A retirement account may be one of your most valuable assets. It is natural to consider naming your children as beneficiaries so they can benefit from those savings after your death.
However, leaving a retirement account directly to a minor child can create complications. A minor generally cannot control an inherited account, and an adult may need legal authority to manage the money on the child’s behalf.
The distribution rules for inherited retirement accounts also affect how long the funds can remain in the account. Before naming a minor child as a beneficiary, it is important to understand those rules and consider whether a trust would better accomplish your goals.
Can a Minor Child Be Named as a Retirement Account Beneficiary?
Yes. A minor child may be named as either the primary or contingent beneficiary of an IRA, 401(k), or another retirement account.
A primary beneficiary inherits the account when the owner dies. A contingent beneficiary inherits if the primary beneficiary dies first, disclaims the account, or is otherwise unable to inherit.
Naming a minor child is legally possible, but that does not mean the child can immediately manage the account.
What Happens If the Child Is Still a Minor?
A minor generally cannot control an inherited retirement account or make decisions about distributions. The account custodian may require a court-appointed guardian or conservator to manage the account until the child reaches the applicable age of majority.
This process can involve court filings, legal expenses, ongoing reporting, and judicial supervision.
A parent may nominate a guardian or conservator in a will. However, that nomination does not necessarily eliminate the need for court involvement. The beneficiary designation and the financial institution’s requirements will determine how the inherited account must be managed.
The Beneficiary Form Controls Who Inherits the Account
Retirement accounts generally pass according to the beneficiary designation on file with the account custodian. They do not ordinarily pass according to the instructions in a will.
For that reason, your will and retirement account beneficiary forms should be reviewed together. Naming one person in your will and someone else on the beneficiary form can produce an unintended result.
You should also review your designations after significant life events, including:
- The birth or adoption of a child
- Marriage or divorce
- The death of a beneficiary
- A child reaching adulthood
- The creation or amendment of a trust
- A significant change in your financial circumstances
How Does the SECURE Act Affect a Minor Child’s Inheritance?
The Setting Every Community Up for Retirement Enhancement Act, commonly known as the SECURE Act, changed the distribution rules for many inherited retirement accounts.
Most nonspouse beneficiaries are now subject to a 10-year distribution rule. This generally means the inherited account must be fully distributed by the end of the applicable 10-year period.
A minor child of the original account owner receives special treatment.
A Minor Child May Be an Eligible Designated Beneficiary
A minor child of the account owner is considered an eligible designated beneficiary while the child is under age 21. This exception applies only to the account owner’s child. It does not automatically apply to grandchildren, nieces, nephews, or other minors.
While the child qualifies as an eligible designated beneficiary, distributions may generally be calculated using the child’s life expectancy. When the child reaches age 21, the 10-year distribution period begins.
The IRS identifies a minor child of the deceased account owner as an eligible designated beneficiary. The child must generally follow the 10-year rule after reaching age 21.
What Happens When the Child Turns 21?
Once the child reaches age 21, the inherited account generally must be emptied by the end of the tenth calendar year following that event. In many situations, that means the account must be fully distributed during the calendar year in which the child turns 31.
Annual distribution requirements during that period can vary. The rules may depend on:
- Whether the original owner died before or after the required beginning date
- Whether the account is a traditional or Roth account
- The type of retirement plan
- The distribution method selected
- The terms imposed by the account custodian or plan administrator
The IRS Publication 590-B provides additional information about distributions from inherited IRAs. The federal government’s final required minimum distribution regulations also address eligible designated beneficiaries and the 10-year rule.
Because these rules are complicated, beneficiaries should consult a qualified tax advisor before requesting or delaying a distribution.
Should You Name the Child Directly?
Naming a child directly may be appropriate when the child is already mature enough to manage the inheritance and you are comfortable with the child receiving control of the funds.
There are also potential disadvantages.
If the child is still a minor when you die, a court proceeding may be required so an adult can manage the account. After the child reaches the applicable age, the child may gain control of the inherited funds.
The child could then withdraw more than the required amount or empty the account entirely. Large withdrawals may create income tax consequences and quickly consume an inheritance that was intended to provide long-term support.
If you want greater control over how and when the money is used, naming a properly drafted trust may be a better option.
Should You Name a Trust as the Beneficiary?
Instead of naming a minor child individually, you may name a trust created for the child’s benefit.
A trust can identify the person who will manage the inheritance, establish standards for distributions, and protect the funds after the child reaches adulthood. It can also reduce the risk that a court will need to appoint someone to control the inheritance.
