What Should You Do with Your Retirement Account When You Have a Minor Child?

Your retirement accounts may be one of the most valuable things you own. As is common, you may consider naming your children as beneficiary on such an account in case something happens to you. However, if you have minor children, there are some factors that make this type of transfer more complicated than you may think.

Can a Minor Be Named Individually as a Beneficiary?
Yes, you can name your minor child as the primary or contingent beneficiary of your retirement account. However, if your child is still a minor when you die, they cannot yet take title to the account or distributions from it. A probate court may have to appoint a conservator to handle any money distributed to the child from the account. If the court is required to name a conservator, the resulting process will take time and money, and the conservator the court chooses may not be the person you would have chosen. There are ways to prevent this unwanted result.

The Secure Act
Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, most beneficiaries must receive an entire retirement account within ten years of the account owner’s death. However, minor children of an account owner fall into a special category of beneficiaries called eligible designated beneficiaries or EDBs. Their mandatory ten-year payout period does not begin until they turn twenty-one, meaning the beneficiary must receive an entire inherited retirement account at age thirty-one. In the meantime, however, they are required to take required minimum distributions (RMDs), which will likely be held in a protected account overseen by their conservator, until they reach the age of majority in the state they live in (age eighteen in Michigan, up to age twenty-one in some states). RMDs for these EDBs are calculated based upon the child’s age and expected lifetime, and they must take them until the end of the calendar year that they turn thirty-one, at which time the retirement account must be fully distributed. The beneficiary must pay income taxes on any amounts distributed to them. This is usually favorable because the RMDs up until the year they turn thirty-one can be made in smaller amounts because of the long life expectancy of a minor and because they will likely be in a low tax bracket. However, the account must be emptied by the end of the calendar year in which the child turns thirty-one. Depending upon the size of the account, this could mean that the child will receive a large amount of taxable income at a relatively young age. In addition to the potential tax liability, one of the disadvantages of naming a minor child as the beneficiary of your account is that when they reach the age of majority, they will gain complete control of the funds and could choose to pull everything out of the retirement account right away, regardless of whether they are mature enough to handle that responsibility.

Should You Name a Trust as a Beneficiary of the Retirement Account and Your Child as the Beneficiary of the Trust?
Another option is to create a trust for your child and to name the trust as the beneficiary of your retirement account. A comprehensive trust can be established as what is often called a “see-through trust” that meets specific requirements under the law and allows the applicable beneficiaries of the trust to be treated as the beneficiary 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 be distributed to the child (or used for the child’s benefit) as soon as the trust receives it. Assets remaining in the trust receive beneficial asset protection and tax deferral. In addition, the terms of the trust can ensure that once the child reaches the age of majority, they will not be able to simply withdraw the entire balance remaining in the retirement account all at once. Also, the trustee can 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. Although the remaining balance must still be fully distributed to the child by the end of the calendar year in which the child turns thirty-one, until that time, the conduit trust will provide asset protection, tax deferral, and additional time for your child to mature and learn how to handle the money responsibly before receiving a potentially large sum of money.

Accumulation Trust
An accumulation trust, unlike a conduit trust, provides the trustee with the discretion to decide whether to pay out the RMDs from the retirement account to the child, or for their benefit, 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 and remain protected from claims made by outside creditors. An accumulation trust will enable you to ensure 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 at the age of majority. 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. Some tax considerations result, as any funds retained by the trust, instead of distributed to your child, will be taxed at trust tax rates which would likely be higher than the individual beneficiary’s tax rates.

We Can Help
There are pros and cons for the various options available, and the one that is best for you and your child will depend on your unique circumstances and goals. We can help you think through whether asset protection, tax minimization, or other goals should be your priority. If you already have made your minor child a beneficiary of your retirement account or have set up a trust as the beneficiary of your retirement plan for the benefit of your children, it is important to review and update your beneficiary designations and your trust if needed. Some recent changes in the rules that govern these important accounts will have a big impact on when the funds must be distributed—and may necessitate a change in your plan. Please call us to schedule an appointment so we can help you think through the best plan for your retirement accounts, as well as any other estate planning concerns.