Overview

Special Needs Trusts (SNTs) are one of the most important estate‑planning tools for families and individuals who rely on means‑tested public programs. They let a third party, or the trust itself, hold and manage assets so the beneficiary can receive supports that public benefits don’t cover—without those assets being treated as the beneficiary’s countable resources. In my 15+ years advising families, a properly drafted SNT has repeatedly prevented benefit loss after inheritances or settlements, and has preserved lifetime access to crucial services.

Types of Special Needs Trusts and when to use each

There are three common SNT structures; each has different rules and planning consequences:

  • Third‑party special needs trust (funded by someone other than the beneficiary): Created by a parent, grandparent, or friend and funded with gifts or inheritances. No Medicaid payback is required at the beneficiary’s death if the trust document directs residual assets elsewhere. This is the preferred option when possible.

  • First‑party (self‑settled) special needs trust (often called a “payback trust”): Funded with assets that belong to the disabled individual (for example, a personal injury settlement or saved wages). Federal law requires most first‑party SNTs to contain a Medicaid payback provision to reimburse the state for medical assistance paid on the beneficiary’s behalf, unless the trust is established under specific exceptions (for example, under 42 U.S.C. § 1396p(d)(4)(A) for certain minor’s trusts or court‑ordered settlements).[Sources: Social Security Administration; Centers for Medicare & Medicaid Services]

  • Pooled special needs trust: Managed by a nonprofit that pools and invests funds from many beneficiaries while keeping separate accounts for distributions. Pooled trusts accept first‑party funds in many states and often offer lower administrative costs than individual first‑party SNTs; they still generally require Medicaid payback for remaining funds at death, with some exceptions depending on the nonprofit’s rules and state law.

For official guidance on how these trusts interact with federal programs see the Social Security Administration and CMS Medicaid rules (SSA.gov; Medicaid.gov).

How an SNT preserves benefits (SSI and Medicaid basics)

Means‑tested programs like Supplemental Security Income (SSI) and Medicaid have rules about “countable resources.” Assets that the beneficiary owns outright can push them over resource limits and cause loss of benefits. An SNT, when properly drafted and administered, keeps trust assets off the beneficiary’s personal resource ledger because the beneficiary does not have direct access or control over principal. That is why a clear distribution policy and a prudent trustee are essential.

  • SSI resource rules and benefit effect: SSI treats most assets owned directly by the applicant as countable resources. Placing funds into an SNT means they are not counted for SSI eligibility, provided distributions are made in ways that do not increase the beneficiary’s countable income or resources (for example, paying for food or shelter can affect certain SSI rules, while paying for therapy or equipment typically does not). See SSA guidance at SSA.gov for program specifics.

  • Medicaid interfacing: Medicaid eligibility is state‑administered, but federal law sets minimum rules. Most first‑party SNTs must include a state payback clause to reimburse Medicaid for paid benefits at the beneficiary’s death per federal statute (42 U.S.C. § 1396p). Third‑party SNTs generally avoid this requirement when drafted to leave remaining assets to others.

Because program rules differ and change, always verify with the relevant benefits office and an attorney familiar with your state’s Medicaid rules.

What an SNT can pay for (permissible supplemental items)

SNT funds should be used to enhance the beneficiary’s quality of life and to pay for things that public benefits generally do not cover. Typical allowable distributions include:

  • Medical equipment not covered by Medicaid/Medicare
  • Therapy, rehabilitation, and attendant care beyond public coverage
  • Personal care attendants, transportation, and home modifications
  • Education, computers, and vocational training
  • Recreation, travel, and social activities
  • Out‑of‑pocket medical and dental expenses

Distributions that provide cash or cover basic food and shelter directly to the beneficiary may affect SSI benefits if not structured correctly. Trustees should coordinate distributions with case managers or benefit administrators before making routine payments that could trigger a reduction in SSI or other needs‑based benefits.

