Retirement Benefits Left to a Disabled or Chronically Ill Individual

Take-Away: An individual who is disabled, as defined by the Social Security Administration, or who is certified as chronically ill, is defined under the SECURE Act as an eligible designated beneficiary who is entitled to use the life-expectancy distribution regime with regard to inherited retirement benefits. One issue associated with these two classifications is how to prove the individual’s condition entitles them to claim the eligible designated beneficiary status?

Background: An individual who is classified as disabled following the Social Security Administration’s definition, or an individual who is certified by a medical professional as being chronically ill, will be classified as an eligible designated beneficiary for purposes of the determining their required minimum distributions to be taken from an inherited IRA. With these two classifications, such an individual will be able to continue to take RMDs over their life expectancy, and not the SECURE Act’s otherwise required 10-year distribution rule.

Direct Beneficiary: An IRA or retirement account that is made payable directly to a disabled or chronically ill individual can take required minimum distributions (RMDs) from that retirement account using that individual beneficiary’s life expectancy.

• A disabled individual is determined pursuant to IRC 72(m) (7). That rule follows the Social Security Administration’s disability definition, which requires a relatively high degree of disability. “An individual shall be considered disabled if he/she is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual will not be considered to be disabled unless he/she furnishes proof of the existence thereof in such form and manner as the Secretary may require… Primary consideration shall be given to the nature and severity of the impairment. Consideration shall also be given to other factors such as the individual’s education, training and work experience.” [Treas. Reg. 1.72-17(A) (f).] Accordingly, there is no set formula to follow that constitutes sufficient proof of an individual’s
• A chronically ill individual is determined with reference to IRC 7702B(c) (2.) Chronically ill is defined to mean an individual who has been certified by a health care practitioner annually as being unable to perform without substantial assistance from another individual at least 2 of the following daily living functions for a period of at least 90 days due to a loss of functional capacity: (i) eating (ii) toileting; (iii) transferring (e.g. moving from bed to chair); (iv) bathing; (v) dressing; and (vi) urinary continence. Consequently, each year, in order to continue to qualify as a chronically ill individual (or trust beneficiary,) there must be a certification by a licensed health care practitioner that the individual meets these requirements. Consequently, a trustee of a trust that is the designated beneficiary of an inherited IRA for the benefit of a chronically ill trust beneficiary will have to obtain proof each year of that chronic illness prior to taking a required minimum distribution that is payable to the trust.

Burden on Trustees: When, and how, a trustee obtains a required chronically ill certification, or confirmation that a beneficiary still meets the Social Security Administration’s definition of disability in order to continue to take life-expectancy calculated distributions from an inherited IRA made payable to the trust will be a challenge. It will probably entail some HIPAA release by the beneficiary, and an established protocol that will have to be followed if the beneficiary fails to  provide timely that required certification to the trustee’s satisfaction. These practical concerns are due to the continued 50% penalty imposed on a trustee for the failure to take a required minimum distribution. With no proof of disability or no certification of chronic illness, the trustee would have to follow the 10-year distribution rule for RMDs, not the disabled/chronically ill beneficiary’s life expectancy to avoid the 50% penalty.

• Conduit Trust: An IRA that is made payable to a conduit see-through trust that is established for a disabled or chronically ill individual beneficiary can have required minimum distributions from the inherited IRA calculated using the disabled/chronically ill individual’s life expectancy. However, the problem remains that the required distribution from a conduit trust to the disabled or chronically ill requires an immediate pass-through of the RMD paid to that  individual beneficiary, which might jeopardize that beneficiary’s eligibility to receive governmental benefits. If governmental benefits were being paid to the beneficiary, it would be better to direct the IRA distributions instead to an accumulation see-through
• Accumulation Trust: An IRA that is made payable to an accumulation see-through trust that is established solely for a disabled or chronically ill individual beneficiary can have distributions from the inherited IRA calculated using the disabled/chronically ill individual’s life expectancy but only if he/she is the sole lifetime beneficiary of the accumulation see-through This limitation is the only way in which an accumulation see-through trust can qualify for the life expectancy distribution regime. If there are other beneficiaries of the same trust, then the 10-year distribution applies to the RMDs taken from the retirement account.
• Special Rule: There exists a ‘special rule’ for accumulation see-through trusts established for a disabled or chronically ill individual. If the IRA is made payable to the trust that subsequently divides into separate trusts, one for the sole lifetime benefit of the disabled/chronically ill beneficiary, then that separate share (subtrust) will qualify so as to use the life expectancy distribution regime for the lifetime of the disabled/chronically ill This ‘special rule’ applies only to disabled/chronically beneficiaries, and not to separate shares that are created in the trust instrument for other eligible designated beneficiaries, i.e. a surviving spouse beneficiary, minor children beneficiaries, and designated beneficiaries less than 10 years younger than the IRA owner. Note, too, that this special rule is also an exception to the IRS’s normal ‘separate share’ rule that requires the separate shares to be created in the retirement account beneficiary designation form, and not under the trust instrument.

Example: Archie owns a large IRA. Archie plans to name as the beneficiary of his IRA an accumulation trust for the benefit of his wife, Edith, and for the benefit of his daughter Gloria, who is classified by the Social Security Administration as being disabled. Specifically, Archie’s accumulation trust will be divided immediately upon Archie’s death into two separate shares of equal value. Edith will be the sole beneficiary of one trust share (subtrust.) Gloria will be the sole beneficiary of the second trust share (subtrust.) The trust share created for Archie’s wife Edith will be subject to the SECURE Act’s 10-year distribution rule, even though Edith would otherwise be classified as an eligible designated beneficiary because it is possible, under the accumulation see-through trust, that some other beneficiary will actually receive the IRA distributions that are accumulated in Edith’s subtrust. With regard for the trust share that is created for Gloria under Archie’s trust, because Gloria is disabled according to the Social Security Administration’s definition, the portion of the IRA that is allocated to Gloria’s subtrust may use her life expectancy to calculate the required distributions payable to, and accumulated in, Gloria’s subtrust. Upon Gloria’s later death, the balance of her subtrust must then be distributed over the following 10 years. In sum, if the goal is to have the trust established for Edith take RMDs over Edith’s life expectancy, an entirely separate accumulation see-through trust for Edith must be used, not a combo-Edith & Gloria see-through trust.

Later Disabled Beneficiary: Most commentators have concluded that the key date to determine the beneficiary’s disabled/chronically ill status is when the IRA owner dies. If the beneficiary is not technically disabled on that date, even if the beneficiary later becomes disabled and thus meets that technical definition, that beneficiary will not be able to convert from the 10-year distribution regime to a stretch distribution regime. That seems unfair and not in keeping with the apparent Congressional intent to protect disabled/chronically ill beneficiaries, but that is probably how the SECURE Act will be interpreted when the Regulations are published.

Conclusion: We will need some examples from the IRS in its promised Regulations on how a trustee will have to proceed to take life expectancy distributions from an IRA when they are paid to a trust that is established for the benefit of a disabled or chronically ill beneficiary, especially when the beneficiary’s disability or chronic illness can arguably shift from year to year or fails in timely providing required certifications.