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Considerations When Designating a Minor as a Beneficiary to an IRA.

Designating a Minor as a Beneficiary to an IRA

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​Key Takeaways
  • If you plan on leaving your Individual Retirement Account (IRA) to a grandchild or other minor, this can be a fantastic and tremendously generous way of gifting wealth.

  • The money will continue to have the tax advantages it had during the IRA owner's lifetime, but there are several things to consider before designating a child as the beneficiary of your IRA.

  • The first thing to consider is: what happens if the child inherits the IRA while still a minor?

  • Secondly, how do distributions from Inherited IRAs work, and what required distributions will the child have?

  • Thirdly, what tax implication will there be on distributions?

Why Choose a Minor As An IRA Beneficiary?

Individual Retirement Accounts (IRAs) have excellent tax advantages when planning for retirement. Money can be contributed tax-free, that money can be invested, and it grows tax-deferred. Then, once you retire and are presumably in a lower tax bracket, you can take distributions from the account and pay income taxes on those withdrawals. If you are lucky enough to live a long, healthy life and have assets left over upon your passing, the question becomes, who do you leave your assets to? Some assets get distributed according to your will or other estate planning documents, while others (like IRAs) are transferred based on your designated beneficiaries. By identifying a beneficiary of your IRA, assuming the beneficiary is not your spouse, the account will be transferred to an Inherited IRA (also called a Beneficiary IRA) upon your passing. Funds in an Inherited IRA can still grow tax-deferred, but there are specific rules about required distributions from the account. Designating a minor as your beneficiary comes with some considerations to keep in mind, but it can be a fantastic and tremendously generous way of transferring wealth to a younger generation.

What Options Do I Have If I Want To Leave My IRA To A Minor?

Name Them Directly As A Beneficiary With A Custodian

Since minors cannot own property (including investment accounts), they cannot inherit the IRA outright. Therefore, to pass the IRA on to the minor, you must designate an adult to manage the account for the benefit of the minor. This adult is also called a "custodian." The custodian can be a parent, family member, or another trusted adult and would manage the money until the child reaches their state's recognized age of adulthood, also called the "age of majority." The age of majority is state-dependent and is usually between 18 to 21. Once the child reaches that age, the custodian is removed from the account, and the child has complete access to the funds. If the IRA owner does not designate a custodian ahead of time, then the probate court would have to assign one. Therefore, it is best to identify the custodian when making the beneficiary designation, as you will likely have minimal control over whom the probate court appoints. Typically, the investment firm where the IRA is located will have a form to designate beneficiaries. On that form, there is usually a section on how to direct assets to minor beneficiaries including designating a custodian. If you are unsure, reach out to the investment firm or your financial advisor about how to accomplish this.

Open A Custodial Account Like An UGMA/UTMA

Upon the passing of the IRA Account owner, all of the funds in the IRA can be distributed and moved into a Uniform Gift to Minors Act or Uniform Transfer to Minors Act Account. This is a taxable account that the child owns, with a custodian managing the account until the child reaches the age of majority in the state in which they reside. This is a way to avoid the confusing required distribution rules for Inherited IRAs, which we will discuss later (see "How Do Distributions From the Inherited IRAs Work, and What Required Distributions Will the Child Have?"), but the beneficiary loses the tax-advantaged growth by leaving the funds in an Inherited IRA. Moreover, the beneficiary will most likely get stuck with a hefty tax bill for taking the withdrawals all at once. The best strategy will probably be to take distributions over the required distribution period and move the withdrawals into a UGMA or UTMA from there rather than taking the distributions all at once.

Open a 529 Plan

Another option could be to open and fund a 529 Plan with the withdrawals from the account. A 529 Plan is a state-run, tax-advantaged account to save for a child's education expenses. Money is put into the account after tax but grows tax deferred. Withdrawals can be made tax-free so long as they are for qualified education expenses.

With this, again, it is a good idea not to distribute the IRA all at once and fund a 529 Plan due to taxation issues. Similar to the UGMA/UTMA strategy, taking smaller distributions over the required period and funding a 529 Plan can be an excellent strategy for saving for a child's college education. Additionally, the beneficiary and their custodian could do both methods simultaneously: take some of the distributions to fund the UGMA/UTMA, and the rest can go into the 529 Plan.

One downside to 529 Plans is that any funds withdrawn and not used for education expenses come with a tax penalty.

Name A Trust As The Beneficiary For The Benefit of The Minor

One potential downside of naming a minor directly as a beneficiary of an IRA is that the minor can come into a large sum of money at a young age. If the IRA account owner is worried about their beneficiary being too young to act responsibly with the funds, another option would be to set up a trust for the child's benefit and to name the trust as the beneficiary of the IRA. This is a bit more complicated and would require an estate planning attorney to draft the trust document, but this does allow the IRA account owner to control how and when money can be distributed to the child. If the account owner is worried about whether the minor will spend the funds responsibly – for example, buying a sports car rather than buying a home or investing in their education – a trust can help mitigate some of these issues. It should be noted, however, that this route is not for everyone and is only worth it if the IRA account is quite large, as the process of creating a trust can be expensive.

