When it comes to estate planning, one of the crucial aspects to consider is what will happen to your retirement account. Many individuals opt to name their children as beneficiaries of these accounts, assuming it will simplify the transfer of their wealth in the event of their passing. However, there are several factors that make this type of transfer more complex, especially when the designated beneficiary is a minor.
Can a Minor Be Named as a Beneficiary?
Certainly, you can name your minor child as the beneficiary of your retirement account or as a contingent beneficiary who would receive the account if the primary beneficiary predeceases you. However, if your child is a minor at the time of your passing and inherits the retirement account, a court might need to appoint a guardian or conservator to manage the funds on behalf of the child. This process can be time-consuming, expensive, and may result in the court appointing someone other than your preferred choice. To avoid this, it is advisable to proactively name a conservator or guardian for your minor child in your will.
Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, most beneficiaries are required to receive the entire retirement account within ten years of the account owner’s death. However, minor children of the account owner fall into a special category called eligible designated beneficiaries (EDBs). Their mandatory ten-year payout period does not begin until they turn twenty-one, meaning they must receive the full inherited retirement account by age thirty-one. During this time, they are obligated to take required minimum distributions (RMDs), which will typically be held in a protected account managed by their guardian or conservator, until they reach the age of majority in their state of residence (usually between eighteen and twenty-one years old). RMDs for EDBs are calculated based on the child’s expected lifetime, and they must continue taking these distributions until the end of the calendar year in which they turn thirty-one, after which the retirement account must be fully distributed. It’s important to note that the child will be subject to income taxes on any distributed amounts. This approach is generally favorable because the RMDs, up until the year the child turns thirty-one, can be made in smaller amounts due to the child’s long life expectancy and lower tax bracket. However, the account must be emptied by the end of the calendar year in which the child turns thirty-one. Depending on the account size, this could mean the child receives a significant taxable income at a relatively young age. Additionally, one disadvantage of naming a minor child as the account beneficiary is that once they reach the age of majority, which could be as young as eighteen in some states, they will gain complete control over the funds and may choose to withdraw the entire balance immediately, regardless of their maturity level.
Should You Name a Trust as the Beneficiary Instead?
Another option to consider is creating a trust for your child and naming the trust as the beneficiary of your retirement account, with your child being the beneficiary of the trust. This approach can work for see-through trusts that meet specific criteria under the law, allowing the applicable trust beneficiaries to be treated as the beneficiary of your retirement account. There are two types of see-through trusts to consider: conduit trusts and accumulation trusts.
Conduit Trust:
A conduit trust requires that all RMDs from the retirement account be distributed to the child or used for their benefit as soon as the trust receives them. The trust will provide asset protection and tax deferral for the remaining funds in the retirement account. Moreover, the trust’s terms can ensure that once the child reaches the age of majority, they cannot immediately withdraw the entire remaining balance from the retirement account. The trustee may also have discretion to withdraw funds from the retirement account, in addition to the RMDs, which would then be distributed to or for the benefit of the child. However, these decisions regarding additional withdrawals would be made by the trustee, not the child. Although the remaining balance must still be fully distributed to the child by the end of the calendar year in which they turn thirty-one, a conduit trust offers asset protection, tax deferral, and additional time for the child to mature and learn responsible money management before receiving a potentially large sum.
Accumulation Trust:
In contrast to a conduit trust, an accumulation trust grants the trustee discretion to decide whether to distribute the RMDs from the retirement account to the child or retain the funds in the trust. Consequently, the funds distributed from the retirement account to the trust can remain in the trust, potentially protected from claims by external creditors. An accumulation trust enables you to ensure that the funds are not distributed to your child earlier than necessary or desired, and that your child does not gain access to the entire amount in the retirement account as early as eighteen. However, the funds must still be fully withdrawn from the retirement account by the end of the calendar year in which your child turns thirty-one. Any funds retained by the trust instead of being distributed to the child will be subject to the higher tax rates applicable to trusts, rather than the likely lower rate applicable to your child.
We Can Help
Each option has its own advantages and disadvantages, and the best choice for you and your child will depend on your specific circumstances and goals. The attorneys at Celaya Law can assist you in determining whether asset protection, tax minimization, or other objectives should be your priority. If you have already named your minor child as a beneficiary of your retirement account or established a trust as the beneficiary of your retirement plan for your children’s benefit, it’s crucial to review and update your beneficiary designations and trust as necessary. Recent changes in the rules governing these accounts can significantly impact the distribution timeline and may necessitate adjustments to your plan. Please contact us to schedule an appointment, and we will help you develop the best strategy for your retirement accounts and address any other estate planning concerns you may have.