Special Needs Trusts in California: When and Why

For California families with a child, sibling, or other beneficiary who relies on means-tested public benefits — Supplemental Security Income (SSI), Medi-Cal, and others — a direct inheritance can be the worst possible thing to leave them. A modest bequest, deposited into a checking account, can disqualify the beneficiary from benefits the inheritance is far too small to replace.

A special needs trust (SNT) is the planning tool that solves this problem. This post is a short overview of what an SNT is, when it is the right tool, the two main types, and what families should know before setting one up.

The problem

Means-tested public benefits — SSI, Medi-Cal, certain housing programs — are conditioned on the beneficiary not having more than a low statutory amount of countable resources, and not receiving more than a low monthly amount of countable income. The thresholds are intentionally tight; the programs are for people without other resources.

A direct inheritance — even one of $20,000, $50,000, or $100,000 — generally counts as a resource and disqualifies the beneficiary from benefits until it is spent down. For a beneficiary with significant ongoing needs, the spend-down rarely buys equivalent value to the lost benefits, and the family ends up worse off.

A direct inheritance also can produce demands from public agencies: when an SSI recipient receives an inheritance, the SSA expects a report and may impose an overpayment recovery against future benefits.

The solution

A properly drafted and properly funded special needs trust holds assets for the benefit of the beneficiary without those assets being treated as the beneficiary's resources for benefits-eligibility purposes. The beneficiary does not have legal title to the assets; the trustee does, and the trustee distributes for purposes that supplement (not replace) what public benefits provide.

The detail matters. An SNT is not just any trust with the words "special needs" in the title; it must comply with specific federal and state rules to achieve its purpose, and the wrong drafting can defeat the structure entirely.

Two main types

First-party (self-settled) SNT. Funded with the beneficiary's own assets — typically the proceeds of a personal-injury settlement, an inheritance the beneficiary received outright (which then needs to be remediated), or back-pay from a benefits award. First-party SNTs are governed primarily by 42 U.S.C. § 1396p(d)(4)(A) and require:

• The beneficiary be under age 65 when the trust is funded
• The beneficiary have a disability as defined by the relevant program
• A "payback" provision requiring that, on the beneficiary's death, the state Medicaid agency be reimbursed up to the amount of medical assistance paid

Third-party SNT. Funded with someone else's assets (the parents', a grandparent's, an uncle's) for the benefit of the beneficiary with a disability. Third-party SNTs are usually built into a parent's or grandparent's revocable living trust as a sub-trust that springs into operation at death. They do not require a payback provision; on the beneficiary's death, remaining assets pass to whoever the parent or grandparent named (often other family members), without reimbursement to Medi-Cal.

For most families doing estate planning during life, the third-party SNT is the relevant tool. The first-party SNT comes up where the beneficiary already has assets in their own name that need to be moved into a protected structure.

What an SNT can and cannot pay for

This is the part that most surprises clients. An SNT is meant to supplement, not duplicate, what means-tested benefits provide. Distributions for items the public benefits already cover (basic shelter, basic food in some cases) can reduce the beneficiary's SSI dollar-for-dollar, defeating the purpose.

Distributions that are generally appropriate from a third-party SNT include:

• Education, training, and tuition
• Therapy not covered by Medi-Cal
• Adaptive equipment, assistive technology, and computers
• Travel and recreation
• Companion and personal-care services
• Home furnishings (within program rules)
• Vehicles (with care around titling and insurance)
• Specific medical needs not covered by Medi-Cal

Distributions for "in-kind support and maintenance" — paying for the beneficiary's food or shelter directly — are technically permissible but reduce SSI under specific rules. Trustees of SNTs must understand the interaction with the relevant programs; this is one of the reasons a professional or knowledgeable trustee matters.

Trustee selection

Choosing the trustee for an SNT is a different exercise than choosing the trustee for an ordinary family trust. The role calls for:

• Familiarity with the rules of the means-tested benefits the beneficiary relies on
• Ongoing engagement with the beneficiary's needs over a long horizon
• Reliable record-keeping and tax-filing capacity
• Willingness to manage the relationship with the beneficiary and the family

Some families use an individual family member as trustee; some use a corporate or professional trustee for the recordkeeping and decisionmaking, with a family member as trust protector or co-trustee for the family-relationship side. The right structure depends on the family.

When an SNT is the right tool

An SNT is generally the right tool when:

• A beneficiary relies on, or is reasonably likely to rely on, SSI, Medi-Cal, or other means-tested benefits
• The family wants to leave assets to that beneficiary at death
• A direct inheritance would disqualify the beneficiary from benefits or trigger overpayment recovery

It is not the right tool when:

• The beneficiary's sole "needs" are non-medical and could be addressed by other planning structures
• The beneficiary does not currently and will not foreseeably rely on means-tested benefits (a high-functioning adult child with a job and private insurance, for example, generally does not need an SNT — though the analysis can be more nuanced if the diagnosis suggests change over time)

Practical takeaway

For California families with a beneficiary whose well-being depends on public benefits, the difference between a thoughtful third-party SNT and a direct bequest can be measured in years of services and supports the beneficiary either receives or does not. The cost of doing the planning correctly is small relative to that gap.

If you have a beneficiary in your family for whom an SNT may be appropriate, please reach out for a consultation.

This article is general information and not legal advice. Federal and California rules around SSI, Medi-Cal, and special needs trusts change periodically; specific situations need specific review with current authority.