Special Needs Trusts and Inheritance: How to Handle Unexpected Windfalls

What You’ll Find in This Post: Special Needs Trusts and Inheritance – How to Handle Unexpected Windfalls
Receiving an inheritance can be a financial blessing, but for individuals with disabilities who rely on SSI or Medi-Cal, even a small windfall can cause major disruptions. In this post, we’ll explain how families can protect both the inheritance and public benefits through careful planning.

Here’s what we cover:

• Why inheritances can unintentionally disqualify someone from SSI or Medi-Cal

• Real-life examples of well-intended gifts that caused benefit loss

• How first-party Special Needs Trusts (SNTs) can protect eligibility after an inheritance or settlement

• When pooled Special Needs Trusts may be the best solution

• The Medicaid payback rule and how it affects first-party and pooled trusts

• Common mistakes families make after a disabled person receives a windfall

• What not to do (like gifting money away or setting up the wrong kind of trust)

• What to do instead and how to get started quickly

• When to work with a special needs planning attorney (and when to seek a referral)

• How Cookman Law can help you preserve benefits and protect your loved one’s future

Whether you’re planning ahead or responding to an inheritance that’s already been received, this guide will help you take the right steps to secure long-term stability for your loved one.

 

 

An unexpected windfall such as an inheritance can feel like a life-changing gift. For many people, receiving extra funds means greater financial security and new opportunities. But for a disabled person who relies on public benefits like SSI or Medi-Cal, an inheritance or other sudden assets can create serious complications.

Programs such as SSI and Medi-Cal have strict income and resource limits. Even a relatively modest inheritance for a disabled person could push them over the threshold, leading to the loss of essential healthcare coverage or monthly income. Families are often caught off guard by this, not realizing that good intentions, like leaving money directly to a loved one, can unintentionally disrupt critical support.

This article explores how to navigate these situations by using tools like special needs trusts. We’ll explain why direct gifts can endanger public benefits, what options exist for managing inheritance and public benefits together, and how families can protect both financial resources and eligibility for essential programs.

 

Why Windfalls Can Be Risky for Public Benefits

For individuals with disabilities, many essential programs are means-tested, meaning eligibility depends on maintaining low income and resources. Two of the most common are:

• Supplemental Security Income (SSI): Provides a modest monthly cash benefit to help cover basic living expenses. To qualify, a single individual cannot have more than $2,000 in countable assets (or $3,000 for a couple).
• Medi-Cal (California’s Medicaid program): Offers healthcare coverage, including services that private insurance often does not cover, such as long-term care. Medi-Cal’s asset limit was eliminated for 2024 and 2025, but is being reimposed at $130,000 in countable assets per person (plus $65,000 for each additional family member).  There are also income limits.

This is where inheritances can create unintended consequences. Even a small inheritance for a disabled person – say, $5,000 from a grandparent’s will – can immediately push them over SSI’s $2,000 limit. The result? Benefits are suspended or terminated until assets are spent down, often forcing the recipient into financial instability and leaving them without crucial medical coverage.

Unfortunately, this situation happens far more often than most families realize. Well-meaning relatives often leave gifts directly to a loved one with a disability, not understanding that the inheritance may do more harm than good. Without the right planning, what was intended as a blessing can quickly become a setback.

Real-Life Scenarios of Unintended Harm

To see how quickly an unexpected windfall can disrupt public benefits, consider these common examples:

Example 1: A Grandparent’s Gift

A grandparent, wanting to help their grandchild with special needs, leaves $10,000 directly to them through a will. On paper, this sounds like a generous act of love. But because the grandchild is receiving SSI, the inheritance immediately puts them over the $2,000 resource limit. SSI benefits are suspended, Medi-Cal coverage is at risk, and the family is left scrambling to spend down the funds just to reestablish eligibility.

Example 2: An Injury Settlement*

An adult with a disability receives a legal settlement after a car accident. The funds arrive in their name, with no protective planning in place. Within weeks, their SSI payments stop, and they are notified of an overpayment penalty. Reapplying for benefits can take months, during which the individual may lose access to essential medical care and services they depend on daily.

*(Please note that while our office handles setting up 1st part special needs trusts for windfalls such as an inheritance, we do not handle creating them for settlements. We can, however, refer you to a trusted professional who can.)

In both cases, the problem wasn’t the size of the inheritance or settlement, it was the lack of planning. Even modest windfalls can create enormous disruptions if they are not properly structured. The good news is that there are proven tools, such as first-party special needs trusts and pooled trusts, that can protect both the assets and the benefits the individual relies upon.

First-Party Special Needs Trusts: A Key Solution

When a person with disabilities receives an inheritance or settlement directly in their own name, one of the most effective tools for protecting their benefits is a first-party special needs trust (SNT), also called a self-settled SNT.

What is it?

A first-party SNT is a trust funded with the beneficiary’s own assets, such as an inheritance, a legal settlement, or back payments from government benefits. Once the funds are transferred into the trust, they are no longer counted as the individual’s personal resources for programs like SSI or Medi-Cal.

Who can create one?

Federal law limits who is allowed to establish this type of trust. It must be created by:

• The individual with the disability (if they have legal capacity),
• A parent,
• A grandparent,
• A guardian, or
• The court.

The beneficiary must also be under age 65 at the time the trust is established and the beneficiary’s assets are transferred into it.

What assets can go into it?

• Inheritance received directly,
• Personal injury or accident settlements,
• Retroactive Social Security or other government back payments,
• Other funds owned outright by the beneficiary.

The Medicaid Payback Rule

One important feature of a first-party SNT is the Medicaid “payback” requirement. When the beneficiary passes away, any remaining funds in the trust must first be used to reimburse Medi-Cal (or other state Medicaid programs) for services provided during the beneficiary’s lifetime. Only after this payback can any leftover funds go to family members or heirs.

When is it used?

• A disabled person unexpectedly inherits money directly (instead of through a third-party SNT).
• An adult with disabilities receives a personal injury settlement or workers’ compensation award.
• A family realizes, after the fact, that assets have already been left to the disabled individual and need to be preserved.

Pros and Cons

Pros:

• Protects SSI and Medi-Cal eligibility.
• Allows assets to be used for supplemental needs like therapies, education, equipment, and quality-of-life expenses.
• Offers court-approved structure for managing funds responsibly.

Cons:

• Limited flexibility: must follow strict rules for distributions.
• Medicaid payback reduces the chance of leaving funds to other heirs.
• Requires setup and administration costs, which can be significant for smaller estates.

A first-party SNT can be a powerful way to safeguard both benefits and financial security after an unexpected windfall. However, it is not always the best or only option – which brings us to pooled trusts.

Pooled Special Needs Trusts: An Accessible Alternative

For some families, especially when the inheritance or settlement is relatively modest, a pooled special needs trust may be the most practical solution.

What is a Pooled Trust?

A pooled trust is a type of special needs trust that is established and managed by a nonprofit organization. Instead of setting up a separate, individual trust, funds from many beneficiaries are combined (“pooled”) for investment and management purposes. Each beneficiary, however, has their own sub-account, and the funds in that account are used for their specific needs.

*Please note that Cookman Law does not handle pooled trusts, but we are happy to refer you to a trusted professional who does.

Why Consider a Pooled Trust?

• Ideal for smaller windfalls: If an inheritance for a disabled person is under a certain amount, say around $100,000, the cost of setting up and maintaining an individual first-party SNT may outweigh the benefits. A pooled trust allows families to protect eligibility without high administrative expenses.
• Professional management: Nonprofits that run pooled trusts have experience following SSI and Medi-Cal rules, ensuring funds are distributed appropriately. This relieves family members of the burden of learning and complying with complex regulations.
• Trustee solution: For families without a reliable relative or friend to serve as trustee, a pooled trust offers built-in professional oversight.

Limitations and Considerations

• Control: Families do not have the same level of flexibility or control as they would with an individually managed trust.
• Fees: While lower than creating a private SNT, pooled trusts still charge fees for management and administration.
• Medicaid payback: Like first-party SNTs, pooled trusts are also subject to Medicaid payback. When the beneficiary passes away, remaining funds are typically used to reimburse the state, though some nonprofits allow a portion to remain in the pool to support other beneficiaries.

For many families, especially when the inheritance or settlement is not large, a pooled trust offers a cost-effective, professionally managed way to protect both the funds and the beneficiary’s public benefits.

What You Can’t Do (and Common Mistakes to Avoid)

When a disabled person receives an inheritance or other unexpected funds, families often scramble to “fix” the situation quickly. Unfortunately, well-meaning but uninformed actions can make matters worse. Here are some of the most common mistakes to avoid:

1. Giving the money away .

Some families try to solve the problem by simply giving the funds to relatives. SSI treats gifting assets away as a transfer of resources, which may lead to penalties or periods of ineligibility.

2. “Spending down” irresponsibly.

Families may be tempted to spend down the money quickly, perhaps on items that the beneficiary doesn’t need or on items that mainly benefit other family members.  This short-sighted approach does not protect the beneficiary for the long term. 

3. Putting the funds into a regular trust or sibling’s name.

Not all trusts protect public benefits. A standard revocable or family trust will still count as a resource for SSI and Medi-Cal. Similarly, putting the money in a sibling’s name may seem like a workaround, but it can create tax liabilities, legal disputes, or even jeopardize the sibling’s own finances, and can also count as a gift for SSI purposes.

4. Waiting too long to act.

SSI has strict reporting rules. If an inheritance or settlement is not reported within 10 days of receipt, the beneficiary risks overpayment penalties. In some cases, the Social Security Administration may demand repayment of benefits already issued, creating unnecessary financial strain.

5. Attempting a DIY approach without legal guidance.

Special needs trust inheritance rules are highly technical. Families sometimes attempt to draft their own solutions or use generic online trust forms, only to find out later that the documents don’t meet SSI or Medi-Cal requirements. By then, it may be too late to undo the damage.

6. Working with a “regular” estate planning attorney.

Very few estate planning attorneys prepare special needs trusts, and even fewer delve into the area of first party SNTs.  Any misstep can lead to suspension or termination of public benefits, which can take years to undo.

The bottom line: When it comes to inheritance and public benefits, quick fixes rarely work. The safest course is to act promptly, report honestly, and seek professional guidance to ensure the funds are handled correctly.

How We Can Help

At Cookman Law, we focus on estate planning and special needs planning, but it’s important to be clear about where our services begin and end. We do not handle personal injury settlements or litigation planning.

What we can do is help you prepare for the future and keep your estate plan aligned with your goals:

• Review and update an existing plan. If your loved one has received an inheritance or windfall, we can evaluate whether their current documents need changes to avoid unintended consequences.
• Set up a first-party SNT for an inheritance. If you receive an inheritance and want to preserve your benefits, we are happy to set up a first-party SNT designed to fit your needs and goals.
• Set up third-party SNTs. For parents, grandparents, or other family members, we can create third-party special needs trusts to ensure that any future inheritance goes into the right kind of trust from the beginning so the disabled beneficiary never receives funds directly.
• Refer to trusted colleagues. When a first-party or pooled trust is the right solution for a matter we don’t handle, we’ll connect you with professionals who handle those specific matters, ensuring your loved one’s benefits are not put at risk.

Because inheritance for a disabled person touches both estate law and public benefit rules, it’s critical to work with professionals who understand both. A misstep can mean months without essential medical care or income. With the right team in place, however, families can safeguard both assets and benefits, ensuring long-term stability and peace of mind.

The key takeaway is this: financial windfalls don’t have to derail a disabled person’s future. With proper planning, inheritances and public benefits can work together to provide long-term stability and support. Whether you are a parent planning ahead, a sibling helping to manage funds, or an individual with disabilities navigating these rules yourself, taking proactive steps now will make all the difference later.

If your loved one is on public benefits and has received (or may one day receive) an inheritance or settlement, we can help guide the next steps, or connect you with a trusted resource who can.