Problems With Naming a Minor Your IRA Beneficiary

We’ve discussed the fantastic benefits that can be realized over time by naming a very young person as the beneficiary of your IRA (see “How To Turn $5,000 A Year Into a $33 Million Legacy” for details).  This makes for a very elegant, clean tax-planning exercise; but in reality, a minor cannot legally hold assets such as retirement accounts.  It’s a standard legal principle that individuals are not allowed to take title to assets until they are of legal majority, which is generally 18 or 21 years of age.

So what’s a budding legacy-builder to do?

A Trusted Alternative

Without a doubt the simplest way to resolve this is to name a trust as the beneficiary of the IRA, and then name the minor beneficiary of the trust.  The trust can receive the IRA and the trustee ensure that the RMDs are properly distributed.

Once distributed, since the beneficiary is a minor, the trustee has to figure out what to do with the money.  One answer to that question is to place the funds in a minor trust – a standard form of which is known as a Uniform Transfers to Minors Act (UTMA) trust.  The same trustee (or a different one, if you wish) can be the trustee of the UTMA account, making sure that the funds placed there are invested wisely on behalf of the minor.

Then when the minor reaches majority age (18 or 21, depends upon the state), the account can be transferred to the control of the original beneficiary of the IRA.  The same can be done with the trust receiving the IRA as beneficiary – the trust can terminate and the (former minor) beneficiary can continue receiving RMDs from the IRA over his lifetime.

A Key – Timing of These Arrangements

It’s vitally important to wring out all of these details prior to the death of the original IRA owner – since the beneficiary designation can’t be changed after she passes away.  If a trust isn’t set up to receive the inheritance on behalf of the minor, it’s quite possible that the resolution would be for the courts to appoint a guardian over the account on the minor’s behalf.  This could be one of the minor’s parents – but then again it might not.

Regardless, this guardianship would introduce a great deal of complexity to the situation, as the court would no doubt want control and oversight into the investment and distribution activities on the account.  Talk about time consuming, expensing, and intrusive!  What a mess.

By taking the time to straighten out these details in advance, you can rest assured that your heirs will be able to enjoy the fruits of your labors for many years to come – without a lot of stress and headaches.

Parting Comments

It should be noted that in the case of a smaller IRA – say, less than $50,000 – it would be cost prohibitive to establish and maintain a trust.  In such a case, the beneficiary designation could be to a custodian for the benefit of the minor under the UTMA rules until the beneficiary reaches the age of majority.  It’s important to make sure that you name successor custodians in such cases, since it’s possible that the original custodian may not be available to act as custodian.

Another factor to keep in mind is that you should address these matters on behalf of ALL beneficiaries for the account – primary and successor – who are minors.  Remember that the reason you name a successor beneficiary is because of the possibility that the primary beneficiary might predecease you.  With that thought in mind, make the same arrangements for your successor beneficiaries as you would for your primary beneficiaries.

Photo by Dudley Carr

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 Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 25 years of experience in the industry. Read more from this author