Retaining Governmental Benefits and Getting the Stretch
In Part 1, I discussed the staggering monetary potential a beneficiary of certain inherited retirement plans is capable of achieving if the beneficiary “stretches” that plan over their lifetime. Most beneficiaries, however, just don’t do it. It doesn’t happen for a variety of reasons, some of which involve a beneficiary who is:
a minor who upon turning 18 steps into a good bit of money and mishandles it;
an adult who is irresponsible; or
someone who is simply not aware of the concept.
I then discussed the reasons why naming a Trust as a beneficiary of your retirement plan addresses these situations, better ensuring that the stretch actually happens.
In Part 2, I discussed how just naming any Trust as the beneficiary is not enough to allow the stretch – the Trust must meet several requirements to allow the beneficiary to be able to use their own life expectancy for the RMD calculation or otherwise the beneficiary will have to withdraw RMDs at a much faster rate, thus costing some beneficiaries what potentially could be millions of dollars! Bottom line: Although it’s not quite this simple, the safest and easiest way to ensure the beneficiary is able to do this is to include “conduit” Trust provisions, which require the RMD to be paid out to the beneficiary.
But what if the beneficiary has special needs and as a result is receiving means-tested governmental benefits? Well, that person can only have so much money to their name and earn a very limited amount of income in order to qualify for those benefits. If you leave the retirement plan outright to the person, they could be disqualified from future benefits. Even if you leave it to them in Trust, there can potentially still be problems …
What happens when the RMD has to be paid out to that beneficiary? Will the RMD be large enough to disqualify him or her from continuing to receive benefits? It may not initially, but there’s a good chance that somewhere down the road it’s going to happen – At some point, the RMD will likely be big enough to cut them off from further benefits.
As discussed above, conduit provisions don’t help us because they require the RMD to be paid out, to allow the Trust to qualify for the stretch – yes, we get the “stretch”, but if that happens, benefits may stop. Here, conduit provisions may do more harm than good.
With a special needs beneficiary inheriting a retirement plan, the most conservative approach to maintaining governmental benefits and getting the stretch for that person is to instead include “accumulation” Trust provisions which, as the name suggests, allow the RMDs to be accumulated in the Trust rather than paid out directly to the beneficiary.
“Accumulation” provisions are a bit trickier to draft than “conduit” provisions because we have to look at who could ever be the contingent beneficiaries, with the shortest life expectancy controlling the calculation of RMDs.
But it’s not that simple – by contingent beneficiaries I don’t mean “if my child dies, then it goes to his kids, and if he has no kids, then it goes to my sister.” It’s more complicated in that often times you’ll see a beneficiary of a Trust granted a power of appointment. A power of appointment is basically a power given to a beneficiary of a Trust allowing them to appoint property of that Trust to other people or entities like charities. I’ve had to fix work that clients already had in place because of a power of appointment granted to a beneficiary and here’s why:
- A general power of appointment is a really bad idea because that means that at the beneficiary’s death, he or she can appoint the remaining Trust property to anyone! It doesn’t matter if they actually do exercise the power, all that matters is that they possess the power. So, going back to Part 2 of this series, it’s possible that the beneficiary could appoint to a charity like the Red Cross, which has no life expectancy because it’s a charity and so we don’t get the stretch. Bottom line: just giving the beneficiary that power is generally a really bad idea.
- You have to be really careful with a limited power of appointment as well. A limited power of appointment basically says that the beneficiary can appoint the property remaining in their Trust at their death to certain people or entities. Does he or she have the ability to appoint to their spouse (whom they may not be married to yet)? It sounds a bit silly but if so, we can’t determine at the time the beneficiary steps into that retirement plan how old their potential spouse could be and thus we have no life expectancy to use – the stretch is blown.
Leaving assets to special needs beneficiaries can be very delicate, to some extent depending on the nature of the issue that person is faced with. But, leaving retirement plans to special needs beneficiaries is often so much more nuanced in order to preserve their governmental benefits and get the stretch, and very careful planning should obviously be considered.
Next time I plan to touch on asset protection as it relates to inherited retirement plans – are they protected from the beneficiary’s ex-spouses and other creditors, and if so, to what extent?
* Please note that I’m using the term “special needs” broadly – in this context, by special needs, I’m referring to any beneficiary receiving governmental benefits that are means-tested.
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** Disclaimer – I have simplified this more than it really is. There are additional issues to address on this specific topic but only so much can be said in less than 2 pages. This is not intended as legal advice. As always, you should not act upon any such information without first seeking qualified professional counsel on the specific matter.