Retirement plans, such as Individual Retirement Accounts (IRAs), are special assets not only when it comes to their favorable income taxation treatment, but also when dealing with SSI and Medi-Cal rules regarding eligibility and estate recovery.

Let us examine the rules, first, and then consider a scenario.

Retirement plans are “income tax shelters.” Except for Roth IRAs, retirement plans are funded with pre-tax earned income by way of an income tax deduction for the contributions. Income earned inside the retirement plan accumulates tax free until distributed out either to the participant or to his death beneficiary.

Distributions are then taxed as ordinary income in the year received.

Tax deferral may not continue indefinitely. The plan must be distributed gradually once a participant reaches 70 ½ through annual “required minimum distributions” (RMDs) over the participant's life expectancy, or, with a married couple, over their joint life expectancy.

A beneficiary who inherits a deceased participant's retirement plan may also use his own life expectancy to compute his or her RMDs, but must commence RMDs the year after the death; unless the beneficiary is married to the decedent, in which case he or she can wait till age 70 ½.

A participant's own retirement plans do not count against the resource (asset) limitation for Medi-Cal eligibility provided that the plan makes sufficient annual distributions, similar to RMDs.

But the income does count towards the Medi-Cal share of cost. After the participant dies, the plan is also exempt from subsequent Medi-Cal estate recovery. This is remarkable; assets that are exempt for Medi-Cal eligibility purposes are normally subject to estate recovery.

But for SSI eligibility purposes an IRA is not an exempt asset. It counts both towards SSI resource and income limitations, and is subject to estate recovery.

So how can someone on SSI who inherits a retirement plan maintain SSI eligibility, and SSI-linked Medi-Cal eligibility, and the favorable income tax deferral discussed above?

I recently assisted a client with this problem. He received SSI/Medi-Cal and was named as a beneficiary on his deceased mother's IRA.

If he received his IRA directly as beneficiary he would lose these benefits. He would have to withdraw all of his inherited IRA at once and spend it down in order to regain his SSI and Medi-Cal eligibility. That would have triggered immediate income taxation of all IRA distributions in the year received.

Instead, we helped the beneficiary's father to establish a “special needs trust” ("SNT") and the beneficiary to assign his inherited IRA to the SNT, with court approval. The order was necessary to confirm the assignment and satisfy the IRA plan administrator.

An inherited IRA account was then established in the name of the trustee of the SNT and the problem was solved.

Now, the SNT receives the beneficiary's RMDs and the beneficiary retains his SSI and Medi-Cal eligibility.

The SNT pays income tax each year on the RMDs which are reported by and taxed to the beneficiary.

The trustee uses the IRA to supplement the government benefits by purchasing the comforts of life that are otherwise not met by his government benefits.

The foregoing approach worked because the beneficiary's father was able and willing to participate and because the beneficiary had the capacity to assign his retirement plan.

Not every person who receives SSI and/or Medi-Cal is in that same situation. Different approaches may, therefore, be required depending on the circumstances.

It may, for example, be necessary to utilize a conservatorship in order to establish the special needs trust and to assign the inherited IRA over to the trust. That would be a more involved affair and whether it is worthwhile proceeding would also require consideration of the various costs and benefits.

 

Dennis A. Fordham, attorney (LL.M. tax studies), is a State Bar Certified Specialist in Estate Planning, Probate and Trust Law. His office is at 55 First St., Lakeport, California. Dennis can be reached by e-mail at This email address is being protected from spambots. You need JavaScript enabled to view it. or by phone at 707-263-3235. Visit his Web site at www.dennisfordhamlaw.com.

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