What Is The Grandfather Rule and How Does It Work?

A grandfather clause is a provision in a new law or regulation that allows pre-existing entities or activities to continue operating under the old rules. This is designed to prevent penalizing individuals or businesses that were in compliance with the law before it changed. The new rule applies to all future cases, while those with “grandfathered” status are exempt.

The term originates from laws enacted in southern states between 1895 and 1910 to disenfranchise African American voters by imposing new requirements like literacy tests and poll taxes. The laws included a clause exempting anyone whose grandfather had been eligible to vote before 1867, a time when African Americans could not vote. This practice was declared unconstitutional by the Supreme Court in 1915.

Qualifying for Grandfathered Status

The central requirement for achieving grandfathered status is a clear “cutoff date” established by the new statute. To qualify, an individual or business must have been engaged in the specific activity before this designated date, as the intent is to allow prior situations to continue without disruption. The new regulations explicitly apply only to activities or entities established after the cutoff.

Proving this pre-existence is necessary for anyone seeking to claim grandfathered status. The burden of proof lies with the party claiming the exemption, accomplished through documentation like dated permits, contracts, or financial records.

For example, a business with a large, non-conforming sign installed years ago would be grandfathered in because its sign existed before a new ordinance’s cutoff date. However, if the business were to replace the sign entirely, it would likely have to comply with the new regulations.

Application in Health Insurance Plans

The grandfather rule has a specific application in health insurance, largely defined by the Affordable Care Act (ACA). A health insurance plan is considered “grandfathered” if it was in existence on March 23, 2010, the date the ACA was enacted. These plans are permitted to continue without being subject to all of the law’s mandates.

Grandfathered plans are exempt from some ACA requirements. For instance, they are not required to provide preventive care services, such as vaccinations and cancer screenings, without cost-sharing. They also do not have to cap annual out-of-pocket spending for consumers or offer an external review process for appealing denied claims.

Despite these exemptions, grandfathered plans must comply with several ACA consumer protections. They cannot impose lifetime dollar limits on most health benefits or cancel coverage retroactively, except in cases of fraud. These plans are also required to extend coverage to policyholders’ children until they reach the age of 26.

Insurers are required to disclose if a plan is grandfathered, allowing policyholders to understand which protections they do and do not have.

Application in Retirement and Estate Planning

The grandfather rule is also a feature in financial regulations, particularly in retirement and estate planning, where law changes can alter long-term strategies. A clear example is seen with inherited Individual Retirement Accounts (IRAs) following the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. Before the SECURE Act, most non-spousal beneficiaries could “stretch” distributions from an inherited IRA over their own lifetime.

The SECURE Act introduced a new rule requiring most beneficiaries to withdraw the entire balance of an inherited IRA within 10 years of the original owner’s death. However, the old “stretch” rules were grandfathered in for anyone who inherited an IRA from an individual who died before January 1, 2020. The act also created a special category of “Eligible Designated Beneficiaries” who are exempt from this 10-year rule. This group includes:

• The surviving spouse
• Minor children of the account owner until they reach the age of majority
• Disabled or chronically ill individuals
• Beneficiaries not more than 10 years younger than the IRA owner

In estate planning, grandfathering often applies to irrevocable trusts. When tax laws change, a trust that was created and became irrevocable before the new law’s effective date may be exempt from the new tax treatment. For instance, changes to the generation-skipping transfer (GST) tax often include grandfathering provisions, meaning a trust established before the enactment of a new GST tax rule might be shielded from that tax.

Maintaining or Losing Grandfathered Status

Obtaining grandfathered status does not guarantee it will last forever, as this protection can be forfeited. The most common way to lose this status is by making a “significant change” to the grandfathered item or activity. The regulations that create the grandfathered provision define what constitutes a disqualifying change, ensuring the exemption is not exploited.

In the context of health insurance, a grandfathered plan under the ACA can lose its status if the insurer makes certain modifications. These triggers include significantly increasing percentage-based cost-sharing requirements or substantially increasing copayments or deductibles beyond allowed limits.

Similarly, in estate planning, a grandfathered irrevocable trust can lose its protected tax status if it is modified in a prohibited manner. An action that extends the duration of the trust or adds new beneficiaries in a way that violates the rules could subject the trust to new tax laws.