Funding a Special Needs Trust With a Structured Settlement
If an individual with a disability expects to receive a structured settlement, directing the settlement payments into a properly established special needs trust may help preserve eligibility for means-tested public benefits.
This arrangement can provide long-term financial support without requiring the individual to receive the settlement funds directly. However, the settlement and trust must be carefully coordinated before the settlement agreement becomes final.
What Is a Structured Settlement?
If you receive compensation through a personal injury settlement, the award may be paid as a lump sum, through a series of scheduled payments, or through a combination of both.
With a structured settlement, the recipient typically receives payments over time. The arrangement may provide a substantial initial payment followed by smaller payments intended to replace lost income or cover future needs.
Depending on the nature of the claim and how the settlement is structured, compensation for personal physical injuries or physical sickness may be excluded from federal taxable income. This exclusion can apply to qualifying damages received as either lump-sum or periodic payments under Section 104 of the Internal Revenue Code.
Tax treatment depends on the facts of the case, so recipients should obtain individualized legal and tax advice before finalizing a settlement.
What Is a Special Needs Trust?
A special needs trust, or SNT, is a trust established to benefit an individual with a disability. It can provide funds that improve the beneficiary’s quality of life while helping preserve access to certain means-tested public benefits.
For example, a person with a disability may rely on Supplemental Security Income or Medicaid. These programs generally have financial eligibility requirements. Receiving a significant settlement directly could cause the individual to exceed the applicable income or resource limits.
A properly drafted special needs trust may allow settlement funds to be used for the beneficiary without treating the trust principal as an available resource. The Social Security Administration explains how trusts are evaluated for SSI purposes in its guidance on trusts and SSI resources.
Trust funds may be used for many supplemental needs, subject to public-benefit rules. These expenses may include education, transportation, recreation, technology, personal services, and other items that improve the beneficiary’s quality of life.
Certain distributions, particularly those involving food or shelter, can affect SSI benefits. The trustee should therefore obtain advice before making distributions.
How Can a Structured Settlement Fund a Special Needs Trust?
A structured settlement may be used to partially or fully fund a first-party special needs trust. Rather than paying the settlement directly to the person with a disability, the settlement documents can direct qualifying payments to the trust.
A first-party special needs trust holds assets that belong to the beneficiary, including proceeds from the beneficiary’s personal injury settlement. Under federal law, this type of trust generally must meet specific requirements to qualify as an exception to the usual SSI resource rules.
The Social Security Administration outlines those requirements in its special needs trust guidance.
Coordinating the structured settlement and the trust can provide several potential benefits:
- A predictable source of funds for future needs
- Professional management of settlement proceeds
- Protection against poor financial decisions or exploitation
- Continued access to qualifying public benefits
- Flexibility in setting payment amounts and timing
The arrangement may also reduce ongoing trust administration costs because only the assets paid into and held by the trust are generally subject to trust management fees.
Protecting the Settlement Funds
Structured settlements and special needs trusts can work together to protect settlement proceeds from financial predators, creditors, and poor money management.
A structured settlement generally creates a schedule of payments, often funded through an annuity purchased from an insurance company. The payment schedule can be designed around anticipated medical expenses, housing needs, lost income, education, or other long-term costs.
When combined with a properly drafted special needs trust, the arrangement can provide the beneficiary with a reliable source of financial support while preserving eligible public benefits.
Structured settlements offer considerable flexibility in payment duration and amount. However, the terms can be difficult or impossible to change once finalized. A special needs planning attorney should review the proposed arrangement before the personal injury settlement is completed.
Providing Initial Funds to Operate the Trust
The special needs trust should receive enough initial funding to cover the beneficiary’s immediate needs and the expenses of administering the trust.
Without sufficient initial funds, the trustee may be unable to make necessary payments while waiting for the structured settlement’s longer-term payments to begin. The initial funding amount may also affect the type of trustee who is willing or able to administer the trust.
When the settlement is being structured, the special needs trust is generally designated as the recipient of the applicable payments rather than the individual beneficiary. Payments made directly to the beneficiary could affect eligibility for SSI, Medicaid, or other means-tested programs.
These details should be addressed in the settlement documents, annuity contract, and trust agreement before the arrangement becomes final.
Understanding Medicaid Reimbursement
A first-party special needs trust must generally provide that, when the beneficiary dies, the state Medicaid agency will be reimbursed from the assets remaining in the trust. Reimbursement is limited to the amount required under applicable law and the funds still available in the trust.
After the required Medicaid reimbursement is made, any remaining trust assets may pass to the other beneficiaries named in the trust.
These requirements arise under 42 U.S.C. § 1396p(d)(4)(A). The exact reimbursement process can depend on the states that provided Medicaid benefits and the terms of the trust.
Why the Annuity Provisions Matter
The annuity and trust documents should also address what happens if the beneficiary dies before all scheduled settlement payments have been made.
Depending on the arrangement, an appropriate commutation or early-termination provision may direct remaining amounts into the trust within a specified period. This may allow the trustee to address final expenses, required Medicaid reimbursement, taxes, and trust administration.
The Social Security Administration has detailed rules governing early-termination provisions in special needs trusts. These provisions must be drafted carefully so they do not cause the trust to lose its protected status.
State and Local Rules May Affect the Trust
State law, court procedures, and local practices can affect how structured settlement payments are allocated and administered.
For example, when the beneficiary is a minor or a person under court supervision, spending trust principal may require court approval. Courts may also differ in how they classify annuity payments as income or principal.
That classification can determine whether the trustee must obtain approval before using certain payments for the beneficiary’s needs.
Before purchasing an annuity or finalizing a structured settlement, the parties should determine:
- Which state’s law will govern the trust
- Whether court approval is required
- How payments will be classified
- Who will receive the scheduled payments
- What happens when the beneficiary dies
- Whether the proposed terms comply with SSI and Medicaid rules
Resolving these questions early can prevent delays and benefit-eligibility problems later.
Choosing a Trustee
Special needs trusts funded by structured settlements can be more complex to administer than many other trusts. The trustee must understand both trust law and the public-benefit rules governing distributions.
A professional trustee may be appropriate when the trust contains substantial assets or requires long-term administration. Depending on the arrangement, the trustee may be responsible for:
- Maintaining accurate trust records
- Managing and investing trust assets
- Paying the beneficiary’s permitted expenses
- Coordinating tax preparation
- Communicating with benefit agencies
- Evaluating proposed distributions
- Preserving the beneficiary’s eligibility for public benefits
Even when a family member serves as trustee, professional legal and financial guidance may be necessary.
Seek Advice Before Finalizing the Settlement
The timing and sequence of events are critical when integrating a structured settlement with a special needs trust.
A special needs planning attorney can work with the personal injury attorney, settlement planner, trustee, and financial professionals to help ensure that the settlement and trust documents function together. Improperly drafted documents or payments made directly to the beneficiary could jeopardize eligibility for important government benefits.
Before accepting a structured settlement in a personal injury case, consult an attorney who understands special needs trusts and public-benefit rules.
Contact Andre O. McDonald, a knowledgeable Howard County, Montgomery County, and District of Columbia estate planning, special needs planning, and Medicaid planning attorney, to schedule a consultation:
- Howard County: 443-741-1088
- Montgomery County: 301-941-7809
- District of Columbia: 202-640-2133
DISCLAIMER: THE INFORMATION POSTED ON THIS BLOG IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONVEY LEGAL, INSURANCE, OR TAX ADVICE.
