Planning for Disabled or Chronically-Ill Beneficiaries Under the SECURE Act

May 12, 2020 | Charitable Planning, Diversity, Equity & Inclusivity, General Estate Planning, IRS / Tax Guidance, Podcasts, T&E Administration

SECURE Act — 5 Part Special

  1. Updating Existing Estate Plans Under the SECURE Act – posted April 21, 2020
  2. Planning for Common Scenarios Under the SECURE Act – posted April 28, 2020
  3. Designing and Drafting Trusts in Light of the SECURE Act – posted May 5, 2020 
  4. Disabled or Chronically Ill Beneficiaries Under the SECURE Act – this podcast
  5. Charitable Planning and the SECURE Act – posted May 19, 2020

Welcome to part four of a five-part series offering professionals information about the SECURE Act, which was signed into law in December 2019. SECURE stands for Setting Every Community Up for Retirement Enhancement. “Planning for Disabled or Chronically-Ill Beneficiaries Under the SECURE Act,” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Lauren Wolven, ACTEC Fellow from Chicago. The new SECURE Act provides tailored treatment for special needs beneficiaries that impacts planning with and for retirement benefits. To give us more information on this topic, you will be hearing today from ACTEC Fellow, Nancy Welber from Farmington Hills, Michigan. Welcome, Nancy.

Thank you, Lauren. So, today I am going to talk about the special treatment that disabled or chronically ill beneficiaries receive under the SECURE Act. Disabled and chronically ill beneficiaries are part of a special category of eligible designated beneficiaries who use their own life expectancies to determine required minimum distributions. In other words, they still get to stretch out IRAs that they inherit. But it is important to understand that in order to be disabled or chronically ill, the disability or chronic illness must be present at the death of the account owner.

Definition of Disabled or Chronically Ill

What are the definitions of disabled or chronically ill? The definition of disabled is found in Code Section 72(m)(7). It is similar to the definition for Social Security disability income, meaning that you are unable to work at anything that is substantial in the national economy. No substantial gainful employment. But, while the Social Security Administration definition is based on a 12-month inability to work, this has to be long-term. So, we are talking about a long-term disability, indefinite. It could even lead to death. Similarly, the definition of chronically ill is found in Code Section 77O2B (c)(2). That definition, likewise, requires a long-term chronic illness. It is defined similar to those in long-term care contracts because that is what 7702B actually covers. So, the eligible designated beneficiary must be unable to do two of five activities of daily living of the six listed in the code or have a disability similar to that or may have a cognitive impairment, such that they need substantial supervision for their health and safety.

Who decides who is disabled or chronically ill? Well, disability refers to regulations but there are no regulations that define it. But, chronically ill has quite an extensive definition of who may certify whether someone is chronically ill – a physician, a registered professional nurse, a social worker or some other person who may be defined in regulations. Perhaps when regulations come out, there will be a uniform standard for the disabled and chronically ill in terms of certification. And when will that certification have to happen? My guess is it will be on October 31st following year of death of the account owner because that will be the same time that you would have to give a see-through trust to the IRA sponsor or plan administrator.

Internal Revenue Code Section 401 (a)(9)

There are many disabled or chronically ill beneficiaries who still may be able to take their benefits outright. For example, they may have no cognitive impairment but they have physical disabilities that make them qualify for this category. But, most disabled or chronically ill beneficiaries may need their benefits in a trust. And that is very important because what is different about the SECURE Act, as it was passed, is there is a new category of trust available for those who have Special Needs Trusts. So, these are third-party Special Needs Trusts that would qualify the beneficiary potentially for Medicaid and other government benefits that are very valuable.

