King & Wood, P.A.

Is Your Estate Plan Ready for Sunsetting Tax Cuts in 2026?

“The sweeping tax overhaul enacted in 2017, known as the Tax Cuts and Jobs Act (TCJA), provided a number of income and estate tax reductions and changes.”

Many of these changes are set to expire at the end of 2025, meaning the time to prepare for their impact on estate plans is now, according to the article “These Tax Cuts are Sunsetting in 2026. Are your clients ready?” from Think Advisor.

The most visible change will be the lifetime estate and gift tax exemption changes. Before 2018, the exemption was $5 million per person and $10 million for a married couple. In 2023, those limits are $12.92 and $25.85 million, respectively. In 2024, those limits will be $13.61 million for an individual and $27.22 million for a married couple.

The annual gift tax exclusion was also increased because of the TCJA. In 2023, it is $17,000; in 2024, it will rise to $18,000. It’s not yet clear what it will be after 2025.

Unless something changes, on January 1, 2026, the estate tax exemption will revert back to $5 million; adjusted for inflation, it’s expected to be approximately $7 million per person.

There won't be much of an impact for estates that won’t exceed the expected 2026 levels. However, the increases in home values may bring some unexpected increases to the size of many estates.

For those whose estates exceed the 2026 exemption levels, there are many options to reduce the size of the estate to minimize the impact of the lower exemption levels on their heirs in the future. An experienced estate planning attorney can make a strategic plan to address these changes.

One option is to spend down part of the estate, especially if you are older. Now would be the time to travel or make purchases you might have been putting off.

Making lifetime gifts is another way to reduce the size of your estate, while enjoying watching heirs enjoy their inheritance. Gifts could be to children, grandchildren, or others.

The same generosity could be focused on charity. If you’ve been meaning to make a gift at some point, this could be the year to make a legacy gift.

Another tactic: a Roth conversion. If your retirement accounts consist of IRAs, converting to a Roth can help with tax diversification. Money in a Roth is not subject to Required Minimum Distributions, which reduce taxes during retirement. Under the SECURE 2.0 Act, inherited Roth IRAs are tax-efficient for leaving an IRA to non-spousal beneficiaries.

The TCJA increased the standard deduction level, making it difficult for many taxpayers to itemize deductions. The higher standard deduction will revert back to roughly the pre-TCJA levels, which were $6,350 for single filers and $12,700 for those filing married and joint, both indexed for inflation.

Speak with your estate planning attorney to determine how the sunsetting of this law will impact your estate plan and choose your best options in the short and long term.

Reference: Think Advisor (Nov. 22, 2023) “These Tax Cuts are Sunsetting in 2026. Are your clients ready?”

Tax Strategies May Have Impact on Medicare Costs

“One factor that may offset those benefit increases is the size of Medicare Part B premiums, which are typically deducted directly from monthly Social Security checks.”

How much retirees pay for Medicare Part B premiums is based on income levels, and an income increase of even $1 can trigger higher tax rates, explains the recent article, “Year-end tax strategies may affect how much retirees pay for Medicare. Here’s what to know” from CNBC.

Social Security beneficiaries will receive a 3.2% increase in benefits in 2024 based on the annual COLA (Cost of Living Adjustment). According to the Social Security Administration, this will result in an estimated increase of more than $50 per month, bringing the average monthly retirement benefit for workers from $1,848 in 2023 to $1,907 in 2024.

How much beneficiaries will actually receive won’t be known until December, when annual benefit statements are sent out. One factor possibly offsetting those benefit increases is the size of Medicare Part B premiums, which are typically deducted directly from Social Security monthly benefits.

Medicare Part B covers physician services, outpatient hospital services, some home health care services, durable medical equipment and other services not covered by Medicare Part A.

Medicare Part B premiums for 2024 have not yet been announced. However, the Medicare trustees have projected the standard monthly premium possibly being $174.80 in 2024, up from $164.90 in 2023.

Some beneficiaries may pay more, based on income, in what’s known as IRMAA or Income Related Monthly Adjustment Amounts. In 2023, it is the standard Part B premium for those who file individually and have $97,000 or less (or $194,000 or less for couples) in modified adjusted gross income on their federal tax return in 2021.

