Many parents and families planning for the care of their loved one with special needs will set up a Special Needs Trust (also often referred to as Supplemental Needs Trusts or SNT). SNTs allow assets to be left to a disabled or chronically ill person without disqualifying them for certain means-tested benefits, such as SSI, Medicaid, SNAP and state services.
A common asset that may be left to an individual living with a disability is a retirement account such as an IRA. However, families who had previously sought to establish an SNT for a disabled loved one were often counselled to not include a charitable organization as a beneficiary (a person or entity getting leftover money in an SNT, or Remainder Beneficiary) after the passing of the disabled individual (the Primary Beneficiary) due to some severe negative tax consequences. Thanks to legislation passed by Congress in late 2022, this is no longer the case.
Background on SNTs and IRAs
When someone is named as a beneficiary of an IRA and the original IRA owner dies, the named beneficiary creates an Inherited IRA to hold the assets that are assigned to them. The Inherited IRA then must distribute funds to the new owner under the Required Minimum Distributions (RMD) rules, paying income taxes as the funds are distributed.
For IRAs inherited prior to 2020, individuals were able to “stretch out” the Inherited IRA distributions over their lifetime using an IRS Life Expectancy Table, continuing to defer the income taxes imbedded in the Inherited IRA for an extended period of time.
If IRAs were left to an SNT (or other trust), the Inherited IRA could look to the beneficiaries of the SNT to determine the proper RMD schedule. However, due to other tax rules, if a non-person like a charity was named a Remainder Beneficiary of the SNT the Inherited IRA would have to be distributed within a much shorter period (usually 5 years) and the taxes paid much sooner. Exacerbating this is that SNTs are “complex trusts” (for tax purposes) and pay income taxes at accelerated rates on income not spent on the Primary Beneficiary. This means after the first $14,451 of realized income (2023) an SNT would pay taxes at the 37% tax rate (individuals only hit that rate after $578,125 of income). These factors can lead SNTs to pay tens of thousands, if not hundreds of thousands, in extra income taxes. No wonder attorneys and tax professionals would recommend that families not name a nonprofit as a Remainder Beneficiary of an SNT if there were IRA assets being left to the SNT.
In late 2019, Setting Every Community Up for Retirement Enhancement (SECURE 1.0) Act, was signed into law, changing the distribution rules for Inherited IRAs. For IRAs that are inherited in 2020 and after, most individuals are now required to take all of the funds out of Inherited IRAs (and thus pay taxes) within 10 years. However, some beneficiaries are excluded from this 10-year rule, including disabled or chronically ill individuals and the SNTs supporting them. These beneficiaries may instead have the retirement asset paid out to them over their lifetime under the old rules, continuing to stretch out the tax payments. However, the non-person remainder beneficiary rules were not changed at that time, continuing to limit non-profits being named as such Remainder Beneficiaries.
The Impact of SECURE 2.0’s Passage on SNTs
In late 2022, significant changes affecting the SECURE Act were approved (SECURE 2.0). Among its provisions was the Special Needs Trust Improvement Act of 2022. Starting in 2023, certain types of charitable organizations can now be named as Remainder Beneficiaries of SNTs funded with retirement accounts — without compromising the favorable stretch payout timeframe available to individuals with disabilities who are the primary beneficiaries.
Imagine a couple who have raised a child with multiple developmental disabilities. As parents, they have relied on the essential care that a certain nonprofit provided throughout their child’s upbringing. As they plan for their child’s future, they establish an SNT to help support their child in the years ahead. Should the child die prematurely, the parents would like the assets in the SNT to transfer next to benefit the nonprofit – the remainder beneficiary.
Many families rely on the essential care that a particular nonprofit provides throughout their child’s life. As such many would like to help the nonprofit directing some or all of any leftover money in their child’s SNT once their child passes away. Now, due to the SECURE Act 2.0, families can safely name that nonprofit as a Remainder Beneficiary of the SNT without severe negative impacts on the value of the funds available for the child’s lifetime. You may want to contact your special needs estate attorney to amend your will and trust to add in a nonprofit as a Remainder Beneficiary.
If you want to understand more about how an SNT works, contact a qualified special needs legal, tax or financial professional in your area.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.