How Do Distributions From the Inherited IRAs Work, and What Required Distributions Will the Child Have?

Under the SECURE Act of 2019, individuals who are not a spouse of the person from whom they inherit the IRA would open an Inherited IRA (also called a Beneficiary IRA) with themselves as the account owner. These individuals would then have to distribute all of the funds from the account by December 31st of the tenth year following their passing. For example, if the IRA owner passed in 2022, the beneficiary would have to withdraw the entire balance by December 31, 2032. This is known as the 10-Year Rule.

However, some individuals are exempt from the 10-Year Rule. They are referred to as eligible designated beneficiaries (EDBs) and include:

  • A surviving spouse,

  • A disabled or chronically ill person,

  • A person less than ten years younger than the IRA account owner, and

  • A child of the IRA account owner who has not yet reached the age of majority.

These beneficiaries are exempt from the 10-Year Rule and, therefore, can stretch the required minimum distributions (RMDs) by taking distributions from the Inherited IRA over their life expectancy.

If the minor beneficiary inheriting the account is not the IRA owner's child, their distributions fall under the 10-Year Rule. Depending on whether the original IRA owner was taking RMDs before they passed away, the minor beneficiary may have to take annual distributions from the Inherited IRA each year, and the account must be depleted in its entirety by the tenth year. Note that any funds not distributed by the 10-year deadline will be subject to a tax penalty.

If the beneficiary is a minor and is also the IRA owner's child, there is a special distribution rule. The minor must start taking minimum distributions each year upon inheritance using their own life expectancy. Once the minor reaches the age of majority, the 10-Year Rule kicks in, and they have until December 31st of the 10th year after they turn the age of majority to withdraw all the funds in the inherited retirement account.

If the minor is disabled or chronically ill, they are not subject to the 10-year rule. Instead, they must take annual minimum distributions, but they can spread them out over the course of their lifetime.

IMPORTANT NOTE: upon the death of the IRA owner, it is essential for the beneficiary and their custodian to find out if the IRA owner had to take a required minimum distribution in the year of their death. If they were obligated to take an RMD in the year of their death and did not, it is the beneficiary's responsibility to take the IRA owner's RMD before the end of the year of the IRA owner's death.

It is also worth noting that the minor (and their custodian) cannot contribute to an inherited IRA. Once the account is in their possession, they can only take money out of it; they cannot put money into it. If the minor has earned income (wages or a salary) and would like to contribute to a retirement account, a custodian can set up a custodial IRA (also called a Minor IRA).

What Tax Implications Will There Be On Future Distributions For the Child?

Traditional IRA

Just like with distributions from a Traditional IRA account, the beneficiary of an Inherited IRA will have to pay income taxes on the distributions they take. Since the minor's withdrawals from the account are unearned income (meaning not income generated from work-related activities), part of this distribution may be subject to the "kiddie tax." In other words, amounts withdrawn from the Inherited IRA may be partly subject to the child's income tax rate, and part may be subject to their parent's income tax rate if the withdrawals exceed a certain limit. These limits are set by the Internal Revenue Service and change annually. Talk to your financial advisor or tax accountant to see if the portion withdrawn from the minor's Inherited IRA is subject to the kiddie tax.

Roth IRA

If the account is an Inherited Roth IRA, the minor beneficiary will not have to pay taxes on distributions as long as the original account owner's Roth IRA was open for at least five years before the account owner's passing. If the account is less than five years old, the beneficiary can either wait until the five-year holding period has passed to take distributions or pay taxes on the amount they take out – they would only pay taxes on the earnings portion of the account, not what the original account owner contributed. They are, however, subject to the same 10-Year Rule as with Inherited Traditional IRAs.

Final Thoughts

Generally speaking, beneficiary designations should be reviewed periodically to ensure the listed parties continue to align with the account owner's wishes. Beneficiary designations can be changed at any point in the account owner's life, so it is worthwhile to keep track in order to make any updates as changing circumstances arise.

All of these rules and best practices can be quite confusing. There are a number of details that, if done incorrectly, can cause hefty tax penalties. We strongly recommend talking with a financial advisor and an estate planning attorney to ensure you take the proper steps to accomplish your goals. Working with these professionals will help you find the path that makes the most sense and works best for you and your beneficiaries.

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About the Author

Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and virtually nationwide with the financial decision-making process to organize, grow, and protect your assets.

** This writing is for informational purposes only. The author and Holzberg Wealth Management do not guarantee or otherwise promise any results that may be obtained from using this report. No reader should make any investment decision without first consulting their financial advisor and conducting their own research and due diligence. These commentaries, analyses, opinions, and recommendations represent the personal and subjective views of the author and do not constitute a recommendation, offer, or solicitation to make any securities transaction. The information provided in this report is obtained from sources that the author believes to be reliable. External links to third parties are being provided for informational purposes only. Holzberg Wealth Management is not affiliated with the third-party websites linked to, unless otherwise explicitly stated, and does not constitute an endorsement or approval by Holzberg Wealth Management of any of the third party’s products, services, or opinions.


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