Selecting beneficiaries for your estate plan can sometimes revolve around their ages at the time that the estate plan is created. While there are many different kinds of assets, from real estate to cars to investment accounts, there are some assets that are better suited to minors than others.
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 long-term 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. Young beneficiaries also get the benefit of a lower required minimum distribution (RMD) over their lifetimes, as the beneficiary’s life expectancy is used when calculating their RMDs.
For example, if you died and left $100,000 of IRA money to a one-year-old granddaughter this year, her current life expectancy would be 81.6 years. Assuming that the funds in the account grow at 8% to 10% per year, she could withdraw several million dollars from the account during her lifetime. If the money were in a Roth IRA, she’d probably also save at least a million dollars in taxes.
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.
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 revocable living trust is a good option for leaving a minor an IRA. You are able to provide very specific directions as to how you want the beneficiary to receive distributions, and the guardian can serve as the trustee.
As you can see, there are many different options. Speak with an estate planning attorney to determine what the best solution is for your family and to ensure that the plan for this asset works with the rest of your estate plan.
Reference: Investopedia (September 7, 2019) “Designating a Minor as an IRA Beneficiary”