Monthly premiums can go up to as much as $560.50 per month for individuals with incomes of $500,000 and up, for couples with $750,000 and up.

Beneficiaries receive the same Medicare services regardless of the monthly Part B premium rate.

In 2024, the monthly Part B premiums will be based on 2022 federal tax returns. Beneficiaries need to pay attention to how their incomes may change when implementing year-end tax strategies.

For instance, if you do a Roth conversion, taking pre-tax funds from a traditional IRA or eligible qualified retirement plan like a 401(k) and moving them to a post-tax retirement account, you’ll trigger income taxes, which may trigger higher Medicare Part B premiums later.

People who do end-of-year tax loss harvesting, selling off assets at a loss to offset capital gains owed on other profitable investments, may reduce adjusted gross income and future Medicare premiums.

If you’re taking distributions from IRAs and want to make charitable donations, you might want to make those donations directly from your retirement account, known as a qualified charitable distribution. These funds don’t appear on your tax return and won’t increase income taxes or future Medicare premiums.

Reference: CNBC (Oct. 12, 2023) “Year-end tax strategies may affect how much retirees pay for Medicare. Here’s what to know”

What Happens when You Inherit a Retirement Account?

“There’s almost always a reckoning when the government proffers a tax break. So it is with individual retirement accounts (IRA)s, 401(k)s and similar accounts that investors fund with pre-tax earnings.”

The SECURE Act of 2019 reset the game for IRAs and other tax deferred retirement accounts, says a recent article from Financial Advisor titled “IRAs, Taxes and Inheritance: Planning Becomes a Family Affair.” Prior to SECURE, investors paid ordinary income tax rates on withdrawals, whether they were voluntary or Required Minimum Distributions (RMDs) from these accounts, except for Roths. When individuals stopped working and their income dropped, so did the tax rate on their withdrawals. All was well.

Then the SECURE Act came along, with good intentions. The time period for payouts of IRAs and similar accounts after the death of the account owner changed. Non-spouse beneficiaries now have only 10 years to empty out the accounts, setting themselves up for potentially huge tax bills, possibly when their own incomes are at peak levels. What can be done?

Heirs of individual investors or couples with hefty IRAs and investment accounts are most likely to face consequences of the new tax regulations for RMDs and inheritances from the SECURE Act.

A widowed spouse faces the lower of either their own or the partner’s RMD rate—it’s tied to birth years. However, there is a pitfall: the widowed spouse files a single tax return, which cuts available deductions in half and changes tax brackets. Single or married, consider accelerating IRA withdrawals as soon as taxable income lowers early in retirement. Taking withdrawals from IRAs at this time voluntarily often means the ability to defer and as a result, optimize Social Security benefits to age 70.

For non-spousal beneficiaries of inherited IRAs, there’s no way around that 10-year rule. Their tax rates will depend on income, whether they file single or joint and any deductions available. If a beneficiary dies while the account still owns the assets, those assets may be subject to estate taxes, which are high.

Here’s where tax planning is could help. IRA owners may try to “equalize” inheritances among heirs with tax consequences in mind. For instance, a lower earning child could be the IRA beneficiary, while a higher earning child could receive assets from a brokerage account or Roth IRAs. Alternatively, an IRA owner could establish trusts or make charitable bequests to empty the IRAs before they become part of the estate.

Your estate planning attorney will help you create a road map for distributing IRA and other tax deferred assets based on the tax and timing for beneficiaries or what you want to fund after you pass.

Another strategy, if you don’t expect to exhaust your IRA assets in your lifetime, is to systematically withdraw money early in retirement to fund Roth IRAs, known as a Roth conversion. The advantage is simple: inherited Roth IRAs need to be drawn down in ten years, but the money isn’t taxable to beneficiaries.

Decumulation planning is complicated to do. However, your estate planning attorney will help evaluate your unique situation and create the optimal income sourcing plan for your family based on their assets, including taxable and tax-advantaged accounts, Social Security benefits, pensions, life insurance and annuities.

