Exploring the Implications of Naming Minor Children as IRA Beneficiaries

Co-Author: Jeffrey Deiss, CFP^®, AEP^®

When contemplating the beneficiaries of any retirement account, such as IRA, Roth IRA, or employer retirement plan, the decision can become especially nuanced and significant when considering the impact of naming minor children. Unlike designating adult beneficiaries, the implications of naming minors involve a multitude of legal, financial, and practical considerations that demand careful attention.

Inherited IRA Custodial Accounts

The fundamental challenge presented is minors lack the legal capacity to manage or inherit financial assets.  As a result, if a minor inherits retirement funds directly, someone of legal age must act on their behalf as a financial custodian or guardian.  The difficulty though is many IRA beneficiary forms do not directly allow for direct appointment of such individuals on behalf of the beneficial child resulting in delays to accessing the inherited assets.

One solution, particularly for accounts held with Fidelity Investments, is including provisions to both name a financial guardian and establish a custodial account under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) statutes.  These statutory frameworks allow for the creation of custodial retirement accounts managed on behalf of minors, providing a structured mechanism for overseeing the assets until the minor reaches’ adulthood.

For example, my beneficiary form could name my wife, Leslie, as my “primary” beneficiary.  But if something were to happen to Leslie, then I’d want to name my son as the “contingent” beneficiary of my IRA.  If Leslie and I both die while my son is a minor, then I could use language on my contingent beneficiary designation naming my sister as the custodian as follows:

“Pamela Deiss, as custodian for Jeffrey Deiss, Jr. under the New Jersey Uniform Transfer to Minors Act, if under the age of 18 until the age of 18”.

 Upon my death, Pamela could then set up an inherited IRA account for Jeffrey, Jr. under the UTMA statues on behalf of Jeffrey, Jr.  Pamela will then control and manage the assets until Jeffrey, Jr. reaches the age under state law in which he could obtain control of the account – typically age 18 or 21.

The 10-Year Distribution Rule

As a result of the recently passed legislation, SECURE Act and SECURE Act 2.0, the post-death distribution schedule for a non-spouse beneficiary has substantially compressed. Currently, if you leave your IRA to an adult child today, they will have 10 years, starting in the year after the year of death, to completely distribute the IRA to themselves and pay all of the income taxes due on the distributions.  In the case of a large IRA, this limited 10-year window typically requires some tax planning and a conversation with your ACM Wealth Advisor.

The rules are different for minor children depending on who they inherit from.  Minors who inherit IRAs from their parents take RMDs based on their single life expectancy, typically a much smaller annual number, until they turn age 21.  At that time, the 10-year rule kicks in and they have to continue to take RMDs in years 1-9 and completely distribute their inherited IRA by age 30.

Minor beneficiaries, such as grandchildren, nieces and nephews who inherit IRAs are subject to the 10-year rule immediately.  They do not get to stretch the inherited IRA RMDs until age 21.  If the IRA account owner died after starting their own RMDs, then RMDs are required from the minor’s inherited IRA in years 1-9 as well. In the case where you consider naming a minor who is not your child as beneficiary of your IRA, the same advice above holds where naming a custodial account as beneficiary makes sense.  As a reminder, minor children are not legally able to make decisions with regard to finances.

For individuals with substantial IRA balances or specific estate planning objectives, simply designating a custodial account may not suffice. In such cases, naming a trust as the beneficiary of the IRA becomes a viable option. This approach offers greater control over the distribution and management of assets, ensuring that they are utilized according to the IRA owner’s wishes and the best interests of the minor beneficiaries.  We’ll follow-up next week with additional information and detail on the role a trust can play within the confines of IRA beneficiary elections.

Conclusion

The decision to name minor children as an IRA beneficiary can involve careful planning. Whether opting for a custodial account or a trust, IRA owners must consider not only the immediate implications but also the long-term consequences for the financial well-being of their minor beneficiaries. If you have questions and or would like to evaluate your options, please reach out to your ACM Wealth Advisor – we are here to help!

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