Inherited IRA Rules for a Disabled Beneficiary

The Setting Every Community Up for Retirement Enhancement (SECURE) Act altered the rules for inherited Individual Retirement Arrangements (IRAs). For most non-spouse beneficiaries, the law now mandates that the entire account balance be distributed within ten years of the original owner’s death. This 10-year rule accelerates tax payments and limits strategies to stretch distributions over a beneficiary’s lifetime.

However, specific exceptions exist for a category of individuals known as Eligible Designated Beneficiaries (EDBs), who can follow more favorable distribution rules.

Qualifying as a Disabled Beneficiary

To use specialized distribution rules, a beneficiary must be formally recognized as disabled according to the strict definition provided by the Internal Revenue Service (IRS). This determination must be met as of the date the original IRA owner passed away. The Internal Revenue Code specifies that an individual is disabled if they are “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.”

There are two primary pathways for a beneficiary to prove they meet this definition. The most straightforward method is to provide evidence of a disability determination from the Social Security Administration (SSA). If the SSA has already classified the individual as disabled, this documentation is sufficient proof.

In the absence of an SSA determination, the beneficiary must furnish proof to the IRA custodian. This involves obtaining a certification from a physician or licensed healthcare practitioner that the beneficiary’s impairment meets the IRS definition. The plan administrator or IRA custodian has the final authority to review this documentation and decide if it meets the requirements.

Distribution Rules for Disabled Beneficiaries

Once confirmed as an Eligible Designated Beneficiary due to disability, the individual is exempt from the 10-year payout rule. Instead, they can use the “life expectancy” method, allowing distributions over their own single life expectancy. This approach results in smaller annual withdrawals and extends the tax-deferred growth of the remaining assets.

The process of calculating the Required Minimum Distribution (RMD) begins in the year following the original account owner’s death. To calculate the first RMD, the beneficiary uses their age and the corresponding life expectancy factor from the current IRS Single Life Expectancy Table. The fair market value of the inherited IRA on December 31 of the prior year is divided by this life expectancy factor.

For example, if the account was worth $400,000 and the beneficiary’s life expectancy factor is 42.7, the RMD for the year would be approximately $9,368. This amount must be withdrawn and is taxed as ordinary income.

For each subsequent year, a non-recalculation method is used. The beneficiary subtracts 1.0 from the life expectancy factor used in the first year. Using the previous example, the factor for the second year would be 41.7, and this new factor would be used to divide the account balance from the end of that year.

Using a Trust for a Disabled Beneficiary

Naming a disabled individual directly as an IRA beneficiary can create complications if that person relies on government assistance. For this reason, many IRA owners name a Special Needs Trust (SNT) as the beneficiary. A properly structured SNT can receive the inherited IRA funds, allowing for asset management while preserving eligibility for means-tested government benefits like Supplemental Security Income (SSI) and Medicaid.

For a trust to use the life expectancy payout method, it must meet IRS requirements to be a “see-through” trust. The rules require that the trust be valid under state law, become irrevocable upon the IRA owner’s death, and have beneficiaries who are all identifiable individuals. If these conditions are met, the IRS will “look through” the trust to its beneficiary to determine the payout schedule.

See-through trusts for disabled beneficiaries come in two forms: conduit and accumulation trusts. A conduit trust must immediately distribute all funds it receives from the inherited IRA to the beneficiary. This can defeat the purpose of the trust, as these mandatory payouts are counted as income and can disqualify the beneficiary from government benefits.

An accumulation trust offers a more protective alternative, as it can receive IRA distributions without being required to pass them out immediately. The trustee can hold the funds and use them for the beneficiary’s supplemental needs. This structure protects benefit eligibility but introduces a tax consideration, as any income retained within the trust is taxed at compressed trust tax rates.

The Process of Claiming and Managing the IRA

The process begins by contacting the financial institution that holds the original IRA to inform them of the owner’s death. The beneficiary or trustee will need to provide a certified copy of the death certificate and the required proof of the beneficiary’s disability status.

A new inherited IRA account must be properly titled. The account cannot remain in the deceased’s name and must be updated to reflect its inherited status. For an individual beneficiary, the title might be “John Doe, Deceased, Inherited IRA for the benefit of Jane Smith.” If a trust is the beneficiary, the title would be similar to “John Doe, Deceased, Inherited IRA for the benefit of the Jane Smith Special Needs Trust.”

Once the account is established, the beneficiary or trustee is responsible for ensuring Required Minimum Distributions are taken annually according to the life expectancy method.