My 55-year-old niece receives Social Security disability. I've listed her as one of my beneficiaries on my IRA, 401(k) and annuity, which I understand are considered taxable income. This isn't income from her working, but an inheritance. Will it affect her Social Security disability benefits? Will she receive Form 1099-Rs?
Retirement account beneficiaries must take annual distributions from their inherited accounts. You're right that, although these distributions aren't earned income, they are taxable as ordinary income.
The account custodians will send your niece Form 1099-Rs, showing the distributions they've reported to the IRS.
"The distribution code in Box 7 of the form will show the number 4. That indicates that this is a distribution from an inherited account," says Ed Slott, a Rockville Centre tax accountant.
Whether this income can affect your niece's disability benefit depends on the type of benefit she receives. People very often confuse Social Security disability with a different benefit, Supplemental Security Income, called SSI. One reason for the confusion is that a disabled person is often eligible to collect both. Your niece's Social Security disability benefit is based on the Social Security taxes she paid while she was working. Her inheritance won't have any impact on that benefit. By contrast, SSI is a needs-based benefit. An SSI beneficiary must have low income and limited assets and be blind or otherwise disabled, or be 65 or older.
It's often wise to leave a disabled heir's inheritance to a Special Needs Trust for her benefit. This trust won't disqualify its beneficiary for government assistance based on financial need. But it can be a mistake to fund such a trust with an IRA, says Slott. In next week's column, I'll explain why.
The bottom line
Social Security disability and SSI are governed by different rules.