Disabled and Chronically Ill Beneficiaries – The ‘Devil is in the Details’

Take-Away: Disabled or chronically ill designated beneficiaries of retirement accounts have the opportunity to stretch required minimum distributions over their lifetimes (using the Single Life Table). Qualifying as an eligible designated beneficiary who is either disabled or chronically ill in order to be able to stretch those distributions is difficult.

Background: A disabled or chronically ill designated beneficiary of a retirement account falls within the unique category of being an eligible designated beneficiary. If so, that individual may continue to use the life expectancy method to take required minimum distributions (RMDs) from an inherited retirement account, notwithstanding the SECURE Act’s 10-year distribution rule. In addition, trusts that are established for a disabled or chronically ill beneficiary, who are an eligible designated beneficiary, are entitled to special treatment under the SECURE Act 2.0 proposed Regulations. These trusts are called applicable multi-beneficiary trusts, or AMBTs. [IRC 401(a)(9)(h)(iv)(v).] The big challenge is how to satisfy the technical definitions of disabled or chronically ill in order to be able to stretch distributions over a lifetime, or to qualify for distributions to an AMBT of which the trust beneficiary is either disabled or chronically ill.

Disabled: In order to qualify as a disabled beneficiary, that determination is made at the account owner’s death, not at a later in time. Consequently, it is a snapshot date when the beneficiary’s disability is determined.

Standard: Disabled under the SECURE Act is similar to the Social Security definition of disabled. However, for the SECURE Act, the impairment must be likely to result in death or to be of continued and indefinite duration. [Regulation 1.401(a)(9)-4(e)(4).] In addition, a disabled determination also turns on the age of the beneficiary. A beneficiary who is age 18 or older must be unable to engage in any substantial gainful activity. A beneficiary who is under age 18 must have marked and severe functional limitations such that later substantial gainful activity is unlikely.

Social Security Eligibility: If the beneficiary is receiving Social Security disability benefits or Supplemental Security Income (SSI) on the snapshot date he/she will automatically qualify as disabled. However, the beneficiary does not need  to receive Social Security or SSI benefits to qualify as being disabled.

Practical Challenges: The problem is that many stay-at-home individuals, or those who only worked sporadically during their work-lives, will have worked enough quarters to be eligible for Social Security benefits. Thus,  many disabled individuals will be left out of automatic eligibility as an eligible designated beneficiary. In addition, children may be disabled  but be too young to be diagnosed on the snapshot date because their symptoms may take years to develop into a diagnosed condition or disease. Similarly, some debilitating mental illness may not be detected until the individual reaches their late teens or early 20’s. They, too, are constrained by the Regulations that closely adhere to the Social Security definition of disability and the arbitrariness of the one-time only snapshot date.

Chronically Ill: A chronically ill individual is defined under the SECURE Act with reference to the Internal Revenue Code that defines chronically ill for purposes of receiving benefits under a tax-qualified long-term care contract. [Regulation 1.401(a)(9)-4(e)(5).] Like the definition of disabled, the definition of chronically ill requires that the individual’s illness must be for an indefinite period that is reasonably expected to be lengthy in nature. And like the disabled definition, the determination of the individual being chronically ill is at the account owner’s death, i.e., the snapshot date.

Tests: Three alternate ‘tests’ are used to satisfy the definition of the individual being chronically ill. The beneficiary must either: (i) need assistance to perform 2 of the 6 activities of daily living [IRC 7702B(c)(2)(B);] (ii) have a disability that is similar to the level of disability that is just described in (i); or (iii) need substantial supervision to protect the beneficiary from threats to health and safety due to significant cognitive impairment.

Certification Requirement: In addition to satisfying the definition of chronically ill, the individual must also furnish documentation of their chronic illness, by a licensed health care practitioner. This documentation must be submitted to the IRA sponsor no later than October 31 of the year following the retirement account owner’s death.

Long-term Care Contract: The beneficiary does not actually have to own a long-term care contract in order to qualify as chronically ill under the SECURE Act’s proposed Regulations.

Practical Challenges: The required documentation delivery to the IRA custodian poses a problem. First, it forces the disclosure of HIPAA protected health care information. Second, it forces the IRA custodian to document the receipt of that disclosed information which leads to more recordkeeping,  and it imposes burdens on the IRA custodian in order to protect the health care information. One of the comments to the IRS has suggested that rather than furnish the actual health care practitioner documents to the IRA custodian, that a certification, similar to what is used for ABLE accounts be used, since the ABLE certification does not include specific health information.

Conclusion: While disabled and chronically ill beneficiaries are given special treat when they inherit retirement accounts, which is appropriate, the requirements to qualify for either status seem to be very rigid, not to mention using a single snapshot date when the condition is determined. The hope is that when the SECURE Act 2.0 Regulations are finally published, they may provide some needed flexibility to assist these beneficiaries.