Ask a room full of parents what stops them from setting up a special needs trust, and eventually someone will say it out loud:
“I’ve heard the state takes it all back when he dies. So what’s the point?”
It is the most common reason families walk away from a trust, and for most of them it is simply not true.
The confusion comes from the fact that there are two different kinds of special needs trust, both are called “special needs trusts,” and only one of them has a Medicaid payback. Which one you are dealing with comes down to a single question.
Whose money is it?
That is the whole test. It does not matter who set the trust up or whose name is on it. What matters is whose money went in.
| Third-party trust | First-party trust |
|---|---|
| Funded with someone else’s money: parents, grandparents, an aunt, a life insurance policy. | Funded with the beneficiary’s own money: a lawsuit settlement, back benefits, an inheritance that landed in their name. |
| No Medicaid payback. Whatever is left goes wherever you said it should go: siblings, grandchildren, a charity. | Medicaid payback required by federal law. At death, the state is reimbursed first. Anything left over then passes to your heirs. |
| Can be created at any time, at any age. | Must be established before the beneficiary turns 65. |
So here is the answer to the question that stops so many families:
If you are a parent or grandparent planning to leave money to a loved one with a disability, you are creating a third-party trust. There is no Medicaid payback at any point. The money you leave stays in your family.
The payback rule that everyone has heard about is real, but it attaches to the first-party trust, and only because Congress required it in exchange for letting someone shelter their own money and stay on benefits. It is the price of a very good deal, not a punishment. A fuller side-by-side comparison is here →
The mistake that turns one into the other
Now the part that actually costs families money.
A third-party trust only stays a third-party trust if the money goes straight into it and never touches your child’s hands. The moment an inheritance lands in your adult child’s name, even for a day, even by accident, it becomes their money. Their money can only be sheltered in a first-party trust, with the payback.
Here is how that happens in real life, over and over:
- A grandparent writes a will leaving “$25,000 to each of my grandchildren,” with the best intentions in the world.
- A parent names their adult child as a beneficiary on a life insurance policy or a retirement account, because that is what the form asks for.
- A relative dies without a will, and state law hands your child a share automatically.
- A well-meaning aunt opens a savings account for your child and puts their name on it.
Any one of these can do two things at once. It can push your child over the $2,000 resource limit and knock them off SSI and Medicaid, and it can convert money that could have passed cleanly to the family into money the state gets reimbursed from.
The fix is simple. Nobody leaves money to your child. Everybody leaves money to the trust, and the trust takes care of your child. The same money serves the same purpose with a completely different outcome.
Three things to do this month
- Set up the third-party trust first. It has to exist before anyone can name it. Until it does, every relative’s will is pointed at a target that is not there.
- Check your beneficiary designations. Life insurance, 401(k), IRA, pension, savings bonds. These pass outside your will. A perfect will cannot save a retirement account that names your child directly. This is the most commonly missed step in special needs planning, and it takes twenty minutes to fix.
- Tell the grandparents. Have the conversation, awkward as it is. Give them the exact language: leave the gift to the trust, not to the child. Most families find that relatives are relieved to be told. They were worried about doing the wrong thing and had no idea what the right thing was.
Watch: Special Needs Trusts & Wills Explained
Attorney Tom Sannicandro walks through how the trust and the will work together, why beneficiary designations matter more than most families realize, and what belongs in each document.
What if the money is already in your child’s name?
It happens, and it is not fatal. A first-party special needs trust can still shelter it and protect their benefits. The payback applies, but the alternative is spending the money down to $2,000 and losing years of Medicaid coverage in the meantime. Sheltering it is almost always the better outcome. First-party trusts for adults with disabilities →
An ABLE account can also hold a modest amount of the beneficiary’s own money. Note that ABLE accounts do carry a Medicaid payback, which is another reason the large, long-term money belongs in a third-party trust and the everyday spending money belongs in ABLE.
What it costs
Attorneys typically charge $3,000 to $5,000 for a special needs trust and a coordinated will. We are a 501(c)(3) nonprofit founded by a disability law attorney who is also the father of an adult son with Down syndrome, and a complete personalized trust and will is $189.99. You answer guided questions in plain English and the documents are emailed to you when you finish.
The Letter of Intent and the HIPAA Release are free to anyone, with no purchase.
Create Your Third-Party Special Needs Trust →
Not sure which kind you need? Book a free 10-minute session and we will tell you straight.
This article is general information about how these trusts work, not legal advice about your family’s situation. State Medicaid rules and trust requirements vary. If your situation involves a settlement, an inheritance already received, or a trust that has already been funded, talk with us or with an attorney in your state before you act.