Can a Pension Be Passed On to a Child?

Pensions represent a significant component of many individuals’ financial planning, designed to provide income during retirement. The ability to pass on a pension depends largely on the type of pension plan and the specific beneficiary designations made by the account holder. Understanding the distinct characteristics of different pension structures is important to determine how these assets can be distributed after the original owner’s death.

Pension Structures and Beneficiary Rules

Pension plans are broadly categorized into two main types: Defined Benefit (DB) plans and Defined Contribution (DC) plans. These structures have different rules governing how benefits are paid out and whether they can be passed on to beneficiaries, including children.

Defined Benefit plans typically provide a fixed income stream in retirement, often based on factors such as salary and years of service. Some Defined Benefit plans may offer survivor benefits to children, particularly if they are under a certain age, such as 18 or 21, or if they are full-time students, sometimes up to age 23. The benefits for a child from a Defined Benefit plan might be a continued annuity or a lump-sum payout, depending on the plan’s provisions.

Defined Contribution plans, which include 401(k)s, 403(b)s, and Individual Retirement Accounts (IRAs), hold an account balance that can fluctuate with investment performance. These plans generally offer more flexibility in designating beneficiaries, as they represent an accumulated fund rather than a guaranteed income stream. Account holders name primary and contingent beneficiaries for these plans. For qualified plans like 401(k)s, spousal consent is often required to designate a non-spouse beneficiary if the account holder is married.

Inheriting as a Child Beneficiary

When a child is designated as a beneficiary of a pension or retirement account, there are specific steps and options involved in claiming the inherited funds. The process typically begins with notifying the plan administrator or financial institution of the account holder’s death and providing necessary documentation, such as a death certificate. The type of pension plan will largely dictate the available avenues for the child to receive the inheritance.

For Defined Benefit plans, if the plan allows for child beneficiaries, the child might receive a continued annuity, a reduced annuity, or a lump-sum payment, all subject to the plan’s specific rules. Some Defined Benefit plans may pay benefits to children only until they reach a certain age, such as 21 or 23, or if they are disabled.

For Defined Contribution plans, including IRAs, a child beneficiary generally has more options for receiving the funds. One option is to take a lump-sum distribution of the entire account balance. Another common strategy is to roll the assets into an “inherited IRA” or “beneficiary IRA”. This allows the funds to remain in a tax-deferred account, though it comes with specific distribution rules that differ from those for the original account owner. A minor child cannot directly own an inherited IRA; a custodian must be appointed to manage the account until the child reaches the age of majority.

Taxation of Inherited Pensions

The taxation of inherited pensions and retirement accounts is an important consideration for child beneficiaries. Distributions from inherited pre-tax retirement accounts are generally taxable as ordinary income to the child.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in 2019, altered the distribution rules for most non-spouse beneficiaries, including children. For deaths after 2019, the majority of non-spouse beneficiaries are subject to the “10-year rule”. This rule generally requires that the entire inherited account balance be fully distributed by December 31 of the calendar year containing the 10th anniversary of the original account owner’s death.

There are exceptions to the 10-year rule for “eligible designated beneficiaries” (EDBs), which include minor children of the original account owner. A minor child who is an eligible designated beneficiary can initially stretch distributions over their own life expectancy until they reach the age of majority. Once the minor child reaches the age of majority, the 10-year rule begins, and the remaining funds in the inherited account must be fully distributed by the end of the 10th year following that birthday. If the inherited account is a Roth IRA, qualified distributions to the child beneficiary are generally tax-free, even under the 10-year rule.