Fundamentals of Special Needs Trusts - Inheritance & Lifetime Gifting; Redirecting IRAs

1-3 Fundamentals of Special Needs Trusts § 3.03

Inheritance & Lifetime Gifting

Redirecting IRAs

In the same way that parents or grandparents sometimes fail to recognize the importance of directing a child/grandchild's inheritance to a SNT when the child/grandchild suffers from a disability, they also forget to take into account the beneficiary designations on IRAs or other retirement type assets.

The issue of properly directing IRA proceeds to a SNT is dealt with in § 3.03[7][d].  When the IRA owner fails to properly name a SNT as the beneficiary, it may still be possible to divert or redirect the proceeds from the IRA to a first-party SNT for the benefit of the child with a disability.

In such cases a petition for substituted judgment could be filed to create the SNT (see  § 4.06) and the petition could also seek an order transferring the child's interest in the IRA into the SNT. Alternatively, any other method by which a first-party SNT can be created (i.e., by a parent, grandparent, guardian or court order)1 (see  § 1.05[2]) should suffice and thereafter, if the child with the disability has the capacity to do so, she may transfer her interest in the IRA into the SNT.

Such an approach has been approved by the IRS in at least one case. In Letter Ruling 200620025 the IRS concluded that the portion of the IRA transferred into the SNT was not a recognized transfer for either estate or gift tax purposes and also that the child's life expectancy could be used in determining the require minimum distributions.

The IRS reached these conclusions by determining that the SNT was a grantor trust and therefore the grantor and the trust are treated as one taxpayer. Therefore, the transfer of the IRA into the SNT was not a sale or other disposition under I.R.C. § 691(a)(2) and thus there was no immediate recognition of federal income tax. The IRS also determined that the terms of the SNT met the test for a designated beneficiary trust (see  § 3.03[7][b]) and therefore the five-year distribution rule did not apply, but rather the beneficiary's life expectancy could be used.

SNT drafting attorneys must keep in mind that letter rulings cannot be cited as precedent, but rather they are an indication of the IRS's position on the specific question presented and may be useful as an indication of how the IRS will evaluate the drafter's situation.

This free download is part of Fundamentals of Special Needs Trusts, which places special needs trusts in the arsenal of tools available to an attorney to help his senior clients and those who have disabilities. It helps the practitioner to understand how she can draft a trust, using the person's own funds or the funds of another, to provide goods and services for those clients that will enhance their everyday existence.

Fundamentals of Special Needs Trusts provides practitioners with analysis of the law, authoritative advice, practice notes, checklists, and forms. It begins with a discussion of the history of special needs trusts, discusses ethical issues, explains the various types of special needs trusts and how to draft, fund, and administer those trusts, how and when to terminate them, and the relevant tax considerations.

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[1] See 42 U.S.C. § 1396p(d)(4)(A) .