If you want to leave your individual retirement account (IRA) to your grandchildren, you should know that minors can’t inherit an IRA directly. Instead, a custodian should be appointed until the minor is of legal age. Here are some things to keep in mind before you consider leaving your IRA to a minor. A financial advisor could help you create an estate plan to protect your family’s future.
Naming a Minor as an IRA Beneficiary
Naming your minor child or grandchild as an IRA beneficiary was historically an excellent estate planning strategy. In the past, this move permitted minor beneficiaries to stretch required minimum distributions (RMDs) over the remainder of their life expectancies. Because their life expectancies would be many years longer than their parents or grandparents, the money would have potentially decades longer to grow.
However, minor beneficiaries who inherit IRAs today generally cannot stretch RMDs like they could in the past. This is due to a new rule that is part of the SECURE Act, which we’ll discuss in greater detail ahead. For now, the important point is that IRA beneficiaries must distribute the entire amount of the IRA within 10 years of the original owner’s death.
There are also tax considerations if you pass an IRA to a minor beneficiary. An IRA will be taxed as income when money is withdrawn. The exception is a Roth IRA, which the beneficiary can withdraw from tax-free right away, as long as at least five years have passed since you opened the account.
IRA Requirements for Minor Child Beneficiaries
It is still possible to pass your IRA to a younger beneficiary. However, here are four things you should keep in mind if you intend to do so:
Minors can’t inherit an IRA directly
The first thing to know about minors inheriting an IRA is that they cannot do so directly. This is because minors are not legally allowed to own property, and this includes IRAs. However, you can name a custodian who is of legal age, typically the minor’s legal guardian. This person will manage the money until the beneficiary is no longer a minor.
You are not legally required to name a custodian, but it is strongly encouraged if you want to leave your IRA to a minor. If you don’t name a custodian, the court system will name one for you, and that person may not manage the IRA according to your wishes.
Another option is to establish a trust. This option can be more costly and time-consuming, but it also gives you more control over how the money should be used.
The 10-year rule
As mentioned, the SECURE Act fundamentally changed how funds in an inherited IRA can be used. Before the act, the beneficiary could stretch RMDs for the remainder of their life expectancy. Thus, if the beneficiary was a minor, they may have had decades of additional growth in the IRA, only taking RMDs during that time.
However, none of this applies to IRAs inherited after the SECURE Act. Not only can beneficiaries no longer stretch their distributions, but there are no longer RMDs for inherited IRAs. Instead, beneficiaries must distribute all the money in the IRA within 10 years; specifically, by the end of the 10th year following the original owner’s death. The beneficiary can then distribute the funds in any manner they choose, as long as the money is fully distributed by the end of the 10th year.
An exception to the 10-year rule
While most beneficiaries are required to distribute all funds in an inherited IRA by the end of the 10th year following the original owner’s death, there are some exceptions. According to the IRS, minor children are considered “eligible designated beneficiaries” to whom the rule does not apply. This means they can make distributions from the IRA using their own life expectancy.
However, once the minor reaches adulthood, the 10-year rule kicks in. In most states, that happens at age 18. If the beneficiary lives in one of those states, they have until the end of the 10th year following their 18th birthday to distribute all the funds in the IRA.
The age of majority
As mentioned, the age of majority is 18 in most states. This is the age at which a person is legally allowed to own property, or in this case, inherit an IRA without the help of a guardian. However, there are three exceptions – Alabama and Nebraska, where the age is 19, and Mississippi, where the age is 21. Thus, the 10-year rule would kick in slightly later in these states.
Leaving an IRA to a minor was often done in the past because it allowed beneficiaries to stretch distributions for the remainder of their life expectancy. This was potentially decades longer than the original owner’s, possibly allowing for many more years of tax-free growth. However, the SECURE Act largely eliminated that strategy, requiring funds in an inherited IRA to be distributed by the end of the 10th year following the original owner’s death.
This does not necessarily mean inherited IRAs should be ruled out completely. It might be one of your largest assets, so it might be a sizable gift to leave to another generation. However, due to the 10-year rule (and the complexity of estate planning more broadly), it makes sense to meet with a financial advisor before you decide if passing an IRA to a beneficiary is the right move for you.
Tips for Estate Planning
- If you have an IRA you want to pass to a minor beneficiary, it can be challenging to know how to go about it. Working with a financial advisor can be useful as they can help you put together a strategy to keep your loved ones financially secure. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Remember that there are tax implications that come with distributed money from an inherited IRA unless it is a Roth IRA. To estimate how much tax will be assessed on the account’s earnings, use SmartAsset’s capital gains tax calculator.
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