Reference: Financial Advisor (Sep. 29, 2022) “IRAs, Taxes and Inheritance: Planning Becomes a Family Affair”

What Happens when You Inherit a Retirement Account?

“There’s almost always a reckoning when the government proffers a tax break. So it is with individual retirement accounts (IRA)s, 401(k)s and similar accounts that investors fund with pre-tax earnings.”

The SECURE Act of 2019 reset the game for IRAs and other tax deferred retirement accounts, says a recent article from Financial Advisor titled “IRAs, Taxes and Inheritance: Planning Becomes a Family Affair.” Prior to SECURE, investors paid ordinary income tax rates on withdrawals, whether they were voluntary or Required Minimum Distributions (RMDs) from these accounts, except for Roths. When individuals stopped working and their income dropped, so did the tax rate on their withdrawals. All was well.

Then the SECURE Act came along, with good intentions. The time period for payouts of IRAs and similar accounts after the death of the account owner changed. Non-spouse beneficiaries now have only 10 years to empty out the accounts, setting themselves up for potentially huge tax bills, possibly when their own incomes are at peak levels. What can be done?

Heirs of individual investors or couples with hefty IRAs and investment accounts are most likely to face consequences of the new tax regulations for RMDs and inheritances from the SECURE Act.

A widowed spouse faces the lower of either their own or the partner’s RMD rate—it’s tied to birth years. However, there is a pitfall: the widowed spouse files a single tax return, which cuts available deductions in half and changes tax brackets. Single or married, consider accelerating IRA withdrawals as soon as taxable income lowers early in retirement. Taking withdrawals from IRAs at this time voluntarily often means the ability to defer and as a result, optimize Social Security benefits to age 70.

For non-spousal beneficiaries of inherited IRAs, there’s no way around that 10-year rule. Their tax rates will depend on income, whether they file single or joint and any deductions available. If a beneficiary dies while the account still owns the assets, those assets may be subject to estate taxes, which are high.

Here’s where tax planning is could help. IRA owners may try to “equalize” inheritances among heirs with tax consequences in mind. For instance, a lower earning child could be the IRA beneficiary, while a higher earning child could receive assets from a brokerage account or Roth IRAs. Alternatively, an IRA owner could establish trusts or make charitable bequests to empty the IRAs before they become part of the estate.

Your estate planning attorney will help you create a road map for distributing IRA and other tax deferred assets based on the tax and timing for beneficiaries or what you want to fund after you pass.

Another strategy, if you don’t expect to exhaust your IRA assets in your lifetime, is to systematically withdraw money early in retirement to fund Roth IRAs, known as a Roth conversion. The advantage is simple: inherited Roth IRAs need to be drawn down in ten years, but the money isn’t taxable to beneficiaries.

Decumulation planning is complicated to do. However, your estate planning attorney will help evaluate your unique situation and create the optimal income sourcing plan for your family based on their assets, including taxable and tax-advantaged accounts, Social Security benefits, pensions, life insurance and annuities.

Reference: Financial Advisor (Sep. 29, 2022) “IRAs, Taxes and Inheritance: Planning Becomes a Family Affair”

How Much Is the Required Minimum Distribution from Retirement Accounts?

“Americans are living longer than they were a generation ago, and the government knows it. Starting in 2022, that will be reflected in the amount of money you have to draw from retirement accounts at different ages.”

The IRS has updated the formulas for Required Minimum Distributions, or RMDs, the amounts required to be taken annually from 401(k)s, 403(b)s, or traditional Individual Retirement Accounts (IRAs) in 2022. According to a recent article from AARP titled “How an IRS Rule Update Impacts Required Minimum Distributions,” the new RMDs will be smaller now than in previous years. RMDs have always been a complicated topic, and now they might just be a little more so.

Getting the calculations right has always been a bit of a muddle. For one thing, in 2020 RMDs were suspended entirely. Before the pandemic, the 2019 SECURE Act changed the age when you had to take withdrawals from 70½ to 72. This was except for people who were already taking RMDs in 2019. Are you confused?

Now, if your 72^nd birthday occurred before July 1, 2021, you need to take an RMD before December 31. However, if your 72^nd birthday takes place in the second half of 2021, you have until April 1, 2022 to take your first withdrawal—only you’ll need to use the 2021 tables from the IRS to calculate it.

