Is There a Good Way to Make a Minor Child the Beneficiary of an IRA?

Creating an estate plan when heirs are minors, requires a special touch. You can leave your asset to whomever you want, of course, but some properties cannot legally be owned by minors. There are special structures and rules to convey assets to minors, but they have to be carefully followed.

If you have an eccentric and wealthy brother who tells your nine-year-old son that he is going to inherit a Ferrari, and then does, chances are you won’t allow your son to drive the car, until he is skilled enough to handle that much horsepower. What if you wanted to leave your son a large IRA and you die while he is a minor?

Investopedia’s article, “Designating A Minor As An IRA Beneficiary,” explains that there are ramifications of leaving one or more of your IRAs to a minor. Let’s look at some of the advantages and disadvantages of this strategy.

There are a few reasons why someone might want to leave an IRA to a beneficiary, who’s not yet reached the age of majority. It is obvious that with a minor child, IRAs can allow much greater flexibility and potential for long-term growth than something like a savings bond. IRAs don’t have to be used for higher education or any other specific purpose to avoid taxation. Young beneficiaries also receive the benefit of a lower required minimum distribution (RMD) over their lives, because the life expectancy of the beneficiary is used when calculating their RMDs.

However, minors can’t own legal property of any kind in their name. Instead, a guardian must be appointed to manage the property for the child until they reach the age of majority. If the owner of the IRA doesn’t appoint one, a judge will do it. That guardian may have very different ideas about how the account should be handled.

There are some other options you can have your guardian implement, once your beneficiary receives the IRA. He can place the distributions in a custodial account pursuant to the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). However, this could have adverse tax consequences for whoever claims the minor as a dependent on their tax return. If the minor’s income is above a certain level, then the parent or guardian must pay tax on the excess at their top marginal tax rate. This option also gives the minor sole custody of the property at the age of majority, when she may not be ready to handle a large sum of money.

A second option is to put the money into a 529 plan. This account lets the assets grow tax-free until they’re used to pay for higher education expenses. However, if the beneficiary doesn’t pursue a college education, the plan can also backfire.

Another answer may be to substitute a carefully drafted revocable living trust as the “designated beneficiary” for the IRA and make the minor child the beneficiary of the trust. The guardian would be appointed as the trustee. A trust allows the creator to provide specific directions on how you want the guardian to handle the IRA distributions for the minor.

These are all alternatives that you need to consider. Talk with an experienced estate planning attorney to determine how this will work with the rest of your estate plan. You’ll also need to speak to your IRA custodians about each institution’s requirements for beneficiary designations. Remember that the beneficiary designation supersedes your will.

Reference: Investopedia (2018) “Designating A Minor As An IRA Beneficiary”