What are California Third-Party Special Needs Trusts
Estate Planning for Loved Ones with Disabilities in California: How to Protect Your Loved One’s Inheritance
Estate planning is very critical for families with loved ones who have disabilities and depend on public benefits like Supplemental Security Income (SSI) and Medi-Cal (California’s Medicaid program). Why? Because SSI beneficiaries often become ineligible for “means-tested” public benefits when they receive an inheritance outside of an appropriate trust vehicle. This applies to parents and grandparents of children with special needs and to spouses and relatives of older individuals living in nursing homes and receiving Medi-Cal long-term care benefits. Without a proper estate plan, the individual with disabilities may lose access to these essential benefits, which could have a devastating impact on their care and quality of life. In many instances, a third-party special needs trust can be an appropriate trust vehicle to shield the inheritance from being (1) a “countable resource” under Medicaid and Social Security Administration (SSA) SSI eligibility rules and (2) used to reimburse these agencies under the “Medicaid payback” rules.
What is a Third-Party Special Needs Trust?
A special needs trust (also known as a supplemental needs trust) is a trust tool designed to enhance the quality of life for individuals with disabilities while ensuring they maintain their eligibility for public benefits like SSI and Medi-Cal. These trusts can provide funds for a wide range of goods and services not covered by government programs, for the beneficiary’s “special needs,” including but not limited to:
Custom accessible vehicles (including purchase, maintenance, and insurance)
Alternative therapies not covered by Medi-Cal
Assistive technology, devices for communicating, and computer equipment
Hobbies, vacations, and recreational activities
Education, job training, and occupational training/rehab
Pets and companion care
Professional services (e.g., for trustee management, accounting, or legal advice)
A third-party special needs trust is funded by someone other than the disabled or special needs individual – often a parent, grandparent, or other relative. This distinguishes it from a self-settled trust (also called a first-party trust or d4a trust), which is funded by the assets of the individual with disabilities themselves (in many cases, a personal injury award or court settlement, or an inheritance where the individual has attained 65 years of age, as all first-party special needs trusts must be established and funded by the individual or another person on the individual’s behalf before the individual turns 65 years old).
Third-party special needs trusts can be established either during the lifetime of the person who wishes to provide for the disabled or special needs beneficiary (known as an inter vivos special needs trust) or upon the settlor’s or grantor’s death through a will or estate plan (a testamentary special needs trust). A third-party special needs trust created during the grantor’s or settlor’s lifetime can be either revocable or irrevocable.
Creating a third-party special needs trust for a special needs child (who may grow out of or no longer be special needs as they grow out of adolescence) or a family member younger than 65 years old, who has suffered a traumatic brain injury or is beginning to show signs of cognitive decline, can help maintain their potential, future need to be eligible for public benefits programs: there is no guarantee they will have the foresight or wherewithal to create a first-party special needs trust on their own before they turn 65 years old. What is more, if you’re the one considering leaving them an inheritance, special needs planning may not even be on their radar. Expecting or assuming that a disabled or special needs individual can or should create their own first-party self-settled special needs trust also forces any assets remaining in the trust at the beneficiary’s death to be used for Medicaid payback. But the SSA trust rules do not require third-party special needs trusts to contain a Medicaid payback clause.
To be clear, while both first-party and third-party special needs trust can be used to maintain a Medi-Cal or SSI recipient’s eligibility, only a third-party special needs trust avoids SSA/Medicaid payback/reimbursement rules, and it is a person other than the disabled or special needs individual that must create the third-party special needs trust, with the assets of someone other than the disabled or special needs individual.
Once established, the trust assets are managed by a trustee on behalf of the individual with disabilities. The beneficiary cannot act as the trustee, and cannot have the power to amend or revoke the trust. But the trustee can be a family member, friend, professional fiduciary, or corporate trustee, depending on the family’s needs. The modern trend is to also incorporate into the third-party special needs trust provisions for a trust advisory committee and a trust protector to advise the trustee. Again, unlike self-settled trusts (the first-party trust, d4a trust, or payback trust), third-party special needs trusts do not have a "payback" provision. This means that if the beneficiary passes away and there are remaining funds in the trust, they can be distributed to other family members, friends, or charitable organizations, according to the grantor’s or settlor’s wishes when the trust is created.
In California, the third-party special needs trust can also contain termination provisions, which gives the trustee the discretion to terminate the trust under certain circumstances, e.g., the beneficiary is no longer disabled or no longer requires public benefits.