A reminder: Roth IRAs do not require any RMDs, but 401(k) Roths do.

Starting in 2022, many people will be able to take about six or seven percent less in their RMD under the life expectancy tables from the IRS. A 75-year-old single woman with an IRA worth $100,000 at the end of 2021 will need to withdraw at least $4,065 in 2022, about $300 less than under prior guidelines.

However, you need to consider whether or not taking less from your IRA or 401(k) or 403(b) is a good idea in the long run. If you need to take more to live on, then you need to withdraw what you need, regardless of the IRS rules. There’s no penalty for taking more, except the taxes you’ll pay.

If you retire before age 70, before any RMDs are required, you might want to withdraw more from your tax-deferred retirement accounts in order to delay taking Social Security benefits. The longer you delay taking Social Security benefits, the larger your monthly payment will be. This is a good move for many Americans, especially those who are counting on Social Security for income in their 80s and 90s.

There isn’t a single person in America (well, maybe there is one) who isn’t frustrated by having to pay taxes on earned income required to be withdrawn from retirement accounts. However, there are ways to blunt the impact of income taxes on IRAs. Those who are older than 70½ can donate to registered 501(c)(3) charities, by making a Qualified Charitable Distribution (QCD), which is counted toward any RMD as the amount of the donation is exempted from income taxes. However, this only works if you take the standard deduction and don’t itemize charitable gifts.

Unless the rules change, converting tax-deferred IRA money into a Roth IRA is a strategy to shift not whether you pay taxes, but when. Converting traditional IRA assets during a low-income year—or a portion of traditional IRA assets—allows the money in the Roth account to continue to grow tax free and no taxes are due on any withdrawals. Unless the laws change—again.

Reference: AARP (Dec. 8, 2021) “How an IRS Rule Update Impacts Required Minimum Distributions”

Is a Rollover IRA a Good Idea?

“With Covid-triggered changes in the economy and more people taking early retirement or changing jobs, there has been a surge in rollovers from 401(k)s to individual retirement accounts.”

In addition to an increase in rollovers, there has been an increase in the mistakes people make when transferring retirement funds as well, reports The Wall Street Journal in a recent article, “The Biggest Mistake People Make With IRA Rollovers.” These are expensive mistakes, potentially adding up to tens of thousands of dollars in taxes and penalties.

Done properly, rolling the funds from a 401(k) to a traditional IRA offers flexibility and control, minus paying taxes immediately. Depending on the IRA custodian, the owner may choose from different investment options, from stocks and bonds to mutual funds, exchange-traded funds, certificates of deposits or annuities. A company plan may limit you to a half-dozen or so choices. However, before you make a move, be aware of these key mistakes:

Taking a lump-sum distribution of the 401(k) funds instead of moving them directly to the IRA custodian. The clock starts ticking when you do what’s called an “indirect rollover.” Miss the 60-day deadline and the amount is considered a distribution, included as gross income and taxable. If you’re younger than 59½, you might also get hit with a 10% early withdrawal penalty.

There is an exception: if you are an employee with highly appreciated stock of the company that you are leaving in your 401(k), it’s considered a “Net Unrealized Appreciation,” or NUA. In this case, you may take the lump-sum distribution and pay taxes at the ordinary income-tax rate, but only on the cost basis, or the adjusted original value, of the stock. The difference between the cost basis and the current market value is the NUA, and you can defer the tax on the difference until you sell the stock.

Not realizing when you do an indirect rollover, your workplace plan administrator will usually withhold 20% of your account and send it to the IRS as pre-payment of federal-income tax on the distribution. This will happen even if your plan is to immediately put the money into an IRA. If you want to contribute the same amount that was in your 401(k) to your IRA, you’ll need to provide funds from other sources. Note that if too much tax was withheld, you’ll get a refund from the IRS in April.

Rolling over funds from a 401(k) to an IRA before taking a Required Minimum Distribution or RMD. If you’re required to take an RMD for the year that you are receiving the distribution (age 72 and over), neglecting this point will result in an excess contribution, which could be subject to a 6% penalty.

