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Should we name minor children or trust as beneficiary for 401k/IRA?

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  • Should we name minor children or trust as beneficiary for 401k/IRA?

    Is it better to name minor children directly or name a revocable trust as a beneficiary for retirement accounts post SECURE act?

    My attorney says it is better to name the children directly to avoid trust tax. The one disadvantage is that the children will inherit the funds at age 18 vs. 30 if it went through the trust.

  • #2
    Not a lawyer, but I do not believe minor children can inherit directly.


    • #3
      Originally posted by Larry Ragman View Post
      Not a lawyer, but I do not believe minor children can inherit directly.
      Not an attorney, but you need to get CPA and legal advice. Will, retirement accounts and revocable trust can easily work together. The age of the kids, guardian and trustee are much more important. Regardless, the IRA will need to be cleaned out by 28, 10 years after the age of 18.

      "Minors can't inherit an IRA outright
      The age of majority generally ranges from 18 to 21, depending on the state of residence. So in your case, while your oldest grandchild might be able to inherit money directly, you should strongly consider establishing a custodian, typically the minor’s legal guardian, for the three younger ones. The custodian would manage the money until the child reached his or her state’s recognized age of adulthood. At that time, the child would have complete access to the funds. If you don't designate a custodian, the child’s parent would have to ask the Probate Court to assign a property guardian. To avoid this complication, it would be best to name a custodian (often a parent) as part of your beneficiary designation.

      Another option is to set up a trust. This requires a bit more expense and time (you will need to work with an estate planning attorney), but it will give you more control over how and when the money can be used. For instance, while you might be thinking the inheritance would be used for education or a down payment on a house, a young beneficiary might be more tempted to buy a fancy car. To me, the choice of a trust depends on how much money you're talking about and how concerned you are about your grandchildren handling their inheritance responsibly.
      Grandchildren generally won’t be subject to RMDsbut they will have to distribute the assets within 10 years

      Prior to the passage of the SECURE Act that became effective as of January 1, 2020, most heirs used to be able to distribute Inherited IRA assets over the course of their lifetime—with the caveat that they had to take RMDs. However, under the new law, only certain types of beneficiaries have this option, and grandchildren are not one of them (unless they are disabled or chronically ill).

      Grandchildren generally fall under the category of ‘Designated Beneficiary,’ which means that they can distribute the assets however they like, without RMDs each year—as long as all assets are distributed within 10 years. In other words, your grandchildren can take some assets out each year or just leave all the assets in the account until the last day. However, any assets that are not distributed by the end of the 10th year will be subject to a 50% penalty.

      How the assets are distributed within that timeframe could have important tax considerations, so it’s best to consult with a tax advisor. Because of the SECURE Act rules, if you are married, in some cases it may make more sense to name your spouse as the designated beneficiary to take advantage of spreading the distribution over his or her lifetime and then they can name your grandchildren as beneficiaries."


      • #4
        You should never name a minor as a direct beneficiary of any financial account. If you don't use a trust, you should at least use a UTMA (UGMA in SC).

        In the majority of states the age of termination can be up to age 21 and in ten states the age can be up to age 25. If I lived in SC, SD and KY where the UGMA/UTMA age of termination was 18. I would always use a trust.

        Financial assets left directly to a minor will require a property guardian to be appointed and supervised by the court. In many states this oversight can be burdensome including control of investment decisions. Not to mention the minor receives full control at age of majority. This is 18 in almost all states.

        Minor direct inheritance is a very bad idea all the way around.

        Finally, this CPA doesn't have a clue about trust taxation. A properly constructed discretionary trust can control distributions.

        This can allow the trustee to decide how much taxable income to retain in the trust or distribute to the child. Only the former will be taxable to the trust and the latter to the child. Then there is the Kiddie Tax.

        ​​​​​​How can a CPA not know that one of the fundamental purposes of a trust of a child can be optimal taxation. Oh wait, we see time and again where "some" CPAs don't have a clue on optimal small business entity selection and/or optimal small business employer retirement plan selection. No disrespect intended to the many great WCI forum financial professionals.
        Last edited by spiritrider; 10-27-2020, 06:13 PM.


        • #5
          We are setting up a living trust. So if we setup a discretionary trust where the trustee can decide whether to hold 401k/IRA distributions in the trust or give them to the children and make that trust the contingent beneficiary of the 401k/IRA, would that work well?


          • #6
            Yes, provided:
            • the trust is designed to meet the IRS pass thru requirements for inherited retirement accounts.
            • the trustee is knowledgeable about trust/beneficiary taxation or will enagage competent finance/tax professionals. This includes any Kiddie Tax considerations.


            • #7
              The other part of the Trust tax rate vs beneficiary tax rate is asset protection. If the $ is kept in the trust then there will be excellent asset protection against future creditors (think malpractice award, divorce, etc), however will be taxed at trust rates (accumulation trust). If the $ is distributed to the beneficiary directly out of the Trust (conduit trust) then the tax rates are at their personal rate but with no asset protection after distribution. Setting up a trust that allows the path to be decided down the line is likely the best approach. The SECURE Act made this a more difficult decision due to the need to move money out of the tax-deferred account over 10 years instead of over a lifetime. The amount of money in the account would certainly affect this decision.


              • #8
                It might depend on what state you're in and how much money is in the accounts, but most likely, you should be having a careful discussion with a good estate planner who can help you determine whether it's best to set up a trust with conduit trust provisions so you can avoid the downsides of naming a trust as beneficiary. It shouldn't be too much extra expense, at least to set up. Even though the money could also be taxed at higher rates, it's well worth it, rather than giving a 20 year old unfettered access to a large account.


                • #9
                  spiritrider - with the SECURE Act a Trust’s ability to ‘optimize’ taxation for a child is severely limited as the trust does not change the 10-year rule. Trusts also have become a risk management tool for the kids (liability, spending habits & litigation/divorce protection) rather than a tax-management strategy due to the higher lifetime exemption for estate taxes. Inherently, a child as a low-to-no income earner presents an advantageous opportunity from a tax perspective but may not be so advantageous from a spendthrift or liability (current or future around ages 18-21) standpoint.

                  An UTMA or UGMA will not do any more than having the minor child as a beneficiary. Your will can provide direction for the guardianship of the accounts for your minor children (just as you’d need a custodian on the UTMA/UGMA) and once at your states age of majority both the outright beneficiary designation as well as the UTMA/UGMA become full property of the child. Only, in converting retirement assets to UTMA/UGMA you are setting a fire with the taxes upon that lump-sum conversion with zero additional protection.

                  The accumulation trust can allow more discretion on Roth assets to higher income beneficiaries vs traditional ones to lower income beneficiaries and some retention etc within the Secure Act’s guidelines.

                  notanotherusername - Its also worth noting that creditor & spendthrift protection leaves upon the trusts direct payments to the beneficiary (necessary in both the conduit & accumulation trusts to avoid trust tax rates). Therefore, many of the “old” benefits that trusts could provide to these retirement funds is relatively phased-out. Using vehicles like CRTs, ILITs, Roth Conversion strategies and spousal/child splits have been ways to manage the burden/tax drain and create some roads to protection (e.g. Roth funds converting/holding in the trust).

                  Tim grandchildren are NOT exempt (only minor children of the account holder) and therefore do not even get a deferral until age of majority to start the 10 year period.
                  Founder, Coastal Wealth Planners- Fiduciary Tax-Sensitive Retirement Planning & Wealth Management email: [email protected]