Funding strategies and coordination with other tools

Common funding sources include inheritances, settlement proceeds, gifts, retirement account rollovers (with careful tax and beneficiary design), and life insurance proceeds. Consider these coordination points:

  • Fund third‑party SNTs with testamentary gifts via your will or payable‑on‑death designations to avoid subjecting the beneficiary to estate‑settlement timing issues.
  • Use life insurance owned by a third party with the SNT named as beneficiary so proceeds pass directly to the trust.
  • Coordinate with ABLE accounts (tax‑preferred accounts for disability expenses) — depending on the beneficiary’s circumstances, an ABLE account may be a better short‑term vehicle for smaller savings while an SNT holds larger sums. ABLE accounts have their own contribution and benefit limits; see ABLE National Resource Center for details.

For help ensuring assets actually reach the trust, see our Trust Funding Roadmap and related coverage on funding guardianships and SNTs.[Internal links below]

Choosing a trustee: duties, qualities, and oversight

The trustee’s role is central. A trustee must:

  • Understand program rules for SSI and Medicaid and how distributions affect eligibility
  • Keep clear, contemporaneous records of receipts and disbursements
  • Make distributions that benefit the beneficiary’s non‑countable needs
  • Act as a fiduciary, avoiding conflicts of interest

Who to name: family members may be appropriate when they have time, financial literacy, and objectivity. Professional trustees (banks or trust companies) offer experience, continuity, and impartial documentation but charge fees. In my practice, I often recommend a co‑trustee model (family member plus corporate trustee) to balance personal knowledge and professional administration.

Taxes and Medicaid payback considerations

  • Taxation: A trust’s tax treatment depends on whether it’s a grantor trust and on the trust’s income. Third‑party SNTs are often drafted as separate entities; trust income may be taxed at trust rates unless distributed. Work with a tax advisor to structure distributions tax‑efficiently.

  • Medicaid payback: As noted above, first‑party trusts generally require reimbursement to the state for Medicaid expenses. Third‑party trusts typically do not. A pooled trust will often have a payback provision for state reimbursement but may allow nonprofit‑retained residuals per the pooling organization’s policies. See CMS Medicaid trust guidance for statutory details.

Common mistakes and how to avoid them

  • Failure to draft the trust specifically as a “special needs” or supplemental needs trust. Generic trust language can trigger disqualification.
  • Naming the beneficiary as trustee or giving the beneficiary unfettered access. This usually defeats the purpose.
  • Improper distributions (e.g., direct cash for food and shelter) that unintentionally count as income/resources.
  • Not coordinating with state Medicaid rules or failing to include required payback language for first‑party trusts.
  • Forgetting to fund the trust — assets must be retitled, and beneficiary designations updated.

Step‑by‑step checklist to set up an SNT

  1. Consult an attorney experienced with special needs planning and your state’s Medicaid rules. 2. Decide whether third‑party, first‑party, or pooled SNT is right for your case. 3. Draft the trust with clear supplemental‑needs language and any payback provisions required by law. 4. Name a trustee and a successor trustee. 5. Fund the trust (retitle assets, name the trust as beneficiary, or deposit settlement proceeds into an appropriately drafted SNT). 6. Keep detailed trust records and review trust terms annually or after material life changes.

Practical examples

  • Example: Parents leave a $200,000 testamentary third‑party SNT for their adult child. Because the trust is funded by a third party and directs residual assets to siblings at the child’s death, no Medicaid payback is required and SSI eligibility is preserved.

  • Example: A $150,000 settlement from a car accident is placed into a first‑party SNT under the supervision of a court to preserve Medicaid eligibility during the beneficiary’s lifetime. On death, remaining funds will reimburse Medicaid per federal rules.

These scenarios mirror cases I have worked on—where timely drafting and correct funding were the difference between uninterrupted benefits and months of eligibility disputes.

Interlinks (additional FinHelp resources)

Resources and authoritative sources

Professional disclaimer

This article is educational and does not constitute legal, tax, or financial advice. State laws and program rules differ and change; consult a licensed attorney and tax advisor who specialize in special needs planning and your state’s Medicaid program before establishing or funding any trust.

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Author: FinHelp contributor (Senior Financial Content Editor). In my practice, I have guided dozens of families through SNT setup and administration; the common thread in successful plans is early coordination among attorneys, trustees, and benefits counselors to avoid eligibility pitfalls and ensure the trust operates as intended.