United States: Minor Children And IRA/401Ks Beneficiary Designations: Dangers And Concerns

Last Updated: July 21 2015
Article by Michael S. Goode

As a parent, one of the most difficult issues that I have had to deal with is what would happen to our young child should anything happen to my wife and I.  No one likes to contemplate their own mortality or the idea of not being there to watch their children grow up.  Unfortunately, mortality is inescapable, and proper planning is essential. Often people think that once they have their Will done everything will be settled. This is rarely the case.

The first concept to understand is probate versus non probate in terms of assets. Assets owned directly by you, and that do not have a beneficiary designation, will generally be in your probate estate. This means your Will would be able to direct where your assets go. For accounts with beneficiary designations, such as IRAs, 401Ks, life insurance, certain banks accounts (joint with survivorship or pay on death or transfer on death designations), certain financial accounts (with named beneficiaries), and even some real property (joint with survivorship, etc.) might all pass outside of probate. Your Will would have no effect whatsoever on how these non-probate items are distributed. Instead, those non-probate items would be distributed in accordance with the various beneficiary designations, regardless of what is written in your Will. Since these items could make up the majority of your estate, it is important to plan properly.

One idea that many people have is to simply name their estate as the beneficiary and therefore have those assets come under control of the Will. Naming the estate as the beneficiary, however, can be disastrous for qualified plans (IRAs, 401Ks, etc.), as such designations generally have adverse tax consequences and may have adverse asset protection consequences.

What happens if assets go directly to a minor child? Generally, if it is more than a certain amount (as determined by the states, usually about $15,000 to $20,000), the parent/guardian would not be able to simply hold the child's assets, and a conservatorship would have to be obtained. Until the child reaches age 18, the conservator would have to be bonded (which can be expensive), and the court would be involved in determining how the money is spent. Upon reaching age 18, the child would get the full value of the assets. For most families conservatorships should be avoided through proper planning.

One solution is to have the minor named as beneficiary pursuant to one of the uniform transfers to minor's acts of the various states. The downside to this designation is that not all qualified plans allow for this designation, and there is little flexibility, as the child will get everything remaining at age 21, which may not be what is desired.

Another solution is to create a trust, and have the trust be the beneficiary of the funds. The trust can be created either as a stand-alone document, or created via the Will as a testamentary trust. Great care should be taken in the creation of this trust.

If the deceased dies after their Required Beginning Date for Minimum Required Distributions (April 1 of the year following the year in which the deceased turned 70 ½) than any Required Minimum Distributions from the qualified plans (IRAs, 401Ks, etc.) would be based upon that decedent's life expectancy, unless the trust properly sets forth a Designated Beneficiary or Beneficiaries (which would generally be your children). If a proper Designated Beneficiary is set up, then the distributions would be based on the longer of the oldest beneficiaries life expectancy or the deceased's life expectancy. It may be beneficial, especially if there is a lot of difference in age between the children, to set up multiple trusts each with a different Designated Beneficiary (i.e. child) so that the stretch-out of the payments isn't limited to the lifespan of the oldest child. If the deceased dies before their Required Beginning Date and there is no Designated Beneficiary, then the entire balance of the account must be distributed within five years of the date of the deceased's death, which is a terrible result. The longer the distributions can be stretched out the longer the tax is deferred (and perhaps at a lower rate as well since income taxes are on a graduated scale) and the longer tax free growth is allowed for the funds remaining in the qualified plan.

You would generally have your spouse named as primary beneficiary, and then the trust (or trusts) as contingent beneficiaries. The spouse would have the option of rolling over his or her inherited IRA into their own IRA (which would then provide asset protection once it is rolled over), and the properly drafted trust (which follows all of the rules regarding designating a beneficiary) would provide asset protection to the non-spousal beneficiaries. A recent Supreme Court case stated that inherited IRAs are not asset protected since they are not retirement accounts, and that is why the spousal rollover, and the trust for the contingent beneficiaries, is important from an asset protection standpoint (unless your state already protects inherited IRAs anyway).

The final issue to be careful of in regard to trusts for qualified plans regards accumulation of income. It may be desirable from an asset protection standpoint to accumulate the distributions in the trust. The downside to having distributions accumulate in a trust (rather than distributing annually) is that trusts are taxed at disfavorable rates. Trusts reach their maximum tax bracket at only $12,150 of income. Therefore, how and when to distribute the distributions coming into the trust from the qualified plan must be carefully considered.

As for other assets (other than from qualified plans), generally the trust can either own the asset directly or the trust can be a beneficiary. Depending upon the tax, estate planning, and asset protection objectives, these trusts can be set up in a variety of ways, and as such a qualified attorney should be consulted as to the appropriate structure depending upon the particular facts of the situation.

Hopefully this article will provide a good, brief overview of an often overlooked part of estate planning, i.e. the importance of checking all of one's beneficiary designations and checking all of one's deeds, account titles, etc., and not simply assuming that the Will can take care of everything, because often a Will might have no effect whatsoever of a great deal of a person's property.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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