Funding a Special Needs Trust With a Structured Settlement

If you win a personal injury lawsuit, you may receive your award in a lump sum or as a structured settlement.

With a structured settlement, you will receive payments over time; you may opt for a substantial initial amount, with lesser succeeding payments to provide for lost income. These periodic payments don't count for income tax purposes or stop a designated heir from receiving the remaining payments tax-free upon your death.

If an individual with a disability is expected to receive a structured settlement, planning to use the settlement money to fund something called a special needs trust may be a particularly valuable decision.

What Is a Special Needs Trust?

A special needs trust (SNT) is a type of trust that provides an individual with a disability with funds meant to improve their quality of life without jeopardizing their access to certain public benefits.

A person who has a disability may, for instance, rely on a public assistance program like Supplemental Security Income (SSI). To remain eligible for such a program, the individual must have limited income and resources. If that individual were to receive a significant settlement, they may no longer qualify for these important government benefits.

With an SNT, the disabled individual can preserve their public benefits without missing out on settlement funds. This is because settlement payments can be directed into the special needs trust, rather than to the disabled individual. The individual can then use the special needs trust funds to help pay for a variety of needs, including education, vacation, hobbies, and more.

A structured settlement may be ideal for partially or fully funding a first-party special needs trust. It can also lower administration costs since only trust assets will be subject to fees. (Learn more about the specifics of a first-party special needs trust in a related article.)

Protecting Your Settlement Funds

Structured settlements and trusts combine to protect funds from financial predators, creditors, or a trustee with poor money management skills. Adequately funding an SNT with a structured settlement can mean that the individual with disabilities will have a steady stream of income along with public benefits. A structured settlement typically establishes this reliable income using an annuity purchased from an insurance company.

In general, structured settlements offer significant flexibility in terms of duration and payment amounts. A special needs planner can help you understand your options before deciding how to settle a personal injury lawsuit.

Initial Funds to Operate the Trust

The SNT must receive sufficient seed money to ensure the trustee can make any initial payments the disabled individual may need. This way, the beneficiary has immediate funding available without having to wait for an annuity’s longer-term payout.

Keep in mind that the initial funding amount and size of the trust affects whom you choose as a professional trustee. The annuity’s payee becomes the SNT, rather than the beneficiary. (Again, monies directly paid to the disabled individual could impact their ability to qualify for certain government benefits.)

Medicaid’s Recovery Program

Federal law requires all first-person SNTs to name the state’s Medicaid agency as the remainder beneficiary upon the beneficiary’s death. The special needs trust will still receive the structured settlement payments during life. Upon death, the Medicaid lien will be satisfied first, and the rest will go to any remaining beneficiaries.

A commutation clause must be part of the annuity provisions in case the disabled beneficiary dies prematurely. The clause states that all remaining assets of the annuity would be paid into the first-party SNT within a limited period, allowing for timely payment of death taxes and trust closure. The commutation clause prevents the trust from becoming insolvent before death.

Local Laws Impacting the Trust

If you're considering the purchase of a structured settlement, such as an annuity to fund a special needs trust, learn more about your county's jurisdiction and position regarding allocating the principal and income for structured settlements. The principal funds for an SNT for a disabled person or minor must be spent with court approval. Some counties consider almost all annuity payments to be income.

In contrast, others deem a percentage as income and the remaining as principal. County jurisdiction affects the trustee's requirements to seek court approval for the ongoing needs of the beneficiary.

Seek Professional Advice

To avoid problems integrating a structured settlement with a special needs trust, retain a special needs attorney familiar with county and state-specific regulations, as the timing and sequence of events are crucial. A special needs planning lawyer can advise your personal injury attorney on the proper structure and terms for such a trust. Improperly drafted documents can trigger earlier reimbursements, making the beneficiary ineligible for government benefits.

Special needs trusts funded by a structured settlement are more complex to manage than many other trust types. A special needs planning attorney can help educate the trustee concerning qualified disbursements to preserve the disabled person's eligibility for public benefits. With so much at stake, it makes sense to employ a professional trustee to keep proper records, manage assets, help with tax preparation, handle bills, and ensure trust distributions maintain the beneficiary’s eligibility.

Before receiving a structured settlement in a personal injury case, consult with a special needs attorney near you. 

To learn more about SNTs as well as structured settlements, check out the following articles:

• How Can I Use a First-Party Special Needs Trust?
• Before Settling a Personal Injury Claim, Consider a Special Needs Trust
• What a Special Needs Trust Is for and How It Can Help
• The Advantages and Drawbacks of Structured Settlements