Rolling funds from a 401(k) to a Roth IRA and neglecting to pay taxes immediately. If you move money from a 401(k) to a Roth IRA, it’s a conversion and taxes are due when you make the transfer. However, if you have some after-tax dollars left in the 401(k), you can make a tax-free distribution of those funds to a Roth IRA. Remember funds must remain in a Roth IRA for at least five years, before withdrawing any earnings or they’ll be subject to taxes and possibly penalties.

Not knowing the limits when moving funds from one IRA to another, if you do a 60-day rollover. The general rule is this: you are allowed to do only one distribution from an IRA to another IRA within a 12-month period. Make more than one distribution and it’s considered taxable income. Tack on a 10% penalty, if you’re under 59½.

Reference: The Wall Street Journal (Oct. 1, 2021) “The Biggest Mistake People Make With IRA Rollovers”

What Is the Best Thing to Do with an Inherited IRA?

“Inheriting an IRA from a parent has a unique set of rules you need to know, which will help you make the most of the money you inherit and avoid a tax-time surprise.”

When a parent dies and their adult child inherits a traditional IRA, knowing what to do can be the difference between an inheritance and a tax disaster. Many people take the money from the IRA account and place it into their own IRA. However, that’s a mistake, says the article “How to manage an inherited IRA from a parent” from Sentinel Source.com.

Any inherited IRA, whether it’s from a parent, sibling, or friend, cannot be simply rolled into your own account or treated as if it’s your own IRA. Instead, the assets must be transferred in a timely manner to a new IRA that must be titled as an “Inherited IRA” that includes the name of the deceased owner and the phrase “For the benefit of…” and your name. Different financial institutions may have small variations in how they title the account. However, this seemingly small detail is critical.

If a traditional IRA has more than one beneficiary, it must be split into separate accounts for each beneficiary. Each heir will treat their own inherited portion in the same way, as if they were the sole beneficiary.

It’s the heir’s choice to either set up a new Inherited IRA Beneficiary account with a financial institution or advisor of their own, or to create a new account using the prior institution. Sometimes using the same firm that held the account is easier, as long as the correct title is used.

The new owner of a Beneficiary IRA needs to know the rules to avoid costly penalties. After the SECURE Act became law in December 2019, most beneficiaries are now required to deplete an inherited IRA within ten (10) years of the original account owner’s death. This applies to any inherited IRAs where the owner has died after December 31, 2019.

The prior rules allowed Inherited IRAs to be depleted over the lifetime of the beneficiary, which allowed the accounts to grow tax-deferred and in many cases, be passed to a third generation, often referred to as “Stretch IRAs.” This option is gone.

There are no limits as to how much or how often withdrawals can be taken from the account, as long as it’s depleted in ten years. However, the withdrawals are taxable as regular income, so if you wait until the ten year mark and take out the entire amount, you’ll end up with a hefty tax bill.

There are exceptions to the withdrawal rule. A surviving spouse, a minor child, a disabled or chronically ill beneficiary, or a beneficiary within ten years of age of the original IRA owner may have a little more time to withdraw funds (and pay taxes on the withdrawals).

If inheriting an IRA from a spouse, you may transfer the IRA balance into your own account and delay distributions until age 72.

Consider your IRAs carefully when working with an estate planning attorney on the distribution of your assets. Will your heirs be able to pay the taxes on their inherited IRAs, or should they be converted to Roth IRAs to relieve heirs of a future tax burden? These are questions that your estate planning attorney will be able to address.

Reference: Sentinel Source.com (Sep. 18, 2021) “How to manage an inherited IRA from a parent”

Mega-IRAs Could Be a Source for New Public Policies

“Congressional Democrats are weighing a new type of required distribution from individual retirement accounts, based on the account value instead of age, according to a discussion list of policy ideas obtained by CNBC.”

There are few specifics but owners of “mega” IRA accounts worth more than $5 million might be presented with new withdrawal requirements, if legislation for a new national safety net becomes law. For a very small slice of the American population, IRAs have become million and even billion dollar tax deferred accounts, according to a recent article from CNBC titled “Democrats may change the rules for ‘mega’ IRAs over $5 million."

