The Voice is the e-mail newsletter of The Special Needs Alliance. This installment was written by Special Needs Alliance members Edward V. Wilcenski, Esq. and Tara Anne Pleat, Esq..

EDWARD V. WILCENSKI, Esq., is a founding partner of the law firm of Jones Wilcenski & Pleat PLLC in Clifton Park, New York. He practices in the areas of special needs planning, elder law and trust and estate planning and administration. A member and past president of the Special Needs Alliance, Ed writes and lectures frequently on issues affecting individuals with disabilities and their families.

TARA ANNE PLEAT, Esq. is a founding partner of the law firm of Jones Wilcenski & Pleat PLLC in Clifton Park, New York. She focuses her practice in the areas of special needs planning, trust & estate planning and administration, long term care planning and elder law. Tara is a member of the Special Needs Alliance, frequently speaking on estate planning and administration, special needs planning and related disability issues for state and local bar associations and community organizations.

September 2010 - Vol. 4, Issue 14

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.

In this issue of The Voice, we discuss how retirement plans may affect eligibility for means-tested government benefits. The next issue of The Voice 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 for 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.

Retirement Plans and Government Benefit Eligibility

People with disabilities often need help from government benefit programs that provide monthly income, medical care, attendant care, housing and food. Many of these programs, including Medicaid, Supplemental Security Income (SSI) and food stamps, are means-tested. These programs count the amount of an applicant’s monthly income and also the applicant’s resources (bank accounts, stocks, retirement plans, and other assets) in determining eligibility for benefits.

For those individuals with disabilities who have worked and accumulated money in a retirement plan, how will those plans be treated when it comes time to apply for benefits? If a parent wants to name a child with disabilities as a beneficiary of the parent’s retirement plan, how will that affect the child’s eligibility for benefits? If a child is offered a retirement plan as part of her employment benefit package in a supported work opportunity, how will that affect her current or future eligibility for benefits?

In almost all cases a retirement plan inherited outright by a person with disabilities will be treated as an available asset or as monthly income that will reduce or eliminate means-tested government benefits, including SSI, Medicaid and food stamps. The fact that the retirement plan is taxable as funds are withdrawn does not mean it will not affect eligibility for needs-based benefits.

For example: If Sam inherits a $100,000 IRA from his mother at her death, that IRA account exceeds the $2,000 Medicaid and SSI asset limit and will disqualify him from those benefits. In the next issue of the Voice we will discuss planning opportunities available to Sam’s mother to avoid this result but still protect the retirement plan for Sam’s benefit.

If the retirement plan is owned by the individual with disabilities, the effect of the plan on government benefits is more complicated. The government benefit program will need to determine if the retirement plan, or any portion of the plan, can be accessed by the individual. In other words, are the plan’s assets available to the individual? This issue of availability will vary from plan to plan, and some state Medicaid rules may vary on how availability is determined.

In most cases, if the plan owner is no longer working, the retirement plan will be available and counted as a resource. If the plan owner is still working, the retirement plan may prohibit the owner from withdrawing funds from the plan while employed. In that case the plan should not be counted as an available asset. If the retirement plan allows a hardship waiver of the prohibition on withdrawing from the plan or the option of borrowing against the account, then the plan may be counted as an available asset depending upon how the plan defines “hardship” or under what circumstances employees can borrow again their account.

In some cases the retirement plan may be treated as monthly income rather than an asset if the plan has been converted from a lump sum to irrevocable periodic payments from the plan over the life expectancy of the plan owner. Income usually reduces or offsets means-tested government benefits, so having a retirement plan treated as income rather than an asset probably will not help. Again, if Sam inherits a $500 per month IRA annuity from his mother at her death, the $500 will offset and reduce his SSI income dollar for dollar (other than $20 that will be disregarded). Instead of receiving his SSI income of $674 plus $500, Sam will receive $500 from the inherited IRA and $194 from the SSI program for total monthly income of $694.

The rules governing the treatment of retirement plans vary depending upon the source of the retirement plan and may vary from state to state. Individuals with retirement plan assets should seek legal advice before applying for means-tested government benefits.

In the next article of The Voice, Alliance member Ken Shulman will address planning options to shelter retirement plan benefits and preserve eligibility for needs-based benefits.

About this Article: We hope you find this article informative, but it is not legal advice. You should consult your own attorney, who can review your specific situation and account for variations in state law and local practices. Laws and regulations are constantly changing, so the longer it has been since an article was written, the greater the likelihood that the article might be out of date. SNA members focus on this complex, evolving area of law. To locate a member in your state, visit Find an Attorney.

 Requirements for Reproducing this Article: The above article may be reprinted only if it appears unmodified, including both the author description above the title and the “About this Article” paragraph immediately following the article, accompanied by the following statement: “Reprinted with permission of the Special Needs Alliance –” The article may not be reproduced online. Instead, references to it should link to it on the SNA website.