As a financial planner, you may have clients who have a loved one with special needs, such as a child, sibling or spouse. Inherited IRAs can be a valuable planning tool for them to support their loved if they have the correct documents in place. It’s important for them to understand the changes enacted by the Secure Act (2020) and Secure Act 2.0 (2023) that affect special-needs planning with IRAs.
In this article, I’ll explain the impact of both laws and what you need to do to ensure your clients’ special needs trusts are compliant and effective. I’ll also provide some best practices and resources that you can use to help your clients navigate this complex and evolving area of financial planning.
‘Stretching’ Still Permitted with Conditions
The Secure Act introduced several changes that affect IRAs. It increased the age for required minimum distributions from 70 1/2 to 72 (Secure 2.0 raised the RMD age from 72 to 75), allows contributions to traditional IRAs after age 70 1/2, expands the use of 529 plans for qualified education expenses, and replaced the “stretch IRA” with a 10-year rule for most non-spouse beneficiaries of IRAs.
Your clients may not be aware that the Secure Act also created an exception to the 10-year rule for beneficiaries who are disabled or chronically ill. Instead of being required to withdraw the entire balance of an inherited IRA within 10 years of the death of the original owner, a beneficiary with special needs is still permitted to take these distributions over his or her lifetime. This allows the beneficiary to extend the tax-deferred growth and reduce the income tax burden on the inherited IRA, allowing it to last longer.
But here’s the caveat: Beneficiaries with special needs remain eligible for the stretch IRA only if the IRA is payable to a special needs trust that qualifies as a “see-through” trust and a supplemental needs trust.
To qualify as a see-through trust, a trust must:
- Be valid under state law.
- Be irrevocable or become irrevocable upon the death of the grantor.
- Identify its beneficiaries in the trust document
- Provide a trust document to the IRA custodian by Oct. 31 of the year following the year of the owner’s death.
A see-through trust is instructed to “look through” to the beneficiary to determine the measuring life of the trust. It could also offer a tax benefit to the beneficiary. A see-through trust does not have to be a special needs trust, and a special needs trust does not have to be a see-through trust. However, for an IRA to be eligible for the stretch, and for the special needs beneficiary to preserve their government benefits, the IRA must be left to a special needs trust that is also a see-through trust. It’s complex – and unfortunately the Secure Act made it more complex.
Multi-Beneficiary Trusts
Secure Act 2.0 introduced additional changes that can also help families. Besides further increasing the age for RMDs, it created a national online database for lost retirement accounts and allows catch-up contributions to 401(k) and IRA plans after age 62.
Secure Act 2.0 also modified the rules for special-needs beneficiaries utilizing the lifetime stretch for inherited IRAs inside special needs trusts. The new rules allow remainder beneficiaries to be named, through applicable multi-beneficiary trusts (AMBTs). An AMBT is a type of see-through trust that has more than one beneficiary, such as a special needs trust that also has a charity or another child as a remainder beneficiary.
Under the Secure Act, an AMBT had to use the life expectancy of the oldest beneficiary to determine the RMDs from an inherited IRA. This could shorten the stretch period and reduce the income for the special-needs beneficiary. Under Secure 2.0, an AMBT can now use the life expectancy of the disabled or chronically ill beneficiary as the measuring life, as long as the trust meets the following requirements:
- It is a discretionary trust, meaning that the trustee has the sole authority to decide how and when to distribute the trust assets to the beneficiaries.
- It has only one disabled or chronically ill beneficiary, who is also the primary beneficiary of the trust.
- The other beneficiaries of the trust are either qualified charities or individuals who are not more than 10 years younger than the disabled or chronically ill beneficiary. (Make sure the other beneficiaries are not donor-advised funds, foundations, or children of the special needs beneficiary).
- The trust does not have any provisions that allow the trustee to distribute the IRA assets to other beneficiaries or to terminate the trust before the death of the disabled or chronically ill beneficiary.
The Secure 2.0 change allows the AMBT to preserve the stretch IRA for the special needs beneficiary and to provide more income for the trust.
Necessary Next Steps
If your client has a special needs trust that is a beneficiary of an IRA, they must review their trust document and make sure it complies with the new rules under Secure and Secure 2.0. The goal is to ensure their trust qualifies as a see-through trust and their special needs beneficiary is eligible for the stretch IRA. As their advisor, you should assist them with the following:
- Meet with an attorney who is familiar with the Secure Acts and specializes in special needs planning. An attorney can help you update your clients’ trust document and advise you on the best strategy for their situation. You can find an attorney who is a member of the Special Needs Alliance or the Academy of Special Needs Planners, national organizations of attorneys dedicated to special needs planning, by visiting their websites.
- Make sure the trust appropriately states that the goal is to hold an inherited IRA and identifies the disabled or chronically ill beneficiary as the measuring life for the RMDs. This will ensure that the trust is recognized as a see-through trust and that the beneficiary qualifies for the stretch IRA.
- Ensure the trust is a third-party special needs trust, not a first-party special needs trust.
- Limit the remainder beneficiaries of the trust to either qualified charities or individuals who are not more than 10 years younger than the disabled or chronically ill beneficiary. This will ensure that the trust meets the requirements of Secure 2.0 for applicable multi-beneficiary trusts (AMBTs) and that the other beneficiaries do not affect the stretch period of the IRA. Private foundations and donor-advised funds cannot be named as remainder beneficiaries for the IRA to realize the stretch benefit in this situation.
- Avoid any provisions in the trust that allow the trustee to distribute the IRA assets to other beneficiaries or to terminate the trust prior to the death of the disabled or chronically ill beneficiary. These “spray power” provisions can disqualify the trust from being see-through , thereby disqualifying the beneficiary from being eligible for the stretch IRA. You can find some examples of spray power provisions and how to avoid them in the Morningstar article “Financial Planning for Disabilities and Special Needs: What to Know.”
By following these steps, you can ensure that your clients’ special needs trusts are compliant and effective under the new laws and that their IRAs can provide the maximum benefit for their loved ones with special needs.
What if Trusts Don’t Comply?
If the special needs trust does not meet the above requirements, the beneficiary could face unfavorable tax consequences and reduced benefits.
For example, if the trust is not written as an AMBT, or if it names an ineligible remainder beneficiary (such as a charity or a non-individual entity) the trust will not qualify for the stretch IRA strategy. Instead, the inherited IRA will be subject to the 10-year rule — and sometimes the 5-year rule.
This could mean the trust will have to withdraw larger amounts from the inherited IRA each year, increasing the taxable income of the trust and the beneficiary. This can also potentially reduce the beneficiary’s eligibility for government benefits, cause them to pay more taxes, or increase the possibility that they run out of money in their lifetime.
Additionally, if the special needs trust does not have the appropriate language to prevent accumulation or distribution of the inherited IRA funds, the trust could be treated as a conduit trust. All the income generated inside a conduit trust pass directly to the beneficiary. The trustee cannot control this amount and cannot ensure what type of expenses it is going to pay. This means the beneficiary could lose crucial government benefits such as SSI, Medicaid, HUD housing and more.
Best Practices and Resources
In addition to updating your clients’ special needs trusts, you can also help them with other aspects of special needs planning with IRAs:
- Educate your clients about the importance of naming their special needs trust — and not their loved one with special needs — as the beneficiary of their IRA. If the beneficiary directly inherits the IRA, the IRA assets will count as their own and may disqualify them from receiving government benefits. Supplemental Security Income (SSI) and Medicaid are based on income and asset limits. However, if the IRA is payable to the trust, the IRA assets will not count as the beneficiary’s own, as long as the trust is properly drafted and administered.
- Explore other options for funding their special needs trust, besides their IRA. While IRAs can be a valuable source of income for a special needs trust, they are not the only option. Your clients may also consider funding the trust with life insurance, annuities, real estate or other assets. These assets may have different tax and legal implications, as well as different benefits and drawbacks, depending on your clients’ situation and objectives.
- Calculate the cost of care of their loved one with special needs, and making sure that the trust will be properly funded through its current named beneficiaries. If not, help your client explore other funding tools available to them.
- Help them put on their life mask first. Many clients we work with have put themselves last, out of fear for the wellbeing of their loved one with special needs. By giving them a robust special-needs plan that provides peace of mind that the needs of their loved one will be met, they can then start to make decisions for their own well-being. Retirement, long-term-care, risk of premature death and loss of income are even bigger risks for a special-needs family. Make sure your clients have strategies in place to address these potential risks.
- Make sure your clients are informed about options from guardianship and conservatorship, powers of attorney, microboards and supported decision-making. Educate them on the options and pros/cons of each.
Overall, the Secure Act and Secure Act 2.0 allowed the stretch provision to stay in place for disabled beneficiaries of inherited IRAs. If this applies to your clients, make sure that they have updated their trust accordingly with the correct legal provisions.
Kristin Carleton, CEO of All Needs Planning, provides special needs planning by addressing the funding supports, legal strategies and clinical supports necessary for every member of the family. Her son Eli was born with a congenital brain disorder, which ignited her passion for planning for her son and daughter. Her life’s purpose is to pave the way for other families to be the heroes of their own stories. Kristin is honored to see families living their best lives and to be a part of those supports. She can be reached at 919-433-7713 or kristin@allneedsplanning.com.
