How Do I Leave My IRA to My Special Needs Child or Grandchild?

IRAs and 410(k)s to Special Needs Children

Many of our client’s have a significant share of their wealth accumulated in qualified plans including IRA or 401(k)s.  Often, when we review beneficiary designations as a part of our planning we find that most have named their disabled child as either a primary or contingent beneficiary of their retirement account. This can have a disastrous effect on a disabled person’s life.

SSI and Medicaid

Many individuals with disabilities receive support though a variety of federal benefit programs such as Supplemental Security Income (SSI) and Medicaid. SSI and Medicaid are means-based programs, which means these programs have restrictions and limitations on the amount of income and assets that a special needs recipient can have  in order to qualify for benefits.

SSI is important because in a majority of states a qualified recipient of SSI automatically qualifies to receive Medicaid benefits.  Medicaid is significant in that it is the portal to healthcare benefits and other programs.  Some of these programs provide ancillary services that benefit and impact a special needs person’s quality of life. Many programs –including supported living and work environments–are only open to participants who have qualified for Medicaid.  Currently, if a disabled person owns more than $2,000 of non-exempt assets, they will not qualify for SSI or  Medicaid.  If a disabled person is named as a beneficiary of a retirement account, they could lose their ability to qualify for SSI and Medicaid.

The solution? 

A Special Needs Trust (SNT) designed to manage resources for the benefit of the disabled person while maintaining the individual’s eligibility for government benefits.

For that portion of a retirement account that a client wants to go to their special needs child upon their death, they can name a properly designed special needs trust as the beneficiary instead. However, a trust without the proper special needs provisions could be a costly mistake and limit the amount of income tax deferral. If the SNT is not properly designed the taxes could be due upon receipt by the special needs trust, losing the ability of the trust to grow and provide much needed resources to the beneficiary.

Tax Deferral and the Stretch

The required distribution rules under Internal Revenue Code Section 401(a)(9) associated with tax-deferred retirement accounts are complicated. Traditional IRAs and 401(k)s are tax deferred. The government’s policy reason for allowing this tax deferral is to encourage us to save for our own retirement. This policy, however, doesn’t extend to perpetual tax deferral. At some point in time, the government requires participants to take distributions from their tax-deferred account and pay income tax.  This forced distribution schedule (called minimum required distributions) can exceed the income limits on a special needs person receiving SSI.  If the income exceeds the limits the recipient may be disqualified from SSI and Medicaid.

The only way to get the stretch out income tax treatment and not be disqualified from SSI and Medicaid is to have a see-through accumulation trust with special needs provisions built in. It is important to use an advisor who understands the proper drafting of these trusts to be sure that your legacy provides for your loved ones as you direct.