At the end of 2019, the law governing retirement account distributions changed significantly. Until the passage of the SECURE Act in December, 2019 beneficiaries might qualify to stretch out an inherited IRA account over their lifetimes. Now, most designated beneficiaries have no more than ten (10) years to receive their IRA distributions. While the stretch has snapped back, disabled beneficiaries can still benefit from the extended lifetime payout.
The SECURE Act makes exceptions for IRA beneficiaries who are considered disabled. The disabled person has to meet a definition that requires the individual to be unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment for an indefinite duration. Internal Revenue Code Section 72(m)(7). How does one know that they are qualified as disabled? As the regulations are not yet written, there is no uniform standard to follow and some doubt remains.
Disabled individuals who fit the category of “eligible designated beneficiaries” can receive the funds in the form of required minimum distributions based on their life expectancy rather than within 10 years. Also excluded from the 10-year rule are beneficiaries who are considered chronically ill or who are less than 10 years younger than the account owner.
The IRA owner can designate a Special Needs Trust as the beneficiary instead of the individual. These are third-party trusts (created most often by a parent for a child) that allow the beneficiary to remain qualified for Medicaid and SSI.
The trustee can use the required minimum distributions (“RMD”) to pay for the care and support of the person with special needs. There are two formats for such trusts. The first and less preferable way to set this up is through what’s known as a “conduit” trusts. Conduit trusts are compelled to distribute the RMD income received on a current basis.
More preferable for inherited IRAs are special needs trusts drafted as “accumulation” trusts. Unlike conduit trusts, they do not require that the RMDs be distributed, because doing so could undermine eligibility for and any qualified public benefits the disabled beneficiary may be receiving. Instead, they can be retained by the trust and distributed as the trustees deem appropriate.
But the trust will only qualify for this treatment if the disabled individual is the only beneficiary of the trust during his or her life. If the trust also permits distributions to a spouse or children, it won’t qualify and the IRA will have to be completely withdrawn under the 10-year rule. No one can have an interest in these Special Needs Trusts except the disabled or chronically ill beneficiary during his or her lifetime. No excess income may be distributed to other descendants or other beneficiaries of the trust. The trust cannot include a provision that changes the character of the special needs trust if the beneficiary no longer qualifies for government benefits. There can be no possibility that the income and/or principal will go to alternate beneficiaries while the eligible designated beneficiary is alive.
Only when the disabled beneficiary dies will the alternate beneficiaries receive anything from the trust and then the distributions will pass under the 10-year rule unless the alternate beneficiaries are also eligible designated beneficiaries.
Drafting a qualified trust for an eligible beneficiary is tricky. For the attorney, there is some guidance if we can follow the rubric of Qualified Disability Trusts found in Section 642 of the Internal Revenue Code. Existing special needs trusts designated as an IRA beneficiary should be reviewed promptly.
To learn more about how Evan J. Krame P.C. can help with your special needs trust planning, contact us at (301) 468 3360 or firstname.lastname@example.org.