IRA Distributions to Third-Party Special Needs Trusts: Avoiding the 'Five-Year Rule'

In This Issue:

1. IRA Distributions to Third-Party Special Needs Trusts 

2. About the Firm  

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IRA Distributions to Third-Party Special Needs Trusts

For many parents, the majority of their savings is held in some kind of a retirement account, often an Individual Retirement Account (IRA). At age 70 ½, an IRA account holder faces the Required Beginning Date, when he or she must take mandatory distributions from the IRA. These payments are determined by the government and are known as Required Minimum Distributions.

If the parents have a child with special needs, it is often important for the parents' estate plan to direct Required Minimum Distributions following the parents' death into a special needs trust (SNT) that has been set up for the child. For income tax purposes, it is usually best to stretch these distributions out over as long a period as possible, particularly if the IRA is a large one.

How long the distributions can be stretched out depends. Typically, if an IRA account holder names a "designated beneficiary," the designated beneficiary's age determines the amount of the distributions. If there is no designated beneficiary, a "five-year rule" for distribution applies, meaning that the account must be paid out in full within five years after the death of the account owner.

Unfortunately, some SNTs may not qualify as a "designated beneficiary" under the IRS rules. As long as all of the SNT's remainder beneficiaries are individuals, required distributions are allowed to be made based on the age of the eldest remainder beneficiary. However, sometimes SNTs are drafted so that entities that don't have life expectancies -- such as a charity -- are potential beneficiaries. In such cases, the five-year rule applies and IRAs can't generally avoid the income tax consequences of expedited withdrawal.

The rules governing IRA distributions to SNTs are exceedingly complicated. This is all the more reason to consult with an attorney such as Evan Farr, whose practice focuses on planning for adults and children with special needs.

 

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About the Firm

Evan H. Farr, CELA, CEA, has been in private practice in Fairfax since 1987, is a Charter Member of the Academy of Special Needs Planners, and is the only attorney in Virginia who is both a Certified Elder Law Attorney and a Certified Estate Advisor.* Since 2007, Evan has been named by Virginia Super Lawyers Magazine as one of the top attorneys in Virginia, and in 2008 Evan was named by Washington, DC Super Lawyers Magazine as one of the top attorneys in DC. The Super Lawyers designation is bestowed upon the top 5% of lawyers in each state as chosen by their peers and through the independent research of Law & Politics.

The Farr Law Firm helps protect individuals with special needs and their families. For those with a disabled family member, proper estate planning often dictates the use of a Third-Party Special Needs Trust. For a disabled person who inherits money, a First-Party Special Needs Trust is typically required. We also help personal injury claimants and attorneys in connection with settlements received by a disabled child or adult.

*Certified as an Elder Law Attorney by the National Elder Law Foundation and Certified as an Estate Advisor by the National Association of Financial & Estate Planning. Virginia has no procedure for approving certifying organizations.

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