If you or someone you love receives SSI, Medicaid, or other means-tested disability benefits, a special needs trust might be one of the most important financial tools you never knew about. These trusts allow people with disabilities to benefit from additional resources — inheritances, settlements, gifts — without losing the government benefits they depend on.
In this article, we'll cover:
- What a special needs trust is and how it works
- The difference between first-party and third-party trusts
- Who should consider setting up a special needs trust
- What expenses a special needs trust can and cannot cover
- How special needs trusts interact with SSI and Medicaid
- Steps to set up a trust and choose a trustee
What Is a Special Needs Trust?
A special needs trust (also called a supplemental needs trust) is a legal arrangement that holds assets for the benefit of a person with a disability. The critical feature is that assets inside the trust are not counted as resources for purposes of SSI and Medicaid eligibility.
This matters enormously because SSI has a strict $2,000 resource limit ($3,000 for couples). Without a trust, receiving an inheritance of $10,000 would push an SSI recipient over the limit, potentially causing them to lose their SSI payments, their Medicaid coverage, and any other means-tested benefits tied to SSI eligibility. With a properly structured special needs trust, that same $10,000 can be held in trust and used to enhance the person's quality of life — all without affecting their benefits.
The trust is managed by a trustee — a person or organization responsible for holding the assets and distributing them according to the trust's terms and the beneficiary's needs.
First-Party vs. Third-Party Trusts
There are two main types of special needs trusts, and the distinction between them is important.
Third-party special needs trusts are funded with money that belongs to someone other than the person with the disability — typically parents, grandparents, or other family members. These trusts can be created during the funder's lifetime or through their will. The major advantage of a third-party trust is that when the beneficiary passes away, the remaining funds go to whoever the trust specifies (usually other family members). There is no Medicaid payback requirement, which means the state cannot claim reimbursement from the trust for Medicaid benefits the person received during their lifetime.
First-party special needs trusts (also called self-settled or d(4)(A) trusts) are funded with the disabled person's own assets. This might include money from a personal injury settlement, a retroactive Social Security lump sum payment, or an inheritance received directly. The key limitation of a first-party trust is the Medicaid payback provision: when the beneficiary passes away, any remaining funds must first be used to reimburse the state for Medicaid benefits provided during the person's lifetime. Only after this payback obligation is satisfied do remaining funds pass to other beneficiaries.
First-party trusts also have an age restriction: the beneficiary must be under age 65 when the trust is established (though existing trusts can continue to operate after the beneficiary turns 65).
Pooled Trusts: A Third Option
Pooled special needs trusts are managed by nonprofit organizations and are available to people of any age. Multiple beneficiaries' assets are "pooled" for investment purposes, but each person has their own individual account within the trust.
Pooled trusts can be a good option for people who don't have a suitable individual trustee, have smaller amounts of money that wouldn't justify the cost of setting up an individual trust, or are over 65 and unable to establish a first-party individual trust. Like first-party trusts, pooled trusts funded with the person's own assets are generally subject to Medicaid payback, though some states allow the nonprofit to retain funds remaining in the account.
What Can a Special Needs Trust Pay For?
A special needs trust is designed to pay for things that supplement — not replace — the benefits the person already receives from government programs. This means the trust should generally not pay for food and shelter directly, because those payments could be counted as income and reduce SSI benefits (through what Social Security calls in-kind support and maintenance, or ISM).
However, the rules around ISM create a relatively modest reduction — the maximum SSI reduction is about one-third of the federal benefit rate plus $20 — so some trustees choose to pay for housing or food from the trust when the benefit to the person outweighs the SSI reduction.
Expenses that are clearly appropriate for a special needs trust include medical and dental care not covered by Medicaid, therapies and rehabilitation services, assistive technology and adaptive equipment, education and training, transportation (including purchasing a vehicle), recreation and entertainment, travel, personal care attendants, home modifications, phone and internet service, and clothing.
The guiding principle is that the trust should improve the beneficiary's quality of life in ways that government benefits alone don't cover.
How Trusts Interact with SSI and Medicaid
For SSI purposes, assets in a properly structured special needs trust are not counted as resources of the beneficiary. This means the trust's balance doesn't count toward the $2,000 limit. However, distributions from the trust can affect SSI depending on what they're used for.
Cash given directly to the beneficiary counts as income and will reduce SSI dollar-for-dollar. The trustee should instead pay vendors and service providers directly on behalf of the beneficiary. For example, rather than giving the beneficiary $500 to pay for a computer, the trustee should purchase the computer directly.
Payments for food or shelter are treated as in-kind support and maintenance, which reduces SSI by up to approximately $351/month (one-third of the federal benefit rate plus $20). This is sometimes acceptable when the benefit of the housing or food payment is worth more than the SSI reduction.
For Medicaid, the trust assets are similarly excluded as long as the trust is properly drafted. The beneficiary continues to qualify for Medicaid based on their SSI eligibility or other Medicaid pathways.
Setting Up a Special Needs Trust
Creating a special needs trust requires working with an attorney who specializes in disability law or elder law. This isn't a DIY project — the trust document must be carefully drafted to comply with federal and state requirements, and errors can result in the trust being counted as an available resource.
When setting up a trust, you'll need to choose a trustee. This person or organization will manage the trust assets, make distribution decisions, keep records, and file any required tax returns. The trustee should understand disability benefits rules, be financially responsible, and prioritize the beneficiary's interests. Many families choose a family member as trustee, but professional trustees (like trust companies or attorneys) and nonprofit organizations are also options — especially if no suitable family member is available.
You'll also need to decide on the terms of the trust — what expenses it can cover, who the successor trustee will be if the original can no longer serve, and (for third-party trusts) who receives remaining funds when the beneficiary passes away.
Expect to pay between $2,000 and $5,000 or more in attorney fees to establish an individual special needs trust, depending on complexity and your location. Pooled trusts typically have lower setup costs but charge ongoing administrative fees.
The Bottom Line
A special needs trust is one of the most effective ways to protect disability benefits while providing supplemental resources for a better quality of life. Whether you're a parent planning for your child's future, a family member who wants to leave an inheritance, or someone who's received a settlement or lump sum, a properly structured trust ensures that additional money helps rather than hurts.
Purple helps disability benefit recipients manage their day-to-day finances with resource tracking and compliance tools — a great complement to the long-term protection of a special needs trust.