There are roughly two dozen tax categories being considered by Congress to help raise money for the expansion of the nation’s safety net, which for now is anticipated to have a $3.5 trillion price tag.

The policy concept was spotted on a draft of ideas lawmakers assemble before formally pitching the ideas before their colleagues. Floating game-changing ideas to gauge response is part of today’s legislative process.

The list didn’t include a specific amount but suggests a limit of $5 million. It also included information regarding the number of mega IRA accounts. Apparently, the number of IRA accounts worth more than $5 million has tripled in the past ten years.

In contrast, the average American’s IRA is valued around $39,000.

The idea is part of a broader theme of raising revenue from the wealthy to pay for social needs, like education, address climate change, assist working families with paid leave, childcare and other basic human needs.

It may have been sparked by a recent report that one of the founders of PayPal owns a Roth IRA valued at $5 billion. IRAs were created as a means of encouraging working Americans to save for retirement. However, they have become huge tax shelters for the wealthy.

More than 28,600 taxpayers owned IRAs worth more than $5 million in 2019, but they account for less than a tenth of 1% of the 70 million Americans who have a traditional or Roth IRA. The mega accounts add up to $280 billion, or about 3% of the total $8.6 trillion owed in IRAs.

Limiting the size of tax-deferred retirement accounts isn’t new. Several attempts have been made to cap the amount in IRAs or change distribution rules.

The final legislation may not be known for some time, but one response to this proposal would be to convert traditional IRAs to a Roth. Paying taxes at the time of the conversion, even if done over time, could be useful to eliminate having to pay taxes on the funds, if withdrawal rules change. In addition, there are no Required Minimum Distributions (RMDs) on Roth IRAs, so funds can grow tax free for the life of the owner.

Reference: CNBC (Sep. 8, 2021) “Democrats may change the rules for ‘mega’ IRAs over $5 million”

Key Dates for Planning Retirement

“Each type of retirement benefit has a different eligibility age. Your age plays a big role in how much you can expect to receive from Social Security and what you need to do to avoid retirement account penalties.”

Just as there are many types of retirement benefits, there are many dates to keep in mind when creating a retirement plan. Some concern when you can make larger contributions to retirement accounts and others have to do with withdrawals. Knowing the dates for each matters to your retirement planning, according to the recent article title “10 Important Ages for Retirement Planning” from U.S. News & World Report.

When should you max out retirement savings contributions? The sooner you start saving for retirement, the more likely you’ll retire with robust tax-deferred accounts. Tax breaks and employer matches add up, as do compounding interest returns. The 401(k) contribution limit in 2021 is $19,500. Wage earners can deposit up to $6,000 in a traditional IRA or Roth IRA. If you’re in your peak earning years, traditional IRAs and 401(k)s may be better, since your tax bracket is likely higher to be higher than when you started out.

Catch-up contributions begin at age 50. Once you’ve turned 50, you can make catch up contributions to 401(k)s—up to $6,500—and up to $7,000 in traditional IRAs. That’s for 2021. If you’re able to take advantage of these contributions, you can put away additional money and qualify for even bigger tax deductions.

401(k) withdrawals could start at 55. If you left your job in the same year you hit the double nickel, you can take 401(k) withdrawals penalty-free from the account associated with your most recent job. The “Rule of 55” lets you avoid a 10% early penalty, but you’ll still have to pay income taxes on any withdrawals from a 401(k) account. However, if you roll a 401(k) account balance into an IRA, you’ll need to wait until age 59½ to take IRA withdrawals without any penalties.

When does the IRA retirement age begin? The magic number is 59½. However, traditional IRA distributions are not required until age 72. All traditional IRA withdrawals are also taxable.

Social Security eligibility begins at age 62. The earlier you start collecting Social Security, the smaller your monthly benefit. Your full retirement age depends upon your date of birth, when the benefit amount will be higher than at age 62. If you work after signing up for Social Security, your benefits could be temporarily withheld if your salary is higher than the annual earnings limit. If you retire before your full retirement age and earn more than $18,960 per year, for every $2 above this amount, your benefits will be reduced by $1. Benefits will be recalculated once you reach full retirement age.

