To Stretch or Not?

According to a U.S. Census report, around 13 percent of our U.S. population who are not in an institution are disabled. It is anticipated with an aging population that over 50 million Americans are disabled. As a result, many plan for those who are disabled by the use of special needs trusts – a trust specifically designed to help those who are disabled. The source of funding (beneficiary’s own funds or the funds of someone else) and the type of public benefits received (Medicaid or Medicare) or anticipated to receive are crucial factors under consideration when planning since the medical costs paid by public benefits is often staggering.

In cases where a special or supplemental needs trust is funded by a third party (i.e., parent, grandparent, etc.), there is no required “payback” provision to the government (unlike firstparty special needs trusts). For many Americans, one of their largest assets is often a retirement account. The IRS has indicated in a private letter ruling that an IRA payable to a special needs trust at the death of the owner of the IRA does not have to be liquidated for funding the trust. The age of the disabled beneficiary will be used for the purpose of “stretching” the inherited IRA. Many prefer to stretch an IRA on inheritance since it allows distributions to be spread over the lifetime of the beneficiary. However, if the beneficiary receives Supplemental Security Income (SSI) and Medicaid and the trust is a “conduit” trust which requires immediate annual minimum distribution, then there could be disqualification for SSI and Medicaid. As a result, many planners use an accumulation trust with a special needs provision when trying to benefit a disabled child.

Even if the beneficiary is not on Medicaid, there are situations where you might not consider stretching the inherited IRA. If the IRA is the sole asset funding the special needs trust and the distributions are not sufficient to meet the annual needs of the beneficiary, then it is probably not best to stretch the IRA. Furthermore, if the beneficiary has a short life expectancy and there are contingent beneficiaries in need of the residue, the a stretch of the inherited IRA is not needed and a five year payout may be more optimal.

Many planners recommend second-to-die life insurance policies for parents to fund the special needs trust for a disabled child so that tax deferred compounding can be utilized.


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