Parents and grandparents of a loved one with a disability often share the same worry: how do you leave money to someone you love without disrupting the public benefits they rely on? A special needs trust is one of the most common tools families use to address that question. It can hold assets for a person with a disability while helping preserve eligibility for means-tested programs such as Supplemental Security Income (SSI) and Medicaid. Because these trusts touch investments, taxes, and estate documents at the same time, they work best when they are part of a coordinated plan. If you are starting to think this through, a complimentary, no-obligation wealth and tax review can help you see how the pieces may connect.
This article explains the purpose of these trusts, the main types, and how families in Milwaukee, Waukesha, Brookfield, and across Wisconsin can coordinate one with a broader wealth management strategy.
What a Special Needs Trust Is Designed to Do
Means-tested programs look at the resources a person owns. If an individual with a disability inherits money outright or receives a large gift, that money may count against eligibility, and benefits could be reduced or suspended until the funds are spent down. A properly drafted trust keeps those assets out of the beneficiary's direct ownership. A trustee manages the money and makes distributions for the beneficiary's benefit.
The goal is usually to supplement, not replace, public benefits. Trust funds may pay for things that benefits do not cover, such as:
Therapies, equipment, or medical services outside of what Medicaid provides
Education, tutoring, or vocational training
Recreation, travel, and enrichment activities
Technology, transportation, and personal care items
How distributions are made matters. Some types of payments, especially those for food or shelter, can affect certain benefits. Trustees need to understand these rules before writing checks, which is one reason ongoing professional coordination is so valuable.
The Main Types of Special Needs Trusts
Not every trust works the same way. The right structure depends on whose money funds it and what the family is trying to accomplish.
First-party trusts. These are funded with the beneficiary's own assets, for example a personal injury settlement, back benefits, or an inheritance that was left outright. Federal rules generally require that a first-party trust include a Medicaid payback provision, meaning that any remaining funds at the beneficiary's death may be used to reimburse the state for benefits it provided. Age and other requirements apply.
Third-party trusts. These are funded with assets belonging to someone else, most often parents, grandparents, or other relatives. Because the money never belonged to the beneficiary, a third-party trust typically does not need a Medicaid payback provision. Remaining funds can pass to other family members or charities named in the document. Many families build this type of trust into their own estate plan so that gifts and inheritances flow into it rather than to the beneficiary directly.
Pooled trusts. A nonprofit organization manages a pooled trust, keeping separate sub-accounts for each beneficiary while investing the funds together. Pooled trusts may be useful when the amount involved is modest or when no family member is available to serve as trustee.
Every family's situation is different, and these trusts are legal documents with strict drafting requirements. You should coordinate with an estate attorney who has experience with disability planning before establishing or funding any trust.
How ABLE Accounts Fit Alongside a Trust
ABLE accounts are tax-advantaged savings accounts for people whose disability began before a certain age. Earnings can grow tax-free when used for qualified disability expenses. Annual contribution limits apply, and balances above certain levels may affect SSI, so it is important to check current rules.
Many families use an ABLE account and a trust together. The ABLE account may give the beneficiary more independence and flexibility for day-to-day spending, while the trust holds larger assets and handles more significant needs. Coordinating the two can help reduce the risk of an unintended eligibility problem.
Tax Considerations for a Special Needs Trust
Trusts are taxed under their own set of rules, and trust income tax brackets are compressed compared with individual brackets. That means undistributed income inside a trust can reach higher tax levels quickly. Depending on how the trust is drafted, it may be treated as a grantor trust (taxed to the person who created it) or as a separate taxpayer.
Some trusts may qualify as a qualified disability trust, which can provide a larger exemption than other complex trusts. Whether a trust qualifies depends on its terms and the beneficiary's circumstances. Careful tax planning and preparation can help trustees file correctly and manage the tax cost of income the trust earns.
Retirement accounts deserve special attention. Under current federal rules, a beneficiary who is disabled or chronically ill may be treated as an eligible designated beneficiary, which can allow inherited retirement assets to be distributed over a longer period when a properly structured trust is named. Getting this right requires coordination between the beneficiary designation forms, the trust document, and your estate attorney.
Investing Trust Assets With a Long Time Horizon
A trust for a child or young adult may need to last for decades. That long horizon has real implications for investment decisions. Trustees need to balance growth, liquidity for expected distributions, and the risk of running short later in the beneficiary's life.
Practical questions include how much to hold in cash for near-term needs, how to diversify, and how to place income-producing assets given the trust's tax treatment. Ideas from asset location strategy and tax-efficient investing can be relevant here, since trust taxes may erode returns if investments are not chosen thoughtfully.
Coordinating the Trust With Your Overall Plan
A special needs trust rarely stands alone. It connects to life insurance decisions, retirement savings, beneficiary designations, guardianship planning, and how parents plan for their own retirement and long-term care. Families often consider:
Who will serve as trustee and successor trustee, and whether a professional co-trustee makes sense
A letter of intent describing the beneficiary's routines, preferences, and care providers
How the trust will be funded, whether during life, at death, or both
How other relatives should direct gifts so they do not land outright with the beneficiary
These decisions link closely to long-term care planning for your wealth and family and to broader generational wealth planning. An integrated approach to wealth management can help make sure investments, taxes, and legal documents point in the same direction.
Next Steps for Your Family
Reviewing how a trust could fit with your investments, tax situation, and estate documents may give you more confidence about the future. When you are ready, schedule a complimentary, no-obligation wealth and tax review to talk through your goals and questions, and bring your estate attorney into the conversation as you move forward.
Frequently Asked Questions
What is the difference between a first-party and a third-party special needs trust?
A first-party trust holds the beneficiary's own assets and generally must include a Medicaid payback provision. A third-party trust holds assets from relatives or others and typically does not require payback, so remaining funds can pass to other heirs.
Can a special needs trust pay for anything the beneficiary needs?
Trust funds can pay for many supplemental needs, but certain distributions, such as those for food or shelter, may affect some benefits. Trustees should understand current program rules before making payments.
Is a supplemental needs trust the same thing?
In most contexts, yes. "Supplemental needs trust" is another name commonly used for the same type of arrangement, reflecting its role in supplementing public benefits.
Should I name a trust as beneficiary of my retirement account?
It may make sense in some cases, but the trust must be drafted correctly for inherited retirement assets to be handled as intended. Coordinate with an estate attorney and your tax professional before changing any designation.
Do I still need an ABLE account if I have a trust?
Not necessarily, but many families use both. An ABLE account may provide flexibility for everyday expenses, while the trust holds larger assets. Annual limits and benefit rules apply.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
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About Compound Wealth
Compound Wealth believes many financial decisions benefit from being evaluated together rather than independently. The firm integrates tax planning, wealth management, accounting, and business advisory services to help clients navigate financial complexity through a coordinated planning approach tailored to their evolving needs.