Medicare eligibility begins at age 65. Enrollment in Medicare may take place during a seven-month period that begins three months before the month you turn 65. Signing up on time matters, because Medicare Part B premiums increase by 10% for every 12-month period you were eligible for benefits but failed to enroll. Are you delaying enrollment because you or your spouse is still covered by a group health plan at work? Make sure to sign up within eight months of leaving your job or health plan and avoid the penalty.

Social Security Full Retirement Age is 66 for most Baby Boomers. 67 is the full retirement age for workers born in 1960 or later. Millennials and younger generations qualify after age 67.

If you can wait until 70, you’ll max out on Social Security. Social Security benefits increase by 8% for each year you wait to start payments between Full Retirement Age and age 70. After age 70, the number remains the same.

RMDs begin for 401(k) and IRA retirement accounts at age 72. These mistakes here are expensive! Your first distribution must be taken by April 1 of the year you turn 72. After that, annual withdrawals from 401(k)s and traditional IRAs must be taken by December 31 of each year. Missing a required distribution and you’ll get hit with a nasty 50% of the amount that you should have withdrawn.

Reference: U.S. News & World Report (July 28, 2021) “10 Important Ages for Retirement Planning”

How Do Special Needs Trusts Work?

“Trusts give parents of special-needs children additional options for extending care and financial assistance. However, you might need some expert help.”

Special-needs trusts have been used for many years. However, there are two factors that are changing and parents need to be aware of them, says the article “Special-Needs Trusts: How They Work and What Has Changed” from The Wall Street Journal. For one thing, many people with disabilities and chronic illnesses are leading much longer lives because of medical advances. As a result, they are often outliving their parents and primary caregivers. This makes planning for the long term more critical.

Second, there have been significant changes in tax laws, specifically laws concerning inherited retirement accounts.

Special needs planning has never been easy because of the many unknowns. How much care will be needed? How much will it cost? How long will the special needs individual live? Tax rules are complex and coordinating special needs planning with estate planning can be a challenge. A 2018 study from the University of Illinois found that less than 50% of parents of children with disabilities had planned for their children’s future. Parents who had not done any planning told researchers they were just overwhelmed.

Here are some of the basics:

A Special-Needs Trust, or SNT, is created to protect the assets of a person with a disability, including mental or physical conditions. The trust may be used to pay for various goods and services, including medical equipment, education, home furnishings, etc.

A trustee is appointed to manage all and any spending. The beneficiary has no control over assets inside the trust. The assets are not owned by the beneficiary, so the beneficiary should continue to be eligible for government programs that limit assets, including Supplemental Security Income or Medicaid.

There are different types of Special Needs Trusts: pooled, first party and third party. They are not simple entities to create, so it’s important to work with an experienced estate elder law attorney who is familiar with these trusts.

To fund the trust after parents have passed, they could name the Special Needs Trust as the beneficiary of their IRA, so withdrawals from the account would be paid to the trust to benefit their child. There will be required minimum distributions (RMDs), because the IRA would become an Inherited IRA and the trust would need to take distributions.

The SECURE Act from 2019 ended the ability to stretch out RMDs for inherited traditional IRAs from lifetime to ten years. However, the SECURE Act created exceptions: individuals who are disabled or chronically ill are still permitted to take distributions over their lifetimes. This has to be done correctly, or it won’t work. However, done correctly, it could provide income over the special needs individual’s lifetime.

The strategy assumes that the SNT beneficiary is disabled or chronically ill, according to the terms of the tax code. The terms are defined very strictly and may not be the same as the requirements for SSI or Medicaid.

The traditional IRA may or may not be the best way to fund an SNT. It may create larger distributions than are permitted by the SNT or create large tax bills. Roth IRAs or life insurance may be the better options.

The goal is to exchange assets, like traditional IRAs, for more tax-efficient assets to reach post-death planning solutions for the special needs individual, long after their parents and caregivers have passed.

Reference: The Wall Street Journal (June 3, 2021) “Special-Needs Trusts: How They Work and What Has Changed”