If you or someone in your family has special needs, financial planning and accommodation may take extra consideration and care. If the person in question has a disability, they are likely receiving government assistance through SSI, Medicaid or Medi-Cal or a local assistance program. There are strict rules for these programs, and your financial advisor should be able to help guide you through the regulation process in order to plan your - and your beneficiaries - finances well.
Special Needs Financial Guidelines for Those on Disability
If someone on disability is receiving government assistance, it is likely that they cannot have more than $2000 to their name, which limits the amount of income they receive. However, if the person with the disability is named as the beneficiary of a Special Needs Trust, that offers some breathing room. The assets in that trust are excluded from restrictions because the assets are managed by the trust.
Non-Spousal IRA Beneficiary Guidelines
The SECURE Act of 2020 mandated that all non-spousal IRA beneficiaries must withdraw inherited funds by the tenth year after the IRA owner’s death. However, if the beneficiary is designated as an eligible designated beneficiary (EDB), the SECURE Act allows for a lifetime stretch payout. The following individuals qualify for EDB status:
- Surviving spouse
- Minor child of the decedent (the status changes once this person is no longer a minor)
- A person with a disability
- A chronically ill person
- A beneficiary less than 10 years younger than the decedent
Conduit Trusts vs Accumulation Trusts
Prior to the SECURE Act, IRAs set up within trusts were often conduit trusts. Conduit trusts allow for earned income and pay required minimum distributions out to beneficiaries yearly. Taxes are reported on individual returns at the individual tax rate.
In an accumulation trust, the assets and income earned by the IRA is held within that trust and the income is taxed at the trust rate. The income does not get paid out to the beneficiary immediately. This is to the advantage of the disabled person named as beneficiary, because if it was paid out to them directly (as in a conduit trust), they could inadvertently be disqualified from their government benefits. However, in the instance of an accumulation trust, there is a huge tax disadvantage. When income goes above $13,450 for the year, it is taxed at the maximum federal tax rate of 37%. For comparison, a household, married-filing-jointly filer would have to make over $539,900 to reach the 37% tax bracket.
What options are available for special needs financial planning?
Tax laws are especially complex around inherited trusts and that’s why it’s extremely important to think about the effects that income will have on a person with a disability - and why special needs financial planning, including a special needs trust, may be needed. There are possible other avenues, such as a Roth conversion, but all possibilities should be discussed and planned with a financial advisor as well as a tax professional and an estate lawyer.
The financial and tax teams at Chatterton & Associates can help discuss your special trust or other inherited IRA needs. Contact us today to help you decide the right path for you and your beneficiaries.
The Team at Chatterton & Associates
Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. Neither Royal Alliance Associates, Inc nor its representatives provide 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.