If you’re like most parents, you want to ensure your children are taken care of financially if something happens to you. One way to do this is to leave assets to them in your retirement account. However, there are some things you need to consider before doing this. This blog post will discuss the pros and cons of leaving your retirement account to a minor child. We’ll also answer the question, “Can a minor be a beneficiary to a retirement account or life insurance policy?”

Then we’ll explore how the SECURE Act affects beneficiaries who are minors and see how to ensure children inherit your assets according to your wishes.

Can a Minor Be a Beneficiary of Retirement Accounts?

You can name a family member who is a minor as a beneficiary designation for your retirement account. You can also name them as the contingent beneficiary in case the primary beneficiary dies before you pass away.

Because of The Uniform Transfers to Minors Act (UTMA), all kinds of property, such as bonds, real estate, can transfer to minors. UTMA allows the property to go to a minor without establishing a formal trust.

However, minor beneficiaries wait to receive assets inherited from retirement plans. Instead of immediate inheritance, state law may require they receive funds through a trusted adult instead. A court may appoint a guardian or conservator to handle any money distributed to a minor child from the account.

A custodian manages property for the minor’s benefit until a certain age. Once the child reaches a specified age set by the state, the child has full control over the assets. Gifts to minors are exempt up to $15,000 a year from Federal taxes, but the minor pays taxes beyond this amount.

Also, UTMA transfer allows the gift to be taxed based on the minor’s tax rate. A downside of the UTMA is that it can reduce or make a minor ineligible for financial aid since the minor owns the property.  

There are two main drawbacks to a minor beneficiary named on your retirement accounts:

• Court processes to name a guardian or conservator take time and money from your estate assets.
• The guardian or conservator the court chooses may not be the person you would have chosen. You can avoid this by proactively naming a conservator or guardian for your minor child in your will.

The SECURE Act and Retirement Accounts

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, new laws require a quick disbursement. Most beneficiaries must receive an entire retirement account within ten years of the account owner’s death.

However, minor children fall into a special category of beneficiaries (called eligible designated beneficiaries or EDBs). Their mandatory ten-year payout period begins once they turn twenty-one. This means they must receive an entire inherited retirement account at age thirty-one.

Before they reach the payout period age, they must take required minimum distributions (RMDs). These inherited assets will likely need to stay in a protected account overseen by their personal guardian, property guardian, or conservator. 

The required minimum distributions for minors (eligible designated beneficiaries (EDBs) are based on the child’s expected lifetime. The minor’s inheritance must pay out from the retirement account until the end of the calendar year they turn thirty-one. At that time, the retirement account must fully distribute.

It is important to note that the child must pay income taxes on any amounts distributed. RMDs up until the year they turn thirty-one are smaller amounts because of the long life expectancy of a minor. They will also likely be in a low tax bracket.

However, the account must pay out fully to them by the end of the calendar year when they turn thirty-one. Depending on the size of the account, the child will receive a large amount of taxable income at a relatively young age.

In addition to potential tax liability, a disadvantage of naming a minor child as the beneficiary of your account is that they gain control of the funds at a young age. Some young adults could immediately pull everything out of the retirement account, regardless of whether they are mature enough to handle that responsibility. 

Naming a Trust as a Beneficiary of the Retirement Account With Your Child as the Beneficiary of the Trust

To act in children’s best interests, it may make more sense to consider other ways to help your minor loved ones receive benefits and other assets from your estate.

Creating a trust for your child and naming the trust as the beneficiary of your retirement account works well. This option is for see-through trusts that meet certain criteria under the law. They allow the beneficiaries of the trust to be the beneficiaries of your retirement account.

There are two types of see-through trusts you can consider: conduit trusts and accumulation trusts.

Conduit Trust

A conduit trust requires all RMDs made from the retirement account to the trust to distribute to the child (or for the child’s benefit) as soon as the trust receives it. In this way, the trustee manages educational expenses or other needs as they occur.

The trust provides asset protection and tax deferral for the funds that remain in the actual retirement account. In addition, the terms of the trust can ensure that a child cannot simply withdraw the entire balance remaining in the retirement account all at once.

The trustee can also may withdraw funds from the retirement account in addition to the RMDs, for the benefit of the child. The remaining balance must fully distribute to the child by the end of the calendar year the child turns thirty-one. Until then, the conduit trust provides asset protection, tax deferral, and additional time for your child to mature. Before receiving a potentially large sum of money, they’ve had time to learn how to handle it responsibly.

Accumulation Trust

Unlike a conduit trust, an accumulation trust gives the trustee the discretion to decide whether to pay out the RMDs to the child (or for the child’s benefit) from the retirement account or to retain the funds in the trust. As a result, the full amount of the funds distributed from the retirement account to the trust can stay in the trust. 

An accumulation trust potentially protects from claims made by outside creditors. An accumulation trust ensures that the funds are not distributed to your child sooner than necessary or desired and that the child does not gain access to the entire amount in your retirement account as young as eighteen. 

However, the child must still fully withdraw the funds from the retirement account by the end of the calendar year they turn thirty-one. At that time, any funds retained by the trust are taxed at the much higher tax rates applicable to trusts rather than the lower rate your child likely enjoyed before.

As part of an estate plan, parents and grandparents consider the minor’s life and how they may receive assets left in a retirement account. However, minors may also receive monies from life insurance benefits.

Who Do Life Insurance Proceeds Pay Out To? Can Minor Children Be Life Insurance Beneficiaries?

When you purchase a life insurance policy, you should name a beneficiary in the policy to receive the benefit when your life ends. In most cases, you cannot name minors as beneficiaries on life insurance policies. 

“Insurance companies will not pay proceeds to anyone under legal age. When a minor is a beneficiary, the money could go into a state-owned trust until the child becomes an adult or until a custodian is named.” (1)

That said, you can still name a minor or minors as beneficiaries on life insurance policies by creating a trust named in the policy. An adult trustee must manage any proceeds until the minor reaches 18 years of age.

Typically, the trustee has the discretion to disperse funds from the trust for the benefit of the minor. For example, the trustee may use funds to pay for medical expenses, educational costs, food and housing expenses or even recreation and entertainment.

Although minors can’t be named directly on life insurance policies, establishing a trust to name them as beneficiaries ensures your children will receive the benefits of your life insurance policy when you pass away.

Other Possibilities

Revocable Living Trust: A revocable living trust can be changed by you while you are living. It can hold life insurance benefits and give you lifetime access to the life insurance money for a spouse while helping prevent estate taxes and probate court. May hold bank accounts and other property also.

Family trust: A family trust makes sense if a person wants to provide financially for children, grandchildren or a disabled relative. A family trust also helps avoid probate proceedings and can provide for more than one generation of beneficiaries.

UTMA Account: UTMA accounts are custodial accounts that parents (or grandparents) can set up for minor children. These accounts are regulated by state law, meaning that the type of investments allowed and the age at which your child will gain access to the account may vary. UTMA accounts enable you to contribute money on behalf of a minor child and manage it until they reach the age of maturity.

Testamentary trust: You can create a testamentary trust in your will. It offers tax advantages, protects the assets from creditors, and can ensure that the money supports a beneficiary for as long as necessary. 

Working with an experienced estate planning attorney can help you answer the tough questions about leaving a life insurance policy or retirement account to a minor child.

We Can Help

Whether you want minor loved ones to benefit from a life insurance benefit, death benefit, uniform transfers, larger sums in a bank account, or other assets, we can help you create a plan.

When it comes to providing for minor children, the most important thing is ensuring they are taken care of even when you can’t be around. With a well-crafted estate plan, you can ensure that your minor children or grandchildren can access the funds you provide for them efficiently and effectively.

At Vail Gardner Law, we understand how important it is to ensure that minor loved ones are taken care of in the event of your death. Our experienced estate planning attorneys can help you create a plan tailored to your family’s unique needs and assist with setting up trusts and other mechanisms for providing for minor children. Contact us today to discuss your options and help you create an estate plan to give your minor children, grandchildren, or other dependents the financial security they need.