An Overview of Special Needs Trusts

December 12, 2011

I have come across many clients who have a child that qualifies for certain government benefits because the child has special needs. Unfortunately, a well-intentioned gift to a child can, in some cases, inadvertently disqualify the child from the government benefits. In other instances, a child might have become entitled to sizeable funds, such as through a settlement or award in a personal injury lawsuit, which could also disqualify the child from benefits. This is where special needs trusts come into play.

The role of special needs trusts is to provide economic security for a person with special needs without disqualifying them from government benefits. There are three types of special needs trusts, depending on the circumstances: common law discretionary trusts, OBRA-93 payback trusts and pooled trusts. 

Common Law Discretionary Trusts:

This type of trust is referred to as “common law” because it arises from a series of court decisions and not from a particular statute. Typically, common law trusts should be used when the source of the funds is coming from a third party, such as money in the form of a gift to the person with the special needs. 

There are four primary requirements for establishing a common law discretionary trust. 

  1. The trust must explicitly state that proceeds of the trust are meant to supplement and not supplant public benefits. 
  2. The trust must also require that public benefits be considered by the trustee prior to distribution of any income or principal. 
  3. The trust must be irrevocable, which generally means that once funds from third parties are in the trust, they cannot be removed later by the third party. 
  4. The trustee must have total, absolute and unfettered discretion to pay, or refuse to pay, the income or principal from the trust to the disabled beneficiary. As a result, required periodic payments are not permissible. It is also helpful if there are other beneficiaries of the trust, such as other children of the parents creating the trust. 

A big advantage with common law trusts is that they do not need to be registered with or approved by the Pennsylvania Department of Public Welfare. In addition, it is not required that funds in the trust be used to pay back the Commonwealth for medical assistance payments upon the beneficiary’s death. 

OBRA-93 Payback Trusts

These trusts are named for and authorized by a federal statute that came out of the Omnibus Reconciliation Act of 1993. They must be used when the assets funding the trust come directly from the child with special needs. This scenario typically arises when someone is disabled in an accident and receives a sizable court award or settlement amount as a result of a lawsuit. These trusts must be irrevocable and the only beneficiary allowed is the person with special needs, who must be under 65 years of age. In addition, this type of trust can only be created by a parent, grandparent, guardian or a court. The trustee must also have absolute discretion to pay or refuse to pay resources of the trust to the beneficiary.

One of the disadvantages of this type of trust is that it must be registered with and approved by the Department of Public Welfare, which then oversees the administration of the trust. Additionally, upon the death of the beneficiary, any amounts paid to the beneficiary for medical benefits must be repaid to the Commonwealth with funds from the trust.

Pooled Trusts

The third kind of trust is commonly referred to as a pooled trust, which is authorized by federal Medicaid and SSI laws. In a pooled trust, the proceeds, which can be from a third party or the child with special needs, are given to a non-profit agency that administers the pooled trust. As the name of the trust suggests, funds put into the trust are then pooled together with monies from other similar beneficiaries. 

An advantage is that this type of trust does not require any filing with the Department of Public Welfare. In addition, there is no payback of medical assistance payments upon the death of the beneficiary. However, at the death of the beneficiary, all of the funds remain in the trust and can be used to pay other beneficiaries of the pooled trust.

Creating a special needs trust can be an important financial tool to ensure the care of an individual with special needs. While it is common for parents to create these trusts for minor children, it is also something that can be beneficial for adults with special needs. This overview provides a basic understanding of the importance of special needs trusts and the types of trusts available. However, there are plenty of other complications and circumstances involved in creating a special needs trust. As a result, I strongly recommend consulting with an attorney experienced in this area to discuss how your specific situation affects the type of trust you should create and help guide you through the pros and cons of each type of trust.

Matthew Grosh is an attorney at Russell, Krafft & Gruber, in Lancaster, Pennsylvania. He received his law degree from Villanova University and practices in a variety of areas including Estate Planning.