Many parents and families planning for the care of their loved one with special needs will consider setting up a special needs trust. (Special needs trusts are also often referred to as supplemental needs trusts and SNTs). These trusts allow assets to be left to a disabled or chronically ill person without disqualifying them for certain benefits, such as Medicaid.
A common asset that may be left to an individual living with a disability is an inherited retirement account. However, families who had previously sought to establish an SNT for a disabled loved one could not effectively designate a charitable organization as a remainder beneficiary. Thanks to legislation passed by Congress in late 2022, this is no longer the case.
Background on SECURE Act 1.0 And SNTs
Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law in 2019, beneficiaries were mandated to liquidate certain inherited retirement accounts (IRAs) according to required minimum distribution (RMD) rules.
In its “1.0” version, the SECURE Act set the distribution timeframe for most IRAs inherited after 2019 to 10 years from the owner’s date of death, with some exceptions. However, particular beneficiaries are excluded from this 10-year rule, including disabled or chronically ill individuals. These beneficiaries may instead have the retirement asset paid out to them over their lifetime.
This means that the inherited retirement funds can be left to an SNT and distributed over the course of the beneficiary’s lifetime. Potentially, this can help in reducing taxes and allowing the beneficiary to supplement their finances for a longer period. The downside under SECURE 1.0 was that charities were not included in any beneficiary category that could qualify for this more prolonged period.
Because of the differing rules for charities and disabled beneficiaries, SECURE 1.0 effectively did not allow creators of SNTs to name charitable organizations as remainder beneficiaries. If the SNT named a charity as a remainder beneficiary, then the retirement funds had to be paid out within shorter timeframes. These timeframes depended on the date of death of the grantor and/or the age of the account owner at death. Unfortunately, they could be as short as five years from the anniversary of the grantor’s death.
By contrast, disabled beneficiaries could receive funds over their lifetime. The result was that special needs trusts could be written to preserve the more extended timeframe for disabled loved ones, but not if the trust named a charity as a beneficiary.
What Is a Remainder Beneficiary?
Typically, in SNT planning, when a grantor considers a charity as a beneficiary, it is as a “remainder beneficiary.” This designation is where a party is named as a beneficiary whose interest would only vest after an event, such as the passing of a disabled child or loved one. Upon the event’s occurrence, the remainder beneficiary receives any remaining trust assets. (Note: This type of arrangement is only available in third-party special needs trusts.)
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 for the assets in the SNT to transfer next to benefit the nonprofit – the remainder beneficiary.
The Impact of SECURE 2.0’s Passage on SNTs
In late 2022, significant changes affecting the SECURE Act were approved. Among its provisions was the Special Needs Trust Improvement Act of 2022. Now law, it allows charitable organizations to be named as remainder beneficiaries of special needs trusts holding inherited retirement accounts.
Unlike in SECURE 1.0, this arrangement is now possible while also preserving the ability of SNT beneficiaries to benefit from the special lifetime payout rule that is available to them. These changes became law on December 29, 2022, as part of the Consolidated Appropriations Act 2023 (2023 Act). Unless the law changes, it will apply to all calendar years from 2023 onward.
The changes mentioned above are part of the so-called SECURE Act 2.0, which updates RMD rules during life and in the event the owner of a retirement account passes away. For example, it increases the RMD age from 72 to 73 as of 2023 and then to age 75 in 2033. It also reduces penalties for failing to take an RMD from 50 percent to 25 percent.
For the special needs planning community, SECURE 2.0 has an added advantage. 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.
Connect With Your Attorney
If you are wondering how a SNT works under the SECURE Act 2.0, it is best to speak with your special needs planning attorney.
If you have a retirement account you intend to leave to someone with special needs, you may be able to create an SNT and designate it as the beneficiary of your retirement plan. By doing so, you may be able to protect your disabled loved one’s continued access to essential government benefits. Or, you may help avoid putting them in a situation where they will have to create a less favorable SNT structure with a Medicaid payback provision.
Leaving your retirement account to an SNT may allow the beneficiary to receive your hard-saved funds over time. You will be helping to ensure they will have funds to supplement their needs for a longer portion of their life. Alternatively, the trustee of the trust could only use the funds as needed for unexpected or more significant expenditures and minimize any tax consequences.
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 2023