Estate Planning Basics, Part 2 – Special Needs Trusts and IRAs for heirs

​In part 1, we wrote about life insurance beneficiaries.  In this part, we continue our mini-series about mistakes in planning related to beneficiaries.  This part discusses special needs trusts and a very short summary of IRA issues.

Part 2 – Trusts and IRAs for the children

A. So, how do you protect heirs and children with special needs? Can I just leave them a part of my estate?

Many families have one or more special needs person.  A child with a disabling physical problem is easy to recognize as having special needs, but there are other serious illnesses that are not so obvious, such as substance abuse.  As the person with assets, and decisions to make about life-time care for your loved one, you may wonder what can you do to protect her from the financial effects of her illness?

One way well- intentioned family members approach this is to designate the special needs individual as beneficiary of life insurance or other financial products, or as heirs of an estate plan.  It is what most people would do. But wait!  This might not work out as well as you’d like.  You could create several kinds of problems, including loss of public benefits and loss of the asset through mis-management.

First, your good intentions may disqualify the special needs child or troubled adult from various benefits and governmental assistance.  Many people with serious medical or mental conditions are receiving Supplemental Security Income (SSI) or disability income (SSDI).  Some are on Medicaid or other local benefits.  Your gift would likely put them over the asset limit and cause loss of benefits.  That isn’t what you wanted!

Second, your gift might be simply taken by creditors, or unwisely spent by the recipient.  You probably would like to help with housing or food costs for your troubled child or grandchild, but not to fund continued abuse or to provide a windfall for a creditor!

You can work this out by seeking the help of a qualified attorney who understands the needs of the families with loved ones with disabilities.  Careful attention to the details in your specific case will make the best outcome.  You can use a “supplemental needs trust” (“SNT”) or special accounts that support the child if you cannot.  The best approach is to integrate your desires with the child’s parents’ planning and possibly use the assets to fund a special (or supplemental) needs trust.

A SNT is like other trusts, but with unique provisions.  Like other trusts, a trustee is named to manage funds on behalf of the beneficiary.  But, in a SNT the trustee is required to consider the effect any distribution would have on the individual’s entire need.  If giving the child money for rent would affect eligibility for Medicaid or SSI, the trustee has to consider that and protect the beneficiary.

A SNT is a great way to protect a child with disabilities, or a troubled adult heir who can’t manage finances on his own.  But, this approach requires careful planning.  See a qualified attorney for help! We regularly help our clients protect heirs, spouse, and others during their lifetimes and as part of a comprehensive distribution of wealth through their estate plans.

B. IRA designations should be easy…  I just list beneficiaries for the IRA, right?

Well, not really!  IRAs require an entire course to understand their unique issues.  But, here are a couple of important points… IRAs are often qualified investments, meaning that taxes are not yet paid (they are “tax deferred”).  Taxes are due when the assets are taken out of the IRA.  The goal in a gift of the IRA should be to provide the eventual recipient the maximum flexibility in handling the divesting of assets and in paying the taxes.  Here are some key points:

  • IRAs should never be owned by a Trust.  Death of the IRA owner will probably cause a complete divesting of the holdings, along with loss of the tax benefits (meaning, you have to pay them right then).
  • You can make the trust a beneficiary if your servicer allows it and if you set up the Trust correctly.  But, great care is required, and the trust must have actual people as its beneficiaries. If you have more than one beneficiary, then consider separate trusts for each.
  • Don’t leave an IRA to a trust for a charity… there are other better ways to manage charitable giving.
  • Beneficiaries with special needs or troubled adult children or relatives should be protected by designating a special needs trust as a beneficiary.  And, of course, with a trustee who will act responsibly.
  • Minor children should be the primary beneficiaries, with a trust as secondary.  Look back at the information about minors if necessary.
  • Pass along IRAs to your spouse as a “spousal rollover.”

Failure to handle IRAs correctly will cause problems and could result in loss of all those tax benefits!​  Seek a qualified financial planner (you can look for certifications, such as CFP) or tax attorney for this complicated area.

Review Part 1 of this series – Beneficiary Designations

Look ahead to the next part, Part 3 – Estate planning coordination​.

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