Ministers will reconsider the abolition of the Independent Living Fund after choosing not to appeal against an Appeal Court ruling that the move was legally flawed, the Department for Work and Pensions said.
Three senior judges ruled there was "simply not the evidence" to show the DWP considered "the potentially very grave impact" of closure on severely disabled people who rely on the fund.
The case was brought by five disabled people among the 20,000 vulnerable recipients the fund helps to live independent lives in the community.
A DWP spokeswoman said: "In light of the guidance provided by the Court of Appeal, ministers will be invited to make a new decision on the future of the Independent Living Fund based on further advice.
"This Government is absolutely committed to supporting disabled people and we continue to spend around £50 billion a year on disabled people and their services."
Lord Justice Elias, Lord Justice Kitchin and Lord Justice McCombe unanimously agreed to quash the December 18, 2012 decision to shut down the fund.
Lord Justice McCombe said it was based on evidence which failed to adequately reflect consultation responses, "indicating that independent living might well be put seriously in peril for a large number".
The judges ruled there was a failure by the Government to comply with its public sector equality duty (PSED) to properly assess the effects of closure, as required under the Equality Act 2010.
Lord Justice Elias said: "Any government, particularly in a time of austerity, is obliged to take invidious decisions which may exceptionally bear harshly on some of the most disadvantaged in society.
"The PSED does not curb government's powers to take such decisions, but it does require government to confront the anticipated consequences in a conscientious and deliberate way insofar as they impact upon the equality objectives (of the Equality Act)."
The ruling was a victory for the five fund users, including Gabriel Pepper, from Walthamstow, east London, who accused the Government of "a vicious attack on the disabled".
The other applicants were Stuart Bracking, Paris L'amour, Anne Pridmore and John Aspinall, who brought his case with his mother, Evonne Taylforth, acting as his litigation friend.
They appealed against a High Court ruling by Mr Justice Blake in April that the closure decision was lawful.
The average payout from the £359 million ILF is £300 a week per recipient for them to employ personal assistants to help with personal needs.
Closing the fund would mean disabled people becoming entirely dependent on local authority services, with the ILF budget transferred to town hall control.
The DWP stressed the Court of Appeal accepted the consultation was carried out " properly and fairly" and that the ILF was closed to new users in 2010.