There are many ways to provide for your family member with special needs after you are gone. One of your largest assets may be a hard-earned retirement fund. Since most Individual Retirement Accounts (IRAs) are made up of pre-tax money, future taxable implications can be burdensome for your beneficiaries depending on how you distribute these funds. However, there are ways to reduce the tax burden inherited by your heirs.
Financial Planning for Your Family Member With Special Needs
One of the first planning steps to protect a loved one with a disability should be establishing a third-party Special Needs Trust (SNT). This trust is extremely important if the beneficiary is receiving government benefits based on a means test. In other words, if your family member only qualifies for government benefits because they have fewer assets than the maximum limit, you don’t want to give them money or assets that will exceed the limit and disqualify them from receiving needed benefits.
Instead, you should create a third-party SNT to accept the money or assets for the benefit of your loved one with a disability. A Trustee is named to control the SNT assets, and the beneficiary has no direct access to the funds. As a result, the funds held in an SNT have no impact on whether the individual with special needs qualifies for government benefits that require a means test.
Can an IRA be Used to Benefit a Person With Special Needs?
The short answer is yes, but again, you do not want to leave IRA funds directly to your family member with special needs. IRA accounts allow for a designated beneficiary which removes IRA assets from the probate process. If you want your IRA funds to be used to support your loved one with special needs, designate the third-party SNT as the IRA beneficiary, not your loved one individually.
The IRS has also established complicated regulations that control when IRA funds must be withdrawn and when taxes must be paid. If IRA funds are properly transferred to an SNT, tax rules may allow the funds to be withdrawn over the lifetime of the beneficiary. Withdrawing funds throughout the beneficiary’s lifetime means taxes are paid at a lower rate and over a longer time frame allowing more funds to stay in the SNT and grow tax-deferred.
However, if the process is not performed correctly, the beneficiary could have as few as five years to withdraw all of the funds and pay the related taxes.
The Best and Worst Ways to Designate an IRA Beneficiary
If you want to leave your IRA funds to a loved one with special needs and not compromise his or her ability to receive public assistance benefits, designate a third-party Special Needs Trust as the beneficiary. While this may sound easy, there are other pitfalls to consider.
For example, some people want to name multiple people or even charitable entities, especially contingently, as IRA beneficiaries. Because of complex IRS rules, if you complicate your IRA beneficiary designation with multiple parties or entities, you may create a tax burden on those you wish to help. Also, you should not simply name your Estate as the beneficiary because shortened timeframes may apply that create increased tax obligations for your heirs.
How to Navigate the Complex Special Needs Planning Process
Every family situation is different and every plan requires careful consideration. Your financial plan will take into account your age, the size of your financial portfolio, whether you have a spouse, the number of children you want to provide for, and many other details. When so much is at stake, you need personalized guidance from experienced special needs planning professionals.
Rubin Law is the only law firm in Illinois exclusively limited to providing compassionate special needs legal and future planning to guide our fellow Illinois families of children and adults with intellectual disabilities, developmental disabilities, or mental illness down the road to peace of mind. For more information, email us at firstname.lastname@example.org or call 866-TO-RUBIN.