The Listen to Lawrence Letter: What are the tax implications of assets that go into a trust?

June 9, 2021
Dear Clients and Friends,
While so many of these LISTEN TO LAWRENCE LETTERS are dominated by Elder Law and Medicaid questions, a lot of our practice here at DAVIDOW, DAVIDOW, SIEGEL & STERN, covers estate and tax planning in general and also Special Needs Law. It is nice to shift gears here a little and talk about something new.
I have a question regarding my special needs adult. We are purchasing a second-to-die life insurance policy to help fund my son’s Special Needs Trust.   What are the tax implications of assets that go into the trust? I am aware that the life insurance benefit will not be taxable. What else might be taxed? In other words, I have our SNT listed on our retirement accounts bank accounts, life insurance policies, and our personal assets like our house. Which of these will be taxed going in or coming out of the SNT?
And if you ever offer a lecture on this subject I’m sure many people would be interested. Thank you.
We represent many people who have children and/or grandchildren who happen to have certain disabilities and are currently or will in the future receive SSI and/or Medicaid, needs-based programs. Because these children or grandchildren must remain poor they cannot inherit money, and many would not be capable of handling the money in any event. This is why people create SPECIAL NEEDS TRUSTS (SNTs), where assets can be placed in the trust for the benefit of the individual with disabilities, managed by a trustee and used to enhance and enrich the beneficiary’s life, but will, nevertheless, not be counted as an asset against them for SSI and Medicaid eligibility purposes.
These SNTs are usually funded with a percent of your estate, or specific assets of your estate, but can also be funded with life insurance and retirement plans. I will not address the estate tax issues here but rather limit my response to the income tax consequences. There are no income tax consequences for leaving any part of your estate to the SNT, including your life insurance (second to die or otherwise), EXCEPT for naming the SNT as beneficiary of your retirement plans…..and here the news may be good!
Generally, pursuant to the SECURE ACT OF 2020, the beneficiary of a retirement plan must withdraw all the money in the retirement plan within a 10 year period following your death. One exception to this rule is for SNTs, where the sole disabled beneficiary gets more favorable treatment. In such a case, the trust, as beneficiary of the retirement plan, is permitted to take money out of the retirement plan into the trust over the life expectancy of the beneficiary. This is called a “Stretch IRA” because the required minimum distributions (RMDs) can be stretched over an entire lifetime. As each RMD payment is made to the trust, the trust will have to pay income tax on it every year. One issue with this is that trusts are in the highest tax bracket. However, if the trustee actually spends the distributed money on the beneficiary within the year, the trust will get a deduction and the beneficiary will pick up the tax at usually a far lesser rate.
This income tax issue will also play out with all the other assets in the SNT. If bank accounts or investment accounts earn income or dividends each year, the trust will pay income tax at a high rate. If the trustee pays out the income to or for the benefit of the beneficiary, then the trust will get a deduction and the beneficiary will pick up the tax at their rate.
If principal (not income) is paid out of the trust to or for the benefit of the beneficiary, no income tax will be due.
Lastly, I am always available to lecture on this topic and have done so for many years prior to the Covid era. If all protocols are in place, I’d be happy to come and speak to any group that would be interested in hosting such an event.
I hope this helps! Please forward this information to your friends and relatives to share these informative answers to some very commonly asked questions.
And, if anyone you know would like to receive this
Listen to Lawrence Letter, just have them email me at and I’ll add them to the list!
As always, please send me your questions. If you are thinking about it, others are probably too, so my answers will no doubt help you and many others.
Let’s stay connected.
Stay safe!
Until next time…
peace, health and happiness,
Lawrence Eric Davidow