Retirement Accounts and Government Benefits – Part 1

September 15, 2010

For many individuals retirement plans are an important part of their financial security. While retirement plans can be great wealth building tools, they can also present some significant challenges if an individual with disabilities needs to qualify for some government benefits.

Retirement plans can be an issue in several different contexts. Parents often want to leave retirement accounts to their children with disabilities as part of their estate plan. People with disabilities may have their own retirement plan that was funded before the onset of their disability. In some cases a person with disabilities may have employment through a PASS Plan or a supported job opportunity that includes either employer funding of a retirement plan or the employee’s option to self-fund a retirement plan through wage deferral or withholding. In each of these cases it is important to know how retirement plans can affect eligibility for government benefits and what options are available to minimize or avoid the loss or reduction in benefits.

We will discuss how retirement plans may affect eligibility for means-tested government benefits in two parts. In a future newsletter, we will address options to shelter retirement plan benefits in order to preserve needed government benefits.

What is a Retirement Plan?

While there are many different types of retirement plans, the following are the most common plans:
• Individual Retirement Accounts (IRAs). IRAs are retirement accounts that are owned and funded by individuals with income they have earned through employment.
• 401(k) Plans. 401(k) plans are employer sponsored retirement plans that are funded by an employee’s salary deferral and in some cases also by employer contributions. 401(k) plans are typically offered by private and corporate employers.
• 403(b) Plans. 403(b) plans function essentially the same way as 401(k) plans. They are retirement plans that are administered the employees of educational institutions, hospitals and municipalities.

Generally speaking, each of these plans defers income taxes. This means that money you put into the plan is not taxable in the year of contribution, and it grows tax free within the plan. But when you withdraw funds from one of these plans, the amount withdrawn is considered taxable income, just like wages. Thus the tax is deferred but not avoided altogether.

There are rules which govern the manner and timing of withdrawals from these plans. These rules are designed to encourage people to save for their retirement, and then use the money once they do retire. The two most important rules for our purposes are as follows:

Rule 1. Prior to reaching age 59 ½ , a retirement plan owner who withdraws funds from his or her retirement plan will be subject to an excise tax (like a penalty) equivalent to 10% of the total distribution. This is in addition to the ordinary income tax that applies to the distribution. This rule is designed to encourage people to keep money in the plan until they retire. There are some exceptions to this rule, however, the most important of which allows a person with a recognized disability to withdraw funds from a retirement plan before age 59 ½ without incurring the 10% excise tax penalty.
Rule 2. Once an individual reaches the age of 70 ½, the individual must begin taking required minimum distributions from the retirement plan. The IRS has a special life expectancy table that is used to calculate one’s required minimum distributions. If the individual fails to take a minimum distribution after reaching age 70 ½ , then there will be a 50% excise tax on the total amount of the required distribution. That excise tax is in addition to the ordinary income tax payable on the distribution. This rule is designed to encourage people to use the money when they retire.

Source:; 9/10 – Vol. 4, Issue 14