Estate Planning for Individuals with Disabilities in California
Absent thoughtful advance planning, an individual with disabilities may, through no fault of their own, lose their eligibility for SSI, Medi-Cal, and other essential government benefits. This could occur if they inherit assets outside of the appropriate special needs trust or if their own estate plan fails to account for their special needs. The goal of a well-structured, holistic estate plan is to provide for the beneficiary without disqualifying them from vital public benefits assistance. Again, as this article has stressed, while a disabled or special needs individual can create and fund a self-settled first-party special needs trust before turning 65 years old, they cannot fund the trust with an inheritance that never comes into existence until after they attain the age of 65, and even if they did create a self-settled first-party special needs trust and fund it prior to turning age 65, that trust would be required to contain the requisite Medicaid payback provisions. Why not avoid that through family members creating their own, respective third-party special needs trusts for each respective inheritance to be given to the disabled or special needs individual? The out-of-pocket costs in attorney’s fees to set up one or more third-party special needs trusts will pale in comparison to the cost of a loss of public benefits eligibility and lost benefits that could result from an improper or inadequate estate plan, compounded higher each year.
Many people have the mistaken belief that, to preserve their eligibility, they must disinherit a loved one receiving SSI or Medi-Cal. However, in general, public benefits cover nothing more than the most basic needs. Rather than disinheriting a loved one, the better option is to direct any inheritance to a third-party special needs trust. As outlined above, the trustee will have the discretion to distribute to the beneficiary for their “special needs.”
When a third-party special needs trust is established through a will, it is called a testamentary trust. This type of trust becomes effective after the death of the grantor or settlor, at which point the trust holds and manages the inheritance for the benefit of the beneficiary with disabilities. A third-party special needs trust can also be created during the grantor’s lifetime (the inter vivos revocable or irrevocable third-party special needs trust), which has several advantages:
Immediate control: A lifetime trust allows the settlor or grantor to see the trust being administered in a proper manner and in accordance with their intent, while they are still alive.
Flexibility: A revocable trust can be modified and amended as needed to reflect changes in the law or the beneficiary’s circumstances. After the settlor’s or grantor’s incapacity or death, a trust protector can make changes to accommodate changes in tax law, SSA or Medi-Cal rules, or other applicable law.
Privacy: A living trust remains more or less private, whereas a testamentary trust created through a will becomes a public record through the probate process.
Streamlined management: If the trust is already in place, it may be easier to communicate with financial institutions and ensure the proper management of assets. The trustee and trust advisory committee (if incorporated into the trust) can begin communicating and developing workflow and responsibilities.
In California, it is quite common for family members to utilize inter vivos third-party special needs trusts rather than testamentary trusts, as they desire to avoid the California probate process (lengthy and expensive), and as the use of professional trustees is common in California.
Stand-by vs. Standalone Third-Party Special Needs Trusts
It can be noted that a third-party inter vivos special needs trust can be drafted “into” a traditional California revocable living trust as a “stand-by” trust or as a standalone document separate from the revocable living trust. While you may feel some peace of mind in including in your revocable living trust stand-by special needs trusts provisions to help maintain a beneficiary’s potential, future public benefits eligibility in the event the beneficiary later requires Medicaid or SSI benefits, if you already know that a particular beneficiary is disabled and/or requires eligibility for public benefits, for the reasons outlined above, it is almost always preferable to incorporate into your estate plan a standalone third-party special needs trust in a separate document, for the sole benefit of that individual.
Creating and funding a standalone inter vivos third-party special needs trust can go a long way in simplifying and clarifying how the inheritance will impact, if at all, the beneficiary’s public benefits eligibility, and often is the preferred approach. As stated below, as a third-party special needs trust can be created now but funded either upon creation, sometime later, or at the settlor’s or grantor’s death, this affords additional flexibility to account for changes in the disabled or special needs beneficiary’s situation, changes in the law, or changes in public benefits programs, during the settlor’s or grantor’s lifetime.
We can also note that a standalone inter vivos third-party special needs trust can be funded either during the grantor’s or settlor’s lifetime or through pay-on-death or transfer-on-death transfer arrangements or death beneficiary designations. This ability to fund at the grantor’s or settlor’s death the standalone inter vivos revocable third-party special needs trust affords lifetime flexibility and is another potential advantage of the inter vivos third-party special needs trust over the testamentary type. And while the inter vivos third-party special needs trust can be either revocable or irrevocable, the revocable trust can be updated if and as appropriate during the settlor’s or grantor’s lifetime, again affording additional flexibility under a “wait and see” approach.
