Retirement Plans & Special Needs Trusts In Depth

It's not unusual for parents of children with special needs, or individuals who have become disabled as adults, to have retirement plans as a significant portion of their assets. In such cases, the question arises as to whether they can put a retirement plan into a special needs trust.

The answer, as with many legal questions, is "it depends." Also, the answer has changed significantly since passage of the SECURE Act.

This question normally comes up for people who become disabled, whether due to injury or illness, after they have worked and accumulated retirement savings. The answer is a clear no. A disabled person cannot transfer a retirement plan into a special needs trust without first liquidating it and paying taxes on the realized income.

If this is necessary in order to receive important public benefits, it may well be worth the cost. In fact, depending on the size of the retirement plan, the individual's other income, and whether medical expense or other deductions are available, the tax cost may not be as high as it seems at first.

Can A Special Needs Trust Be Named As Beneficiary Of Your Retirement Plan?

More often, parents would like to leave all or part of a retirement plan to a trust for the benefit of their child with special needs. This can be done, but it's a bit complicated. Before passage of the SECURE Act, we would advise clients to avoid doing so, if possible, to keep the trust simpler. In order to be the beneficiary of a retirement plan and spread the retirement plan withdrawals out over the beneficiary's lifetime, the trust must qualify as a so-called "accumulation" trust, which presents certain challenges.

To avoid this, clients might name their non-disabled children as beneficiaries of their retirement plans and name the special needs trust as beneficiary of other assets.

However, the SECURE Act made it more difficult to stretch out retirement plan withdrawals for the lifetime of most beneficiaries, limiting the withdrawal period to the 10 years following the death of the primary owner. One of the exceptions is beneficiaries who qualify as disabled. So now, in many cases, we give the opposite advice.

If possible, the retirement plan should be payable to the special needs trust so withdrawals and the payment of taxes can be spread out over the disabled beneficiary's lifetime. In each case, the attorney and the client must balance the potential tax savings with the added complication of creating and managing an accumulation trust.

Does Transferring An Inherited IRA To A Special Needs Trust Work?

Here the answer is less definite. There's no regulation on point, but there are revenue rulings that would permit such a transfer without having to liquidate the IRA first. Without a regulation on point, the challenge may be less the law and more the willingness of the bank or investment firm where the account is located to permit such a transfer to trust. They may well first require that the account owner obtain a revenue ruling from the IRS that is specific to the account in question.

The cost of obtaining such a private revenue ruling in most cases would outweigh the potential benefit of making the transfer to trust.

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