However, naming a trust as a retirement account beneficiary requires careful planning. A trust must satisfy specific requirements for its beneficiaries to be treated as designated beneficiaries under the retirement account distribution rules.
These arrangements are often described as “see-through trusts.”
What Is a See-Through Trust?
A trust is not an individual, so it is not automatically considered a designated beneficiary. If the trust satisfies the applicable requirements, the individuals who benefit from the trust may be considered when determining the required distribution period.
The trust generally must be valid under state law, become irrevocable upon the account owner’s death, have identifiable beneficiaries, and satisfy applicable documentation requirements.
A see-through trust may be structured as either a conduit trust or an accumulation trust.
How Does a Conduit Trust Work?
A conduit trust generally requires retirement account distributions received by the trust to be distributed to the child or used for the child’s benefit.
The trustee controls the account and makes decisions according to the trust’s instructions. This structure can prevent a minor child from directly managing the retirement account.
However, money distributed from the retirement account generally cannot remain protected inside a conduit trust. When the inherited account must be emptied, those distributions usually must pass out to or for the child.
As a result, a conduit trust may offer limited protection after the applicable 10-year period ends.
How Does an Accumulation Trust Work?
An accumulation trust gives the trustee greater ability to retain retirement account distributions inside the trust.
The inherited retirement account must still comply with the applicable distribution deadline. However, after funds are withdrawn from the retirement account, the trustee may be able to keep those funds in the trust rather than distribute them directly to the child.
This can provide several benefits:
- The trustee may manage the inheritance beyond the child’s age of majority.
- The trust can establish standards for education, health care, housing, and other expenses.
- The inheritance may receive protection from creditors or an irresponsible beneficiary.
- The funds may remain in trust after the retirement account has been emptied.
One disadvantage is that income retained by a trust can reach the highest federal income tax bracket much more quickly than income reported by an individual. The trustee may need to balance asset protection with the potential tax cost of retaining income.
Direct Beneficiary or Trust: Which Option Is Better?
The right choice depends on your child, your estate plan, and your goals for the inheritance.
| Planning issue | Child named directly | Trust named as beneficiary |
|---|---|---|
| Management while the child is a minor | A guardian or conservator may be required | The named trustee manages the inheritance |
| Control after the child reaches adulthood | The child may receive control | The trust can delay or limit access |
| Protection from creditors | Usually limited | May provide protection if properly drafted |
| Distribution flexibility | Controlled by the child once legally permitted | Controlled by the trustee and trust terms |
| Tax complexity | Generally lower | Generally higher |
| Trust income tax exposure | Not applicable | Retained income may be taxed at higher trust rates |
A direct beneficiary designation is simpler. A trust can provide greater control and protection, but it must be drafted and administered correctly.
What If the Child Has a Disability?
Additional planning may be necessary when a child has a disability or receives means-tested government benefits.
An inheritance paid directly to the child could affect eligibility for programs such as Supplemental Security Income or Medicaid. A properly designed special needs trust may allow the inheritance to be managed for the child without unnecessarily disrupting those benefits.
Different retirement account rules may also apply when a beneficiary meets the federal definition of disabled or chronically ill. These rules require individualized legal and tax advice.
Review Your Retirement Account Beneficiary Designations
Retirement account planning should not be completed in isolation. Your beneficiary forms should coordinate with your will, trust, tax planning, and the needs of the people you want to protect.
If you are considering naming a minor child as a beneficiary, ask the following questions:
- Who will manage the account if I die while my child is a minor?
- When should my child receive control of the inheritance?
- Could a large distribution create unnecessary income taxes?
- Does my child need protection from creditors or poor financial decisions?
- Should a conduit or accumulation trust be used?
- Do my current beneficiary forms match the rest of my estate plan?
The answers will help determine whether the child should be named directly or whether a trust should receive the retirement account.
Speak With an Estate Planning Attorney
The attorneys at McDonald Law Firm can help you coordinate your retirement account beneficiary designations with the rest of your estate plan. We can review whether naming your child directly or through a trust better reflects your goals.
To schedule a consultation, contact one of our offices:
- Howard County: 443-741-1088
- Montgomery County: 301-941-7809
- District of Columbia: 202-640-2133
DISCLAIMER: THE INFORMATION POSTED ON THIS BLOG IS INTENDED FOR EDUCATIONAL PURPOSES ONLY AND IS NOT INTENDED TO CONVEY LEGAL, INSURANCE, OR TAX ADVICE.
