Though SECURE eliminated the life expectancy payout for inherited retirement benefits for most beneficiaries, it preserved that favorable payout option for five classes of eligible designated beneficiaries, or EDBs. Two of the EDB categories are a disabled individual and a chronically ill individual. Estate planners who work with the disabled or their families will want to know how best to structure inherited retirement benefits to take advantage of this now-rare payout option.
The first step is to determine whether the proposed beneficiary is disabled or chronically ill within the meaning of SECURE. The law cites the definition of disability in Code section 72(m)(7) as "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." Virtually the same definition is used to determine eligibility for Social Security disability benefits.
"Chronically ill" status is based on the individual's inability to perform at least two specified "activities of daily living," or requiring substantial supervision for safety purposes because of cognitive impairment, all as certified by a licensed healthcare practitioner. Relevant primarily when placing an individual in a nursing home, this definition (in Code § 7702B) is used in connection with "qualified long-term care insurance" as a health insurance benefit.
While it is nice to know that retirement benefits left to the client's disabled child (or other disabled or chronically ill individual) will qualify for the life expectancy payout, that won't help the beneficiary much if (1) the benefits must be left outright to him/her to qualify for the life expectancy payout and (2) the beneficiary receives medical care, subsidized housing, or other "welfare"-type benefits under Medicaid or other government programs available only for individuals whose assets and income are below certain levels. If the disabled individual is named as outright beneficiary of an IRA, he/she is likely to be disqualified from further participating in the government programs until the inherited account has been "spent down," a prospect that would discourage IRA owners from leaving the retirement plan outright to the disabled beneficiary.
Typically, a person wishing to leave an inheritance to a disabled individual who participates in government programs providing medical care, housing, and/or other benefits would leave the inheritance to a "supplemental needs trust" for the disabled individual's benefit rather than outright to him or her. A supplemental needs trust provides the disabled individual only with benefits that supplement rather than replace the applicable government benefit programs. Thus, the trust does not pay for housing, medical care, and other basic needs, but rather provides only supplemental benefits (eyeglasses, dental care, pet care, and vacations, for example) that enhance the disabled individual's quality of life without disqualifying him/her from the programs that provide basic living needs and medical care.
But can a supplemental needs trust for a disabled individual get the same life expectancy payout treatment that the disabled beneficiary could get under SECURE if named directly as beneficiary?
The answer is yes, thanks to a special provision in SECURE that applies only to these particular EDBs (the disabled and chronically ill): A trust that, during the entire lifetime of the disabled or chronically ill individual, pays nothing to anyone other than such individual is entitled to use the life expectancy payout. SECURE gives such a trust the cumbersome name of "applicable multi-beneficiary trust," or AMBT.
For other classes of EDB (such as the donor's spouse), based on present law, the individual must be either named directly as sole beneficiary or (if a trust is named) must be the sole beneficiary of a "conduit trust" to qualify for the life expectancy payout. Under a conduit trust, all distributions from the inherited retirement plan during the lifetime of the individual beneficiary must be paid out to such individual more or less as received. But SECURE removes that particular requirement in the case of trusts for the disabled or chronically ill (since such mandatory payouts would likely disqualify the individual from his/her applicable government benefit programs).
Oddly, under an AMBT, it is technically not required that anything actually be paid to the disabled or chronically ill individual; all that is required is that none of the inherited benefits be paid to anyone else during the disabled individual's lifetime.
This special provision of SECURE, blessing the AMBT, allows the client to leave retirement benefits to a supplemental needs trust for a disabled or chronically ill child (or other individual) and know that such trust will qualify for the life expectancy payout while still also functioning as a supplemental needs trust.
Does this mean that SECURE did no harm to estate planning for the disabled? Not quite. Remember, the AMBT must provide that nothing can be paid from the trust to anyone other than the disabled individual so long as he or she is living. What if in a particular year the required minimum distribution from the inherited plan exceeds the beneficiary's supplemental needs for such year? Suppose, for example, the trustee must withdraw an RMD of $40,000 but the disabled beneficiary's supplemental needs for the year amount to only $18,000? The trust will be left with $22,000 of gross income with no ability to pay it out to (for example) another family member as "distributable net income." Prior to SECURE, a supplemental needs trust funded with retirement plan death benefits could typically include a "relief valve" provision permitting the trustee to pass out excess income to other family members (and deduct the amount so passed out as distributable net income), thus shifting the income tax burden to family members who could be in a lower income tax bracket than the trust itself. Any such relief valve provision is foreclosed by SECURE if the trust is to qualify for the life expectancy payout.
The good news is that SECURE has preserved the life expectancy payout for disabled beneficiaries, and it has enabled benefits to be left to a supplemental needs trust for the disabled individual and still qualify for that life expectancy payout. But to the extent the inherited retirement benefits exceed the amount of such supplemental needs, other family members will not be allowed to "piggyback" on their relative's disabled status and benefit from the life expectancy payout.
Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.