The important point is recognizing the need to create the third-party special needs trust during the settlor’s or grantor’s lifetime (rather than forcing the disabled or special needs beneficiary to create their own self-settled first-party special needs trust with a Medicaid payback provision) and following through with a plan to properly fund the third-party special needs trust.
Protecting Against Long-Term Care Costs with Special Needs Trusts
Special needs trusts are also an essential strategy for protecting assets when one spouse is in a nursing home or facing long-term care costs. In California, if the well spouse passes away and no planning is in place, their estate will pass to the surviving, unwell spouse either through an outdated will or by the laws of intestacy. This inheritance could disqualify the surviving spouse from Medi-Cal and SSI, forcing them to “spend down” assets before qualifying for Medi-Cal long-term care benefits or other government assistance again.
To be accurate, California’s Medi-Cal long-term care framework very different from other states. While most state Medicaid agencies impose a $3,000 limit to countable assets before a married individual can qualify for long-term care benefits, as of January 1, 2024, the Medi-Cal long-term care countable-asset eligibility limit (which was $130,000) is eliminated. However, each state’s Medicaid program must receive approval from the Center for Medicare and Medicaid Services (a federal agency under the U.S. Department of Health and Human Services), and there is no way to know whether or for how long California’s “no-asset-limit Medi-Cal” will continue. It’s possible that, depending on who occupies the White House and Congress, CMS may decide to no longer approve California’s current Medi-Cal regime.
Should you disinherit your unwell spouse to prevent them from receiving an inheritance that you fear will jeopardize their public benefits eligibility? Often, the answer is no, you shouldn’t. Even under the current “no-asset-limit Medi-Cal,” the well spouse or another family member can create for the unwell, older family member expected to require funds for ongoing long-term care in the future an inter vivos or testamentary third-party special needs trust that can help ensure the individual’s potential, future eligibility for Medi-Cal long-term care benefits and, if necessary, SSI.
Rather than relying on a child or another family member to help care for the unwell family member or pay for their care, a better approach is to establish an inter vivos or testamentary third-party special needs trust for the unwell spouse or family member. This ensures that the surviving spouse can inherit assets without losing their eligibility for Medi-Cal or SSI, as the funds are held in trust and managed for their benefit.
Choosing the Right Trustee for a Special Needs Trust
Choosing the right trustee is one of the most important decisions in setting up a third-party special needs trust. The trustee is responsible for managing the assets and ensuring the funds are used in accordance with the grantor’s wishes. Trustees can be family members, friends, or professional fiduciaries, but they should be financially competent, ethical, and well-organized. Ideally, the trustee should also have experience with the complexities of special needs planning and an understanding of the requirements for maintaining eligibility for Medi-Cal and SSI. As many individuals have not served as a fiduciary before – let alone as a trustee of a special needs trust – families often select a professional fiduciary to serve as trustee of the third-party special needs trust. There are numerous licensed, professional trustees throughout California.
Attorney Ryan J. Casson believes that, in most instances, a client considering setting up a third-party special needs trust should select a professional trustee. If the trust will be an inter vivos revocable living trust, the client (the settlor or grantor) can serve as trustee during their lifetime, and upon their death (or upon the trust becoming irrevocable upon the occurrence of a certain triggering event), the successor trustee will be a professional trustee experienced in administering special needs trusts. Including provisions for a trust advisory committee (three to five persons) creates a mechanism for family members to remain involved in the disabled beneficiary’s life and to provide informal guidance and direction to the trustee.
Conclusion
Estate planning for a loved one with disabilities requires careful attention to detail and knowledge of California’s unique laws and programs. A properly drafted third-party special needs trust can provide the financial resources necessary to care for your loved one while preserving their eligibility for essential government benefits. If you need assistance with estate planning for a loved one with disabilities, California estate planning and special needs planning attorney Ryan J. Casson is here to help you navigate the complexities of Medi-Cal and SSI eligibility, and ensure your loved one’s future is secure.
Please contact the Law Office of Ryan J. Casson at (805) 384-0400 to learn more about how Ryan can help you create a California estate plan that meets the needs of your family.
