or contrary to the terms in the trust. Because the primary purpose of a special needs trust is to enhance the quality of life of the beneficiary with a disability, the list of things that can be paid for is quite broad. Generally, trust funds can be used to pay for:

• caregiving, such as a personal attendant or therapies not paid for by Medicaid
• experiences, such as travel or concerts
• services, such as a cell phone, internet, or cleaning service
• pet care, such as pet food or veterinarian care, or
• things, such as a computer, clothing, or new furniture.

Payments for food or shelter are more complicated because they generally trigger a reduction in SSI benefits. However, even though it's tricky, it often still makes sense for trustees to use trust funds for food and shelter because there are exemptions and rules that make the trade-off worthwhile.

On the other hand, trust funds cannot be used for things that would make the beneficiary ineligible for government benefits, such as large gifts of cash. Learn more about How Trust Funds Can Be Used and Payments for Food and Shelter.

Terminating the Special Needs Trust

The special needs trust ends when it's no longer needed. There are four reasons to end a special needs trust:

• Trust funds are depleted.
• The beneficiary no longer needs government benefits.
• The beneficiary is no longer eligible for government benefits.
• The beneficiary dies.

Disadvantages of the Special Needs Trust

Here are some potential drawbacks to consider before creating a special needs trust:

• If you use a lawyer to create the trust, setting up the special needs trust can have a significant initial cost.
• If the person with special needs is fairly independent, a third-party special needs trust can feel restrictive. The person will have to go through the trustee to have access to the trust funds, and the trustee has the final say.
• While a properly drafted special needs trust can protect the beneficiary's eligibility for Medicaid, the state can later recover some or all of the costs paid for care, through a process known as Medicaid estate recovery.

To learn more about special needs trusts, go to the Special Needs Trusts section of Nolo.com.

This article was excerpted from Special Needs Trusts, by Kevin Urbatsch and Michele Fuller-Urbatsch (Nolo).