What Happens to a Special Needs Trust When the Beneficiary Passes Away?

Written by: Connor Kavanaugh, Special Needs Planner

Updated December 4th, 2025

Special needs trusts are among the most important planning tools for individuals with disabilities. They protect eligibility for benefits like Medicaid and SSI, preserve assets for quality-of-life needs, and provide long-term financial stewardship. But an important question often comes up: what happens when the primary beneficiary passes away and assets remain in the trust?

The answer depends heavily on the type of trust—first-party or third-party—and understanding the differences is critical for proper planning.

When the Trust Terminates

In most cases, a special needs trust terminates when the beneficiary dies. At that point, the trustee is responsible for:

• Following the termination instructions in the trust

• Filing the final trust income tax return

• Paying any income taxes owed

• Addressing allowable final expenses (as permitted by the trust)

Some expenses—such as funeral and burial costs—cannot be paid from a first-party special needs trust after death, which is why prepaid burial arrangements are an important planning tool.

Medicaid Payback for First-Party Special Needs Trusts

A first-party special needs trust is funded with assets belonging to the beneficiary. Common examples include lawsuit settlements, accumulated savings, or inherited assets received improperly.

Because these assets originally belonged to the beneficiary, federal law requires that any state Medicaid agency providing benefits during the beneficiary’s lifetime may claim reimbursement after death. This Medicaid payback rule applies only to first-party trusts.

The payback requirement is dollar for dollar—meaning the state is reimbursed up to the amount it spent on Medicaid services provided to the individual during their lifetime. Only after Medicaid is repaid can any remaining funds be distributed as directed by the trust.

What Happens with a Third-Party Special Needs Trust?

A third-party special needs trust is funded with assets belonging to someone other than the beneficiary—most commonly parents or other relatives.

Key differences:

• No Medicaid payback requirement

• Remaining assets pass to the remainder beneficiaries named in the trust

• Assets are not part of the beneficiary’s estate for estate-tax purposes

Once the trust terminates, the trustee distributes remaining funds according to the trust document—often to siblings, other family members, or charities. There may be income tax consequences to the recipients, depending on the trust’s accumulated income, but no Medicaid recovery applies.

Important Rules to Remember

• First-party special needs trusts cannot pay funeral or burial expenses after the beneficiary’s death.

• Unpaid medical bills or invoices generally cannot be paid after death from a first-party trust.

• Prepaid burial policies are strongly encouraged for beneficiaries with first-party trusts.

• Third-party trusts provide greater flexibility, lower administrative burden, and no Medicaid payback risk.

Planning for a Difficult but Essential Part of the Journey

Discussing the death of a loved one is never easy, especially when navigating the complexities of disability and long-term care. Yet understanding what happens at the end of a trust’s life is essential for responsible planning.

Working with an experienced special needs planning team—attorneys, planners, tax advisors, and trustees—ensures that your family follows the correct procedures, minimizes tax exposure, protects remaining assets, and honors the intent behind the trust.

If you need support evaluating your current trust or planning for the future, Palladio Consulting LLC is here to guide you with clarity and compassion.