Special-needs trusts have been used for many years. However, there are two factors that are changing and parents need to be aware of them, says the article “Special-Needs Trusts: How They Work and What Has Changed” from The Wall Street Journal. For one thing, many people with disabilities and chronic illnesses are leading much longer lives because of medical advances. As a result, they are often outliving their parents and primary caregivers. This makes planning for the long term more critical.
Second, there have been significant changes in tax laws, specifically laws concerning inherited retirement accounts.
Special needs planning has never been easy because of the many unknowns. How much care will be needed? How much will it cost? How long will the special needs individual live? Tax rules are complex and coordinating special needs planning with estate planning can be a challenge. A 2018 study from the University of Illinois found that less than 50% of parents of children with disabilities had planned for their children’s future. Parents who had not done any planning told researchers they were just overwhelmed.
Here are some of the basics:
A Special-Needs Trust, or SNT, is created to protect the assets of a person with a disability, including mental or physical conditions. The trust may be used to pay for various goods and services, including medical equipment, education, home furnishings, etc.
A trustee is appointed to manage all and any spending. The beneficiary has no control over assets inside the trust. The assets are not owned by the beneficiary, so the beneficiary should continue to be eligible for government programs that limit assets, including Supplemental Security Income or Medicaid.
There are different types of Special Needs Trusts: pooled, first party and third party. They are not simple entities to create, so it’s important to work with an experienced estate planning attorney who is familiar with these trusts.
To fund the trust after parents have passed, they could name the Special Needs Trust as the beneficiary of their IRA, so withdrawals from the account would be paid to the trust to benefit their child. There will be required minimum distributions (RMDs), because the IRA would become an Inherited IRA and the trust would need to take distributions.
The SECURE Act from 2019 ended the ability to stretch out RMDs for inherited traditional IRAs from lifetime to ten years. However, the SECURE Act created exceptions: individuals who are disabled or chronically ill are still permitted to take distributions over their lifetimes. This has to be done correctly, or it won’t work. However, done correctly, it could provide income over the special needs individual’s lifetime.
The strategy assumes that the SNT beneficiary is disabled or chronically ill, according to the terms of the tax code. The terms are defined very strictly and may not be the same as the requirements for SSI or Medicaid.
The traditional IRA may or may not be the best way to fund an SNT. It may create larger distributions than are permitted by the SNT or create large tax bills. Roth IRAs or life insurance may be the better options.
The goal is to exchange assets, like traditional IRAs, for more tax-efficient assets to reach post-death planning solutions for the special needs individual, long after their parents and caregivers have passed.
Reference: The Wall Street Journal (June 3, 2021) “Special-Needs Trusts: How They Work and What Has Changed”
Suggested Key Terms: Special-Needs Trusts, Pooled, First Party, Third Party, Beneficiary, Trust, Trustee, Supplemental Security Income, SSI, Medicaid, Traditional IRA, Roth IRA, Life Insurance, Required Minimum Distributions, RMDs