I want to leave my Individual Retirement Account to a Special Needs Trust for my adult disabled child. What should I be aware of?
When making a bequest to someone who's disabled, it's often a good idea to leave it to a Special Needs Trust for that person's benefit, because a direct inheritance might inadvertently disqualify him for government benefits like Medicaid or Supplemental Security Income. A Special Needs Trust won't affect your heir's potential financial aid eligibility because it only buys services and products that aren't covered by government benefits.
But an IRA isn't a good asset to put into a Special Needs Trust, says Ed Slott, a Rockville Centre tax accountant. By law, an inherited IRA must make annual required minimum distributions (called RMDs) to its beneficiary — in this case, the trust. The problem: If the RMDs remain in the trust, they're subject to onerous trust tax rates. If the trustee promptly pays the RMDs to your heir, they're taxable at his own lower rate — but they may disqualify him for government assistance.
Slott says a Special Needs Trust should be funded with assets that aren't subject to required distribution. For example, let's say you have a $300,000 IRA to divide between your three children, one of whom is disabled.
"I would withdraw the $100,000 that's earmarked for the disabled child, pay taxes on it and buy a life insurance policy, making the trust the policy beneficiary," he says. "The policy's death benefit goes into the trust tax-free. The trustee can withdraw the amounts required for your child's needs. His siblings each get a $100,000 inherited IRA. And the insurance policy might pay more than $100,000 for the disabled child," Slott says.
THE BOTTOM LINE
Leaving an IRA to a trust can be counterproductive.