Naming Minor Children As IRA Beneficiaries

A traditional IRA or a Roth IRA owner can name any adult as their IRA beneficiary. The IRS owner simply names an adult on the IRA beneficiary form. But this is not the case if the IRA owner wants to name a minor as beneficiary. When a minor inherits retirement dollars, the child is not legally able to make decisions with regard to finances. Some type of custodian or guardian will be needed. A potential problem is that not all IRA beneficiary forms allow nomination of a guardian.

Another option is to name a custodial account for the minor on the IRA beneficiary form. Custodial accounts established either the Uniform Gifts to Minor Act (UGMA) or the Uniform Trusts to Minors Act (UTMA) can be used for this purpose. The IRA owner names the custodian of the account on the IRA beneficiary form.

For example, the beneficiary form could include language such as naming “Peter Jones, as custodian for Peter Jones, Jr. under the Florida Uniform Gift to Minors Act.” Upon the IRA owner’s death, Peter could then set up an inherited IRA account for Peter, Jr. under the UGMA. Peter will control and manage the assets until Peter Jr. reaches the age under state law in which he could obtain control of the account.

For larger IRA balances and when more control is desired, a trust may be the best option. It is important to mention that trusts can be complex when they are named as IRA beneficiaries as well as expensive when they are set up. But trusts can be useful and make sense when it comes to naming a minor as an IRA beneficiary.

Required Minimum Distributions for Minor Beneficiaries

Effective January 1,2020 following the passage of the SECURE Act in December 2019, the rules for inherited IRAs were significantly changed. Prior to the SECURE Act passage, naming a minor as a beneficiary was an effective way to take advantage of the “stretch” IRA. A grandparent could name a grandchild as their IRA beneficiary and required minimum distributions (RMDs) would be paid from the inherited IRA for decades over the grandchild’s long-life expectancy, 60 to 80 or more years.

But for those IRA owners who die after December 31, 2019 whose accounts will pass to the next generation, they need to rethink their estate planning strategy. The rules have changes under the SECURE Act with respect to naming a minor as a beneficiary. Under the SECURE Act, the “stretch” IRA is no longer available for most IRA beneficiaries, including minor children.

Any IRA beneficiary who is not an eligible designated beneficiary (EDB) is subject to a 10-year payout rule in which the inherited IRA must be withdrawn withing 10 years of the death of the IRA owner. However, there is a special rule for some minor children. Minor children of the IRA owner (traditional or Roth) are considered to be eligible designated beneficiaries (EDBs). They can take their required minimum distributions (RMDs), based on their single life expectancy, but only until they become age 21. At that time, the “10-year distribution” rule will apply.

Under IRS proposed RMD regulations that were issued earlier in 2022, upon the death of a traditional IRA owner who reached his or her required beginning date (RBD (April 1st following the year the traditional IRA owner became age 70.5 if the owner was born before July 1, 1949 or April 1 following the year the traditional IRA owner becomes age 72 if the owner was born after June 30, 1949) annual RMDs for inherited traditional IRAs are required during years 1 through 9 of the 10-year period.

Inherited Roth IRAs would not be subject to annual RMDs during years 1 through 9. Both inherited traditional and Roth IRAs would have to be withdrawn in its entirety by the end of the 10th year. The following example illustrates:

Example 1. During 2021, Alice, age 13, inherited a traditional IRA from her father. Alice is an EDB and can “stretch” required IRA distributions over her single life expectancy, approximately 82 years. This “stretch” will continue for eight years until Alice’s 21st birthday in 2029. At that time, Alice will reach the age of majority (age 21, regardless of state law) and the 10-year rule will then apply. Alice must continue to take annual RMDs in years 2030 -2038 and empty the inherited IRA by December 31, 2039, the end of the 10th year after Alice reached age 21.

Note that minor beneficiaries who are not the child of the IRA owner cannot delay the 10-year rule until their 21st birthday. Other beneficiaries including grandchildren, nieces and nephews are not considered EDBs and are subject to the 10-year rule immediately upon the death of the IRA owner. If a traditional IRA owner dies before his or her RBD, then annual RMDs would not be required during the 10-year period. The following two examples illustrate:

Example 2. Calvin, age 82, died in 2022. The beneficiary of his traditional IRA is his granddaughter, Cecelia, age 11. Cecelia does not qualify as an EDB because she is not the daughter of the IRA owner. Cecelia will have to take annual RMDs from the inherited IRA for the years 2023 – 2031 (the years 1 – 9 of the 10-year period following the year Calvin died) because Calvin died after his RBD of age 70.5. In addition, the entire remaining inherited IRA balance must be distributed by December 31, 2032.

Example 3. Margaret, age 68, died in 2022. The beneficiary of her traditional IRA is her grandson William, age 10. William does not qualify as an EDB since he is not the son of the IRA owner. William does not have to take RMDs from the inherited IRA because Margaret died before her RBD of age 72. But William must withdraw his entire inherited IRA by end of the 10th year following Margaret’s death, December 31, 2032.

Trusts for Minor Children Beneficiaries

For those IRA owners who have large balances and who want more control after death, naming a trust established for the benefit of a minor beneficiary can be a solid strategy. However, the rules for RMDs from inherited IRAs to trust beneficiaries can be complex. In short, here are some of the requirements for naming a trust as a beneficiary of a minor child:

• If a trust for a minor child of the IRA owner meets certain requirements and the child is the beneficiary of a conduit trust, then RMDs can be made based on the child’s life expectancy until the child is age 21, at which time the 10-year rule will then apply

•The proposed regulations stipulate that if one of the trust beneficiaries is the minor child of the IRA owner, that child qualifies as an EDB even if the other beneficiaries do not, and

• Minor beneficiaries of trusts who are not a child of the IRA owner will not qualify as EDBs.

Many federal employees and retirees own traditional IRAs and Roth IRAs that they have contributed to during their lifetime in order to build a legacy for their families. When IRA bequests are intended for a minor child, proper planning before death – by naming a UGMA or a UTMA account and a custodian or a trust – can help facilitate the transfer of IRA assets.

Upon the IRA owner’s death, it is vital that IRA beneficiaries including minor children and their custodians understand when annual RMDs are required and when the 10-year payout rule applies. For additional guidance and information, they are advised to seek legal and tax counsel. Proper planning and full awareness of the RMD requirements and the 10-year payout rule is vital in ensuring a safe and efficient passage of wealth to a younger generation.