Advances in medicine sometimes carry mixed blessings. According to a September, 2011 article in Financial Planning magazine, it is more likely than ever that special needs children will outlive their parents. This prediction would seem to indicate a more focused attention to planning, but two-thirds of parents with special needs children have not prepared wills, according to a study by MetLife of more than 1,700 parents. Nearly one-third have done nothing to plan for their child’s financial future, and this lack of planning can potentially be very costly. There was a recent IRS private letter ruling dealing with “post death” transfers. A disabled man—the beneficiary of an IRA account—proposed that his share of the inherited IRA be transferred to a special-needs trust for his benefit. He would be the sole beneficiary of this trust, with the trustee deciding how much of the income and/or principal would be available for the disabled person’s benefit. The trust terms prevent any distributions that would reduce or eliminate any governmental assistance to which he was otherwise entitled. At the man’s death, any unused trust assets would first be distributed to the state as repayment for his benefits with any excess passing to his children. A favorable ruling was issued by the IRS in this case (PLR 201116005).
There are better ways. Private letter rulings are expensive and there is no guarantee of a favorable ruling. Meeting with your advisors to develop a plan could be much more efficient and no more expensive. For example, there are third party special-needs trusts that are funded with assets belonging to someone other than the disabled individual. In such trusts, all remaining assets can pass to remainder beneficiaries once the special needs individual dies. There is no requirement to repay the state for any benefits received, if properly structured. Another option is the purchase of life insurance by the parent, using IRA distributions to pay the premiums. Life insurance proceeds, which would fund the trust, are free of state and local personal income taxes. The funds will not be depleted by taxes at accelerated trust tax rates as an IRA would be. Converting the parent’s IRA to a Roth IRA is another alternative. The conversion comes with an upfront cost—the taxes that will be paid at the IRA owner’s personal rates (and a possible 10% tax penalty for early withdrawal), but these rates may be more favorable than trust tax rates.
Another possibility is funding the trust with non-IRA assets, leaving the IRA to healthy children, if applicable. This way, the trust would get a step up in basis on the non-qualified assets and the non disabled children receive the entire IRA, which they can stretch out over their lifetime, paying tax at their personal rate. Obviously, there are a lot of working parts in this planning process, so it is imperative that you meet with your legal, financial and tax advisors to put the pieces together correctly.
In a related article, “Plan for Incapacity Before You Need To”, found in the June 16, 2011 online version of Morningstar, it was pointed out that for those folks in their 80’s, about one-half of the U.S. population either has full blown dementia or cognitive impairment. Assuming this is correct, perhaps you and I should consider planning for the possibility of some degree of mental impairment before it is too late. According to this article, you have to fix the problem ahead of time, because once the problem comes in, we may not know or recognize what we have. We keep on doing what we have been doing and that can be disastrous. One of the first steps to consider is to plan to put your finances on autopilot so that active management is not required. Make sure all your estate documents are in order. Set up proper powers of attorney. Consider a health care proxy that assigns someone to help you make health care decisions if you are no longer mentally competent. Try to plan for the risk of living too long and the cost of living increases. Plan for a safe strategy for spending your retirement portfolio.
I heard this hymn the other day and it seemed to fit the season: “Come, labor on. Who dares stand idle on the harvest plain, while all around us waves the golden grain? And to each servant does the Master say, ‘Go, work today.’ Come, labor on. The enemy is watching night and day, to sow the tares, to snatch the seed away; while we in sleep our duty have forgot, he slumbered on. Come, labor on. Away with gloomy thoughts and faithless fear! No arm so weak, but may do service here; by feeblest agents may our God fulfill his righteous will. Come, labor on. Claim the high calling angels cannot share; to old and young the hours too swiftly fly. The night draws nigh. Come, labor on. No time for rest, till glows the western sky, till the long shadows o’er our pathway lie, and a glad sound come with the setting sun, ‘Servants, well done’.”
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