TEN THINGS TO KNOW ABOUT RETIREMENT ACCOUNTS PAYABLE TO THIRD PARTY SPECIAL NEEDS TRUSTS

1. Retirement Account.  A retirement account is a tax-free way to save money.  Money placed into the account is tax deferred until it is withdrawn, usually after the individual has retired and is in a lower tax bracket.  The income and growth in the account is not currently taxable.  Therefore, if you put significant dollars in a retirement account for a long number of years, you would achieve significant tax savings.  Some accounts are employer sponsored and others are established by the employee.  Typical accounts include:
2. 401(k).  A 401(k) is generally established by the employee but the employer can make matching contributions to those accounts.  The employee portion of the contribution is excluded from tax for the current tax year.
3. 403(b) and 457(b).  A 403(b) and a 457(b) are retirement accounts offered by non-profit organizations and government agencies.
4. Pension.  A pension is generally provided by an employer.  Generally, they are provided by government agencies and unions.  Pensions are often referred to as defined benefit plans, because the money that funds the pension does not belong to the employee.  The employer invests the money with an agreement that when the employee retires he or she will receive a pre-determined amount – either a lump sum or a monthly payment, often for the remainder of the employee’s life.
5. Traditional IRA.  A Traditional IRA lets the employee contribute directly, unlike a 401(k) or a 403(b).  There is a maximum annual contribution limit of $7,500 for 2026.
6. Roth IRA.  Under a Roth IRA, the individual may contribute after tax dollars but cannot deduct the contributions from their taxes.  However, investment gains belong to the employee without having to pay capital gains and income taxes.  Individuals may contribute to a Roth IRA even if they have a workplace 401(k) or 403(b) plan.
7. Rollover IRA.  When an employee leaves his or her job, he or she can typically transfer the 401(k) or 403(b) to the new workplace or simply roll it into an IRA.
8. Roth 401(k).  Contributions are made from payroll deductions after taxes are taken out.  Thereafter, the money grows tax free.  No taxes need be paid until withdrawal at age 59.
9. Health Savings Account (HSA).  It is possible to contribute pre-tax dollars and some employers make contributions to an employee’s HSA.  Monies in the HSA must be used to pay qualified medical expenses.
10. Required Minimum Distributions (RMDs).  For traditional accounts, the IRS mandates that withdrawals be made at a calculated minimum amount annually starting at age 73.  If the owner died before their Required Beginning Date (RBD), it defaults to their estate.  In those cases, the account must be liquidated by the end of the fifth year following the owner’s death.  The money need not be distributed annually or more frequently so long as the account is completely liquidated by the end of the fifth year. 

An entity without a natural life expectancy, such as a charity, an estate, or a non-qualified trust.  This classification applies unless there is a designated person on file.  This is known as a non-designated beneficiary, subject to the five-year withdrawal rule.

If the owner died on or after their RBD, the beneficiary must take minimum distributions based on the original account owner’s remaining life expectancy.

• Retirement Account Taxation.  Generally, how your retirement account is taxed depends on whether it is funded with pre-tax or after-tax dollars and when you withdraw the funds.  If money is withdrawn prior to attaining age 59-1/2, there is generally a 10% penalty in addition to the usual tax with certain limited exemptions.
• Beneficiary Designations.  It is extremely important to designate the retirement accounts to an individual or the trust under the individual’s Will or a Living Trust.  The TPSNT is the best choice.
• Designated Beneficiaries.  Designated beneficiaries include most non-spouse or adult child.  They must withdraw the inherited account balance by December 31 of the tenth year following the owner’s death.
• Eligible Designated Beneficiaries (EDBs).  EDBs include:
• A surviving spouse
• Minor children
• Chronically-ill or those with disabilities

EDBs can stretch out distributions over their own life expectancy.  Since the Third Party Special Needs Trust is considered to be an EDB, the effort should always be made to name the trust as beneficiary of the retirement plan. 

• EDBs’ Payout Schedule.  The distributions must be taken in annual payouts in the years 1 through 9.  The account must be completely depleted by year 10.
• See-Through Trust.  There are four essentials for qualifying under IRS rules as a See-Through Trust. 
• Valid.  The trust must be valid under state law.
• Irrevocable.  The trust must be legally irrevocable or explicitly becomes irrevocable on the death of the retirement account owner.
• Underlying Individuals.  All underlying individuals must be distinct, named and easily identifiable.  Charities and other entities lack human life experiences and do no qualify as EDBs.
• Documentation Deadlines.  A complete copy of the finalized trust paperwork must be physically provided to the retirement plan administrator or custodian by October 31 of the year following the account owner’s death.
• Penalties.  A penalty for failure to withdraw an RMD after age 73 results in a 25% excise tax on the amount not withdrawn.  The penalty drops to 10% if the shortfall is corrected within two years.

Withdrawal from a retirement account results in a 10% withdrawal, if may prior to age 59-1/2.

1. Conclusion.  Since withdrawals from retirement accounts enable the beneficiary to stretch the withdrawals over his or her lifetime, a properly-drafted TPSNT is able to stretch the withdrawals and the tax over the lifetime of the beneficiary resulting in significant tax savings.