There are many ways to give assets to those for whom you wish to leave a legacy. You can leave tangible assets such as cars, houses or other belongings, or liquid assets such as cash or securities. But the age of the person to whom you leave these assets will often determine the form of, and conditions under which, they receive the property. One special case to consider is the ramifications of leaving one or more of your individual retirement accounts (IRAs) to a minor. Here are some of the advantages and potential pitfalls of this strategy.

Why Choose a Minor as an IRA Beneficiary?
There are several reasons why a donor might choose to bestow an IRA upon a beneficiary who has not yet attained the age of majority. One of the most obvious is that because IRAs are self-directed, they can provide much greater flexibility and potential for long-term growth than, for example, savings bonds. IRAs do not have to be used for higher education or any other specific purpose in order to escape taxation. More importantly, young beneficiaries get the benefit of a lower required minimum distribution (RMD) over their lives. This is because the life expectancy of the beneficiary 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 money in the account grows at 8-10% per year, she could withdraw several million dollars from the account over her life. Of course, if the money is inside a Roth IRA, she would probably save at least a million dollars in taxes as well. (For more, read our Roth IRAs Tutorial and our Traditional IRA Tutorial.)

Problems with Minor Ownership
Common law dictates that certain legal measures must be taken to protect minors in these circumstances. Minors cannot own legal property of any kind in their name; a guardian must be appointed to manage the property on their behalf until they reach the age of majority. Appointing a guardian is your responsibility; if you do not do this, then the court will appoint one for you - one who may have very different ideas about how the account should be managed and invested.

There is no escaping this appointment since the law prohibits IRA custodians from dealing directly with minors in any capacity. A will alone will not rectify this problem for you because wills only deal with probatable assets, and IRAs are exempt from probate. One of the minor's parents or another relative can petition the court for guardianship if you don't appoint one, but this can be costly, time-consuming and in the end, it is totally unnecessary. It can also become a protracted legal battle if the minor's parents have divorced and both seek custody of the account. (Read more in our related article Tax Treatment Of Roth IRA Distributions.)

Find the Solution That's Right For You
There are a few alternatives that you can have your guardian implement once your beneficiary receives the IRA. One is to put the distributions inside a custodial account such as an UGMA or UTMA. However, this could have adverse tax consequences for the minor's parents (or whoever claims the minor as a dependent on their tax return). If the minor's income is above a certain level, then 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 - an age at which they may not be ready to handle a large sum of money.

Another possible solution is to put the money into a 529 plan, which allows the assets to grow tax-free until they are used to pay for higher education expenses. However, if the minor decides not to pursue a college education, then this plan can also backfire.

A more comprehensive (albeit expensive) solution may be to substitute a revocable living trust as the beneficiary for the IRA, with the minor as the beneficiary for the trust. The guardian would then be appointed as the trustee. The trust will allow you to provide specific instructions as to how you want the guardian to handle the IRA distributions for the minor.

There are several types of trusts that you can use to this end. A "conduit" trust would siphon the distributions directly from the IRA to the minor so that the trust is not taxed (a situation you want to avoid whenever possible, as trust tax rates are currently among the highest in existence). If the minor has special needs, an accumulation trust may be appropriate. Although this arrangement does keep the money inside the trust to be taxed at higher trust rates, it also ensures that the money will be used for the minor's benefit, conceivably even after he or she reaches adulthood. (Learn more in our related articles Problematic Beneficiary Designations - Part 1 and Part 2.)

The Bottom Line
There are several alternatives to choose from if you wish to leave your IRA to a minor beneficiary. Check with your IRA custodian to see what their requirements are regarding this matter. If your wishes cannot be fulfilled through mere beneficiary designations or guardian appointments, then consider using a trust to ensure that the minor receives the IRA distributions in the manner you specify.

Related Articles
  1. Savings

    6 Ways to Save Money on Back-to-School Stuff

    Those school-supply lists just keep getting longer each year. Here's how to shop smart.
  2. Insurance

    Who is a Beneficiary?

    A beneficiary is a person or entity that receives funds, assets, property or other benefits from a trust, will, or life insurance policy.
  3. Professionals

    How to Protect Elderly Clients from Predators

    Advisors dealing with older clients face a specific set of difficulties. Here's how to help protect them.
  4. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  5. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  6. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  7. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  8. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
  9. Professionals

    Top Social Security Issues for Divorced Women

    What female divorcees need to know about the twists and turns of figuring out Social Security benefits.
  10. Taxes

    How to Tell if You Need an Estate Planning Lawyer

    Estate planning is an important and often neglected part of financial planning, which can be costly when avoided or done improperly.
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. Wealth Management

    A high-level professional service that combines financial/investment ...
  3. See-Through Trust

    A trust that is treated as the beneficiary of an individual retirement ...
  4. Settlor

    The entity that establishes a trust. The settlor also goes by ...
  5. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  6. Personal Representative

    The executor or administrator for the estate of a deceased person. ...
  1. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>
  3. Can I use my IRA to pay for my college loans?

    If you are older than 59.5 and have been contributing to your IRA for more than five years, you may withdraw funds to pay ... Read Full Answer >>
  4. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  5. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  6. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!