A special needs trust is a way for families to financially support their family members with special needs without endangering their eligibility for needs-based government benefits like Medicaid and SSI. Many families in this situation set up a special needs trust as part of their estate plan and then use certain assets to fund the trust, typically after their death.
Your Estate Plan, IRAs, and Life Insurance Policies
While there are many assets that you can use to fund a special needs trust for your loved one, IRAs and other retirement plans, as well as life insurance policies, are some common sources of funding for special needs trusts. However, you must remember that your will doesn’t control assets with a named beneficiary, such as an IRA or life insurance policy. Therefore, you should designate the special needs trust as a beneficiary on those assets if you wish to leave them to your child with special needs.
Many people list all their children as equal beneficiaries on their life insurance policies or retirement accounts. However, if you do that and one of your children has special needs, the proceeds of the assets that pass to the child upon your death may disqualify them from important government benefits based on need. Therefore, it is crucial to name the special needs trust benefitting your child as a beneficiary, not the child.
Designating a Special Needs Trust as the Beneficiary of Your Life Insurance Policy
Naming a special needs trust as a beneficiary of your life insurance policy is a fairly simple process. You must set up the special needs trust before you name it a life insurance policy beneficiary. You can then name the special needs trust as the sole beneficiary of your life insurance policy or as one of the multiple beneficiaries you wish to receive the policy’s proceeds. If you are naming multiple beneficiaries, you must specify the percentage of the assets you want each beneficiary to receive.
Designating a Special Needs Trust as the Beneficiary of Your IRA
Designation of a special needs trust as the beneficiary of your IRA or other retirement plan (aside from a Roth IRA) is more complex because those accounts involve pre-tax dollars, which create tax-deferred assets. As a result, if the proceeds of that account are distributed all at once or over time in large amounts, the corresponding tax bill will also be high. The resulting tax bill will be high due to the high tax rates paid by trusts on income retained in the trust. For instance, in 2025, retained income over $15,650 is subject to a 37% tax rate. State taxes will only add to that tax burden.
Stretching out IRA distributions over time will result in a more consistent and less onerous tax bill. This strategy also leaves more assets in the trust to grow tax-deferred over time. However, there are limitations to stretching out IRA distributions, as well.
The SECURE Act and SECURE 2.0, which made some changes to the original legislation, have limited the ability to stretch out inherited IRA distributions over a beneficiary’s lifetime. For most beneficiaries, the maximum stretch payout is now ten years. However, some individuals with disabilities – eligible designated beneficiaries – constitute an exception to this general rule.
Eligible Designated Beneficiaries
The following eligible designated beneficiaries (EDBs) enjoy exceptions to the general rule about stretching IRA payouts over time:
- Spouses;
- People who are not more than ten years younger than the account owner/participant;
- Minor children of the owner; and
- People who are “disabled” or “chronically ill.”
The term “disabled” has the same definition as used by the Social Security Administration: a person who is unable to engage in substantial gainful activity (SGA) for at least 12 years or ends in death. The term “chronically ill” refers to a person unable to perform two or more unassisted activities of daily living for an indefinite or lengthy period.
For the purposes of this exception, people with disabilities or chronic illnesses can stretch the payout of inherited retirement accounts over their actuarial lifetime. Furthermore, a trust for the sole benefit of a person with a disability or a chronic illness can stretch the distributions from an inherited IRA over the same timeframe.
Subsequent guidance from SECURE 2.0 and accompanying regulations resolved some concerns about the eligibility of special needs trusts for this exception. For instance, SECURE 2.0 clarified that naming a charity as a remainder beneficiary of a special needs trust does not affect the EDB status of the trust. A doctor’s certification is also sufficient to verify an EDB’s disability or chronic illness.
However, certain provisions in a special needs trust could disqualify it from this exception. For instance, if the trust provides for distributions to anyone who is not disabled or chronically ill during the lifetime of the beneficiary who is disabled or chronically ill, the trust will not qualify for the exception.
Contact Us Today to Learn More About Our Legal Services
Rubin Law is the only Illinois law firm to dedicate itself exclusively to providing compassionate legal services for children and adults with special needs. We offer unique legal and future planning techniques to meet your family’s individual needs.
Call us today at 866-TO-RUBIN or email us at email@rubinlaw.com to learn more about the services we can offer you and your family.
