Individuals with disabilities often require ongoing medical care, therapy, and other services that can be expensive. So, many families may opt for a special needs trust. If you have a 401(k) retirement plan, you may be wondering whether you can put it into a special needs trust. We’ll explore the factors that determine whether a 401(k) can be put into a special needs trust, and how to do so if it’s possible.
What is a 401(K)?
A 401(k) is a type of retirement savings plan that allows employees to contribute a portion of their pre-tax income to the plan. The money in the plan grows tax-free until it is withdrawn, usually after the employee retires. Many employers offer 401(k) plans as a benefit to their employees, and some may also offer matching contributions or other incentives to encourage participation.
What is a Special Needs Trust?
A special needs trust is a legal arrangement that allows you to set aside money and other assets for the benefit of a loved one with a disability, while still preserving their eligibility for government benefits like Medicaid and Supplemental Security Income (SSI). Many families of individuals with special needs use special needs trusts to provide financial support for their loved ones without jeopardizing their access to these crucial benefits.
Whether or not you need a special needs trust depends on your unique circumstances. A special needs trust is typically recommended for individuals with disabilities who receive or may need to receive government benefits such as Medicaid, Supplemental Security Income (SSI), or other means-tested benefits. These benefits are typically only available to individuals with limited income and resources, and having significant assets in your name could disqualify you from receiving these benefits. Consulting with a professional estate planning attorney can help you better understand a special needs trust, as well as other trusts that may be available to you.
Can a 401(k) be put into a special needs trust?
The short answer is: it depends on the type of special needs trust you have.
There are two main types of special needs trusts: first-party and third-party. A first-party special needs trust is funded with the disabled individual’s own assets, while a third-party special needs trust is funded with assets belonging to someone else, such as a parent or grandparent.
First-Party Special Needs Trust
If you have a first-party special needs trust, also known as a self-settled special needs trust, you may be able to transfer your 401(k) into the trust, depending on the rules of your specific plan. However, there are some important considerations to keep in mind.
If you transfer your 401(k) into a first-party special needs trust, the transfer will be considered a taxable event. You will owe income tax on the value of the assets transferred, and you may also owe penalties if you are under age 59 1/2. The transfer may also affect your eligibility for certain government benefits, particularly if the trust balance exceeds certain limits.
If you transfer your 401(k) into a first-party special needs trust, the assets in the trust will be subject to Medicaid payback requirements when the disabled individual passes away. This means that any funds remaining in the trust at the time of the individual’s death must be used to reimburse the state for Medicaid benefits received during the individual’s lifetime, before any remaining funds can be distributed to other beneficiaries.
Third-Party Special Needs Trust
If you have a third-party special needs trust, you cannot transfer your 401(k) into the trust. Third-party special needs trusts are funded with assets belonging to someone else, so you cannot transfer your own retirement plan assets into the trust. However, you can name the trust as a beneficiary of your 401(k) plan, which will allow the funds to pass to the trust after your death without going through probate.
Benefits of putting a 401(k) into a special needs trust
Putting a 401(k) into a special needs trust can offer several benefits for families of individuals with disabilities, including:
- Protecting eligibility for government benefits: By placing assets into a special needs trust, families can provide financial support for their loved one with a disability without jeopardizing their eligibility for government benefits like Medicaid and SSI. These benefits are often critical for individuals with disabilities who may require ongoing medical care, therapy, and other services.
- Tax-deferred growth potential: 401(k) plans offer tax-deferred growth potential, which means that the money in the account can grow tax-free until it is withdrawn. By transferring a 401(k) into a special needs trust, families can take advantage of this tax-deferred growth potential and potentially increase the value of the assets over time.
- Asset protection: Assets held in a special needs trust are protected from creditors, which can be particularly important if the individual with a disability is involved in a lawsuit or has significant debts.
- Control over how assets are used: By creating a special needs trust, families can specify how the assets in the trust should be used to support their loved one with a disability. This can help ensure that the funds are used in a way that is consistent with the family’s wishes and that maximizes the individual’s quality of life.
- Estate planning benefits: Transferring a 401(k) into a special needs trust can also offer estate planning benefits. For example, if the individual with a disability predeceases the account owner, the assets in the trust can pass to other beneficiaries without going through probate. This can help simplify the estate administration process and potentially reduce estate taxes.
Schedule a Consultation with a Professional Estate Planning Attorney
Navigating the estate planning process can be challenging, especially when trusts are taken into consideration. At Galanti & Copenhaver, we understand that understanding the complexities of different kinds of trusts can be overwhelming. Our experienced team is dedicated to providing an individualized and client-centered experience. Schedule a consultation with one of our team members today!