People often leave assets to minors, but is making a minor an IRA beneficiary a really bright idea?
There are many ways to give assets to those for whom you want to leave a legacy. You can leave tangible assets. However, the age of the person to whom you leave the gift will frequently decide the form of, and the conditions under which, they receive the property. Let’s look at some of the advantages and potential negatives of leaving an IRA to a minor.
Investopedia’s recent article, “Designating a Minor as an IRA Beneficiary,” explains that there are several reasons why someone might want to give an IRA to a beneficiary who is not yet an adult. One of the most obvious is that IRAs can provide much greater flexibility and potential for growth than, for example, savings bonds. IRAs also don’t have to be used for higher education or any other specific purpose in order to avoid taxation.
If you leave an IRA to a minor, there must be an appointment of a guardian to manage the account, until the child reaches adulthood. Minors can’t own legal property of any kind in their name. Instead, you can appoint a guardian to manage the property on their behalf, until they reach the age of majority (18 or 21, depending on the state). If you do not do this, the court will appoint one for you—and that could be a person who may have very different thoughts about how the account should be managed and invested.
The law prohibits IRA custodians from dealing directly with minors in any capacity. A will doesn’t solve the problem because wills only deal with probate assets, and IRAs are exempt from probate. The minor’s parents or another relative can petition the court for guardianship, if you fail to make an appointment. However, this can be expensive, time-consuming and really unnecessary.
The passage of the SECURE Act has drastically changed the rules when it comes to inherited IRAs. For instance, as of December 2019, minor children may withdrawal assets over their life expectancy only until they are 18 or 21 (depending on their home state), after which they will have an additional 10 years to deplete the account. Because of these dramatic changes, it’s important that you talk to finance, accounting and legal professionals before designating minors as beneficiaries.
There are a couple of different ways that your beneficiary can receive the IRA. One option is to put the distributions inside a custodial account, like an UGMA or UTMA account. However, there could be adverse tax consequences for the minor’s parents (or whoever claims the minor as a dependent on a tax return) if the minor’s income is above a certain threshold. That’s because the parent or guardian must pay tax on the excess at their top marginal tax rate. This also gives the minor sole custody of the property at the age of majority, but she may not be prepared at that time to handle a large sum of money.
Another possibility is to put the money into a 529 plan. This will let the assets grow tax free, until they’re used to pay for qualified higher education expenses.
A more comprehensive solution may be to use a revocable living trust as the beneficiary for the IRA. The minor is named the beneficiary for the trust, and the guardian would be appointed as the trustee. A big benefit of a trust is that you can provide specific instructions as to how you want the guardian to handle the IRA distributions for the minor.
There are several available options, so talk with an experienced estate planning attorney about what makes the most sense for you and your family.
Reference: Investopedia (September 7, 2019) “Designating a Minor as an IRA Beneficiary”