Retirement plans often make up a significant portion of the assets of parents of children with special needs, or of individuals who have become disabled as adults. In such cases, the question arises as to whether the retirement plan can be put into a special needs trust. The answer, as with many legal questions, is "it depends." Also, the answer has changed significantly since passage of the SECURE Act at the end of 2019.
There are three different questions that need to be answered:
- Can you transfer your own IRA or 401(k) into a special needs trust?
- Should you name a special needs trust as the beneficiary of a retirement plan?
- Can you transfer an inherited IRA into a special needs trust?
Can You Transfer Your Own IRA or 401(k) into a Special Needs Trust?
This question normally comes up for people who become disabled, whether due to injury or illness, after they have worked and accumulated retirement savings. The answer is a clear no. A disabled person cannot transfer a retirement plan into a special needs trust without first liquidating it and paying taxes on the realized income. If paying the taxes owed is necessary in order to shield the funds in a special needs trust and receive important public benefits, it may well be worth the cost. In fact, the tax cost may not be as high as it seems at first depending on the size of the retirement plan, the individual's other income, and whether medical expense or other deductions are available.
Should You Name a Special Needs Trust as Beneficiary of Your Retirement Plan?
More often, parents would like to leave all or part of a retirement plan to a trust for the benefit of their child with special needs. This can be done, but it's a bit complicated. Before passage of the SECURE Act, special needs planners would advise clients to avoid doing so, if possible, to keep the trust simpler. In order to be the beneficiary of a retirement plan and spread the plan withdrawals out over the beneficiary's lifetime, the trust must qualify as a so-called "accumulation" trust, which presents certain challenges. To avoid this, clients might name their non-disabled children as beneficiaries of their retirement plans and name the special needs trust as beneficiary of other assets.
However, the SECURE Act made it more difficult to stretch out retirement plan withdrawals for the lifetime of most beneficiaries, limiting the withdrawal period to the 10 years following the death of the primary owner. One of the exceptions is beneficiaries who qualify as disabled. So now, in many cases, planners give the opposite advice. If possible, the retirement plan should be payable to the special needs trust so withdrawals and the payment of taxes can be spread out over the disabled beneficiary's lifetime. In each case, the special needs planner and the client must balance the potential tax savings with the added complication of creating and managing an accumulation trust.
Can You Transfer an Inherited IRA to a Special Needs Trust?
Perhaps you have a special needs trust and have inherited an IRA. Can the IRA be transferred to your trust without having to be liquidated first? Here the answer is less definite. There's no regulation that directly answers this, but there are IRS rulings that have permitted such a transfer without having to liquidate the IRA first in individual cases. Absent a regulation that directly addresses this, the challenge may be less the law and more the willingness of the bank or investment firm where the account is located to permit such a transfer to the trust. They may well first require that the account owner obtain a ruling from the IRS that is specific to the account in question. The cost of obtaining such a private “revenue ruling” in most cases would outweigh the potential benefit of making the transfer to the trust.
As you can see, the subject of retirement plans and special needs trusts is a complicated one. If you want to know how a retirement plan can fit with your or a loved one’s special needs trust, talk to your special needs planner.
This information is not intended to be a substitute for specific individualized tax, legal or estate planning advice as individual situations will vary. Neither Royal Alliance Associates, Inc., nor its registered representatives or employees, offer tax or legal advice. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.
Securities and investment advisory services offered through Royal Alliance Associates, Inc. member FINRA/SIPC. Royal Alliance Associates, Inc. is separately owned and other entities and/or marketing names, products or services referenced here are independent of Royal Alliance Associates, Inc. Special needs consulting services are not offered through Royal Alliance Associates, Inc.
Content provided by the Academy of Special Needs Planners, Copyright 2021