When a person with a disability receives a personal injury settlement, medical malpractice recovery, workers’ compensation settlement, inheritance, or other money that legally belongs to that person, the funds can create an immediate public benefits problem. A properly drafted and administered first-party Special Needs Trust can be a solution, but it is not simply a form document. The trust must be coordinated with SSI, Medi-Cal, lien resolution, settlement approval, tax reporting, and trustee administration.
This article focuses on first-party Special Needs Trusts funded with settlement proceeds in California.
What Makes the Trust “First-Party”?
A first-party Special Needs Trust is funded with assets that belong to the beneficiary or to which the beneficiary is legally entitled. The California Department of Health Care Services (DHCS) describes first-party SNTs as trusts funded with assets belonging to the trust beneficiary, including assets from an award or settlement.1
This is different from a third-party Special Needs Trust, which is funded with someone else’s assets, such as a parent’s living trust, life insurance, or gift. The funding source matters because first-party trusts usually require a government payback provision, while properly structured third-party trusts generally do not.
Why Settlement Proceeds Can Affect Benefits
SSI remains resource-sensitive. The Social Security Administration states that the countable resource limit is $2,000 for an individual and $3,000 for a couple.2 A settlement paid directly to an SSI recipient can therefore suspend or terminate SSI eligibility unless the funds are properly handled.
Medi-Cal also requires current analysis. California eliminated the asset test for Non-MAGI Medi-Cal programs in 2024, but DHCS guidance states that starting January 1, 2026, Medi-Cal again counts assets for many affected categories, including people who are 65 or older, have a disability, live in a nursing home, or are in certain families with income too high for tax-based rules. DHCS lists the 2026 asset limit as $130,000 for one person, plus $65,000 for each additional eligible family member, subject to category-specific rules.3
For many beneficiaries, SSI is still the tighter limit. For others, Medi-Cal eligibility, share of cost, long-term care rules, and future redetermination issues may be equally important.
The Federal First-Party SNT Exception
The federal authority for the most common individual first-party SNT is 42 U.S.C. § 1396p(d)(4)(A).4 In general, the trust must contain the assets of an individual under age 65 who is disabled, must be established for that individual’s benefit by the individual, a parent, grandparent, legal guardian, or court, and must provide that the State receives remaining trust amounts at death up to the amount of medical assistance paid on the individual’s behalf.
SSA’s current POMS guidance reflects the 21st Century Cures Act change allowing a legally competent disabled individual to establish their own first-party SNT on or after December 13, 2016.5 That change is important, but it does not eliminate the need to analyze capacity, settlement approval requirements, lien issues, and California court rules.
California Settlement Proceeds and Court Approval
When money for a minor or person with a disability is paid to a Special Needs Trust under California Probate Code section 3604, the court must review and approve the trust terms.6 Section 3604 requires specific findings, including that the person has a qualifying disability, is likely to have special needs that will not be met without the trust, and that the amount to be paid to the trust does not exceed what appears reasonably necessary to meet those special needs.
California Rule of Court 7.950 requires petitions for approval of compromise, settlement, or disposition of proceeds for a minor or person with a disability to be verified and to fully disclose information bearing on the reasonableness of the compromise or disposition.7 If the trust is funded by court order, Rule 7.903 requires the order to provide that the trust is subject to the court’s continuing jurisdiction and may provide for court supervision.8
For plaintiff attorneys, this means the SNT should be addressed before final settlement distribution. If the funds are disbursed first and trust planning is handled later, the client may lose benefits, create reporting problems, or require a more expensive court fix.
Liens Must Be Coordinated Before Funding
California Probate Code section 3604(d) requires a court order for payment of money to a Special Needs Trust to include a provision that statutory liens in favor of specified public entities, including DHCS, are first satisfied.6 DHCS also states that personal injury liens must be satisfied before funding an SNT from personal injury settlement proceeds.1
This is a practical issue. The SNT is not a substitute for lien resolution. The settlement team should coordinate personal injury liens, Medi-Cal liens, Medicare issues, private health insurance claims, structured settlement planning, and trust funding instructions before funds are released.
What Can the Trust Pay For?
A Special Needs Trust is designed to supplement, not replace, public benefits. SSA policy generally treats cash paid directly from the trust to the beneficiary as unearned income. Payments for food or shelter may create in-kind support and maintenance (ISM).
Payments to third parties for items such as education, therapy, transportation, professional fees, uncovered medical services, phone bills, recreation, and entertainment generally may avoid being treated as income, depending on the facts and the item purchased.
Because the distribution rules are technical, the trustee must understand benefits administration. A well-drafted trust can still fail in practice if the trustee gives the beneficiary cash, pays the wrong bills, ignores reporting obligations, or fails to keep records.
The Payback Requirement
The defining drawback of a first-party SNT is payback. At the beneficiary’s death or earlier termination, first-party SNTs must include federal and state payback provisions. DHCS states that it is required to recover up to the total medical assistance paid by Medi-Cal on the beneficiary’s behalf.9 California Probate Code section 3605 also addresses claims against trust property at death or termination for court-established SNTs under section 3604.10
This is why the source of funds matters. If the money belongs to the beneficiary, a first-party SNT may be necessary. If the money belongs to a parent, grandparent, or other family member, a third-party SNT should usually be considered instead.
Key Takeaway
A first-party Special Needs Trust can preserve eligibility and protect settlement proceeds, but the trust should be built into the settlement process early. The attorney handling the settlement, the SNT attorney, the lien resolution team, the structured settlement professional, and the trustee should coordinate before disbursement. In California, the details of Probate Code section 3604, California Rules of Court 7.903 and 7.950, DHCS notice and lien issues, SSI resource rules, and the required payback provision all matter.
Need help coordinating a Special Needs Trust with settlement proceeds? Contact Duisters Giarratano, APC at SdCountyTrusts.com to learn more about your options.
Disclaimer: This article is for educational purposes only. It does not constitute legal advice and does not create an attorney-client relationship. Public benefits rules are fact-specific and may change. Consult qualified counsel before taking action.
Legal Authorities and Sources:
- California Department of Health Care Services, Special Needs Trust.
- Social Security Administration, Supplemental Security Income (SSI) Resources.
- California Department of Health Care Services, Asset Limit Frequently Asked Questions.
- 42 U.S.C. § 1396p(d)(4)(A).
- SSA POMS, SI 01120.203, Exceptions to Counting Trusts.
- California Probate Code § 3604.
- California Rule of Court, Rule 7.950.
- California Rule of Court, Rule 7.903.
- SSA POMS, SI 01120.200, Trust Disbursement Rules.
- California Probate Code § 3605.