ESTATE PLANNING FOR CHILDREN WITH SPECIAL NEEDS

In an earlier column, I discussed the pros and cons of different annuities and whether they should be considered as part of your overall estate plan. Shortly thereafter, a colleague posed a question which I thought was worth sharing.

The attorney’s client had been diagnosed with terminal cancer and was only given 90 days to live. She immediately decided to retire and to roll over her 401(k) retirement plan into her existing IRA with her three children as beneficiaries. Her husband agreed with her decision. They had a problem, however, in that one of their daughters had special needs. The client wanted funds to be available to meet her needs, but only if it would not disqualify her for government benefits.

The client met with a financial advisor who disagreed with her and instead recommended she transfer her retirement account into an annuity with controlled pay outs to the three beneficiaries. The client then met with her attorney, who felt she was right initially and would be better served by transferring the funds to her IRA, but thought she should make the distributions from the IRA payable to a revocable living trust.

The attorney, client and financial advisor all met to discuss the client’s options and could not agree. The financial advisor saw no benefit to establishing a revocable living trust and the attorney couldn’t get comfortable with the annuity. They agreed to seek another opinion.

The attorney admitted he was in a quandary as to what to do even though he was a highly qualified and experienced estate planning attorney.

It may or may not make you feel good to know that even well established estate planners sometimes have trouble finding the right answers. This just points out how complex the issues can be.

Let’s examine this case further. Without knowing more, we probably don’t want the daughter receiving regular payments from an annuity as this income could disqualify her for public benefits.

Now what? Normally, based on past IRS rulings I probably would have recommended that the client roll her retirement plan into her IRA and create a revocable living trust with three separate pots, one for each child. The share allotted to the special needs daughter would go into a special needs trust with the trustee designated as the beneficiary. Because of recent private letter rulings from the IRS, I suggested the client transfer her retirement account into three separate IRAs, rather than just one, and then establish separate trusts for each of the children, incorporating language allowing the IRAs to be stretched out over each of their respective life expectancies.

Each trust authorizes the trustee to direct the plan administrator on the timing and amount of distributions from the IRA. The trustee has complete discretion in this matter.

The special needs trust allows the trustee to expend all IRA distributions on behalf of the beneficiary so long as these distributions do not violate public benefit rules. This means the trustee can use the funds for any purpose which will not disqualify the beneficiary for government programs. Distributions will be reported on the daughter’s personal income tax return as ordinary income.

If in any year the trustee cannot spend all of the IRA distribution without jeopardizing the daughter’s entitlement to governmental aid, the trustee can withhold all or part of the distributions and retain them in the daughter’s trust. If this occurs, the trust will pay taxes on the withheld income at a higher rate than the daughter would have, but the daughter will remain eligible for Medicaid or other social programs.

If I confused you, I apologize. This is a highly complex area of the law which is constantly changing and one in which you should tread lightly. If you have a child with special needs, be sure you confer with an estate planning specialist who can help you make the right decision.

Under different circumstances, an annuity might have worked here. Because of the daughter’s other income, regular payments from the annuity would have disqualified her from receiving government aid. She would have had to spend down her assets and might quickly have found herself with nothing left to meet unforeseen needs.

If you have a special needs person in your life, you need to know that converting an asset into an annuity changes it into an income stream, so it longer counts against the Medicaid "asset cap." That is, it won’t count as an asset if the annuity is irrevocable, non-assignable, pays out over the life expectancy of the individual, and pays interest at the market rate. Remember that to qualify for government benefits, your countable assets cannot exceed $2,000.

In this case, even though the annuity recommended by the financial advisor met all the requirements above, the daughter still could not qualify for government assistance because her income would then exceed the "income cap." Since the client was able to accomplish her goal by using separate IRAs and trusts, she didn’t need to delve deeper into the annuity issue.

If you should find yourself requiring special needs planning, be sure your attorney understands all the issues and carefully reviews all the tax, estate planning, government assistance, and retirement rules and regulations. Only then can you be sure the estate plan you select will meet your needs and those of your family today and well into the future.

© Jerry E. Shiles 2004

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