If you have a child or other loved one with special needs who receives benefits through programs with needs-based qualification rules, you are probably already aware that your loved coming into money can have harmful consequences. The receipt of substantial assets, including through inheritance, can disqualify your loved one from continuing to receive the benefits upon which he or she has come to rely. One way to leave a portion of your wealth to your loved one with special needs, while avoiding this disastrous disqualification scenario, is the creation of a supplemental needs trust (also called a special needs trust.) However, if your estate also includes IRAs, you’ll want to take care regarding how you fund this special needs trust.
One plan that is almost always the wrong move is to name your loved one with special needs as the death beneficiary of your IRA. Your death would create a “Catch-22” of bad choices. Taking the required minimum distribution from the account very likely will result in your loved one losing eligibility and losing his/her benefits. Failure to take required distribution will trigger severe penalties from the IRS.
In certain situations, the solution to this problem is to name the special needs trust you’ve created for your loved one as the beneficiary of your IRA. The rules governing needs-based program eligibility say that, as long as the beneficiary does not possess direct control over the assets in a special needs trusts, that wealth does not count against him or her. This generally means having a trustee manage the trust who is not the beneficiary.
In some cases, though, naming your loved one’s special needs trust as the beneficiary of your IRA can be tricky. The rules controlling IRAs allow you greater flexibility when you name a person as the beneficiary. An individual has a specific life expectancy, so the tax code allows for the stretching out of distributions from the inherited account over the span of that beneficiary’s life expectancy. This lets you keep a larger amount of principal in the account, which can continue to grow income tax-free. If the special needs trust you’ve created names your loved one as the primary beneficiary during his/her lifetime, but then names a favored charity to receive the assets that remain after your special needs loved one’s death, then that stretching option is not available.
So what should you make of all this? More than anything, it is that leaving an inheritance to a loved one with special needs requires prompt and very thoughtful planning. It is important to work with an experienced estate planning team who can lay out all of your options and explain them in an understandable way. That way, you can have the peace of mind that you’ve not only taken care of your loved one, but have done so in the most financially efficient way possible.
Summary: Leaving a portion of your assets for the benefit of a loved one with special needs, and who receives needs-based benefits, requires engaging in careful estate planning. Implementing a special needs trust is often a vital component of such a plan. If you have wealth in an IRA, you can use that asset to benefit your special needs loved one, but you should be very diligent in this area of your planning in order to ensure that you neither place your loved one’s benefits at risk nor trigger certain tax penalties related to how the IRA’s funds are distributed.