Under this equable multi-beneficiary trust, found in Section 401(a)(9) of the code, you would typically have a revocable living trust that has multiple beneficiaries, one of whom is disabled or chronically ill. All of the beneficiaries of this trust have to be individuals, and it can also apply to a standalone third-party trust; but no one can have an interest in these Special Needs Trusts except the disabled or chronically ill beneficiary during his or her lifetime. What does it mean? It means that if you typically draft with a poison pill so that if the trust no longer qualifies for government benefits, such as Medicaid, that it will go to alternate beneficiaries. That will not work under the SECURE Act. Likewise, if you have a provision that says if there is excess income distributed to other descendants or other beneficiaries of the trust, that won’t work either. So, it is very important to draft very carefully and follow the disabled or chronically ill requirements in the code, which by the way are very similar to Qualified Disability Trusts found in Section 642 of the code. The other thing is, is that the shares for those beneficiaries who are not disabled or chronically ill will be allowed to be divided in the trust but will use the 10-year rule that is required for those people who are designated beneficiaries. And again, all of the beneficiaries of this trust must be individuals and all designated beneficiaries are individuals. So that is an important point to understand.

How Will a Special Needs Trust Work Under the SECURE Act?

Now, will this be a panacea for all families? No. I don’t think so. I think that this will work if all of the beneficiaries are adult children, one of whom is disabled or chronically ill – is special needs. So, that is important because, how will it work? Well, the special needs trust will be funded, and we think that the special needs beneficiaries’ life expectancy will be used to determine their required minimum distributions. When that beneficiary dies, the 10-year rule will then kick in for the remainder beneficiaries. However, the other beneficiaries will all take under the 10-year rule. And whether they take in an accumulation or conduit trust, it sort of remains to be seen how that will all work in further guidance; but they will all take under the 10-year rule. So, it is actually a simplification because the account owner can name their trust as the beneficiary instead of having to name everyone separately in the beneficiary designation.

It also has the advantage of being able to pick and choose assets that can be allocated among the different beneficiaries. So, the retirement benefits are more valuable to the Special Needs Trust beneficiaries. So, maybe more retirement benefits are going to be allocated to that beneficiary than the after-tax assets; or perhaps, the needs of the beneficiaries are different and the allocations may change.

So, this will work well, and the division has to happen immediately. And what does immediately mean? It means probably by December 31st of the year following the year of death of the account owner, which is when separate accounts have to be established under current regulations for beneficiaries of IRAs. But what happens if there are, for example, minor children? Because, perhaps, this special needs beneficiary is also a minor and the minor children also happened to be eligible, designated beneficiaries who have a limited ability to stretch out their IRA. How will we have to do that under SECURE? Well, until we get more guidance, we have to do it the “old-fashioned way,” which means we probably will have to name the sub-trust of the revocable trust through a beneficiary designation to get the desired result, both for the Special Needs Trust and for the minor children’s trust, which probably will have to be conduit trusts in order for them to get the limited stretch.

So that means there is no ability, for example, to pick and choose which assets go to the Special Needs Trust, which still will be more valuable because it gets a full life expectancy payout as opposed to a more limited payout for minor children. In fact, the beneficiary designation will govern that split. So that means, for example, it may be very important to provide in your general powers of attorney that your agent will have broad powers, or at least some powers, to execute beneficiary designations that might change the allocations among beneficiaries as their needs change. And in terms of drafting trusts, assume until we get new guidance that the current rules apply. So, even though we believe Congress’ intent is to use the special needs beneficiaries’ life expectancy to determine how required minimum distributions are used, draft defensively and do two things. One, name remainder beneficiaries who are about the same age, if possible, as the special needs beneficiary – in other words, younger or siblings or first cousins. And also put statements of intent into your documents showing that you want this to be considered an applicable multi-beneficiary trust under the SECURE Act; or if that also applies, a qualified disability trust. So, it is important to understand that the trust can only have individuals, no charities, as remainder beneficiaries, but that this is really a special benefit that all estate planners must become acquainted with. And that is the wrap-up on the disabled and chronically ill beneficiaries, Lauren.

Thank you, Nancy, for giving us the late-breaking news on planning for special needs beneficiaries under the SECURE Act.

Tune in next week for our final SECURE Act topic, Charitable Planning and the SECURE Act. Visit actec.org/secure-act to find additional resources.

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