Can You Leave Your Retirement Account to Your Child?

Leaving a retirement account to a child involves navigating financial regulations and tax implications. Designating a child as a beneficiary is possible, but understanding the rules is important for effective and tax-efficient asset transfer. This process requires careful planning.

Naming a Child as a Beneficiary

Designating a child as a beneficiary for a retirement account is a fundamental step in estate planning, often superseding instructions in a will. This direct designation helps ensure retirement assets pass to the intended recipient without undergoing the lengthy probate process.

Designating a beneficiary involves contacting the plan administrator, using an online portal, or completing forms from the financial institution. Key information includes the child’s full legal name, relationship to the account holder, date of birth, and Social Security number. Accurate details prevent complications during transfer.

Account holders can name both primary and contingent beneficiaries. A primary beneficiary is the first to receive assets upon the account holder’s death. A contingent beneficiary inherits if primary beneficiaries predecease, cannot be located, or decline. This provides a backup plan for asset distribution.

When designating multiple beneficiaries, specify how assets are divided. Options include “per stirpes” or “per capita” distributions. “Per stirpes” (by branch) ensures a predeceasing beneficiary’s share passes to their direct descendants. “Per capita” (per head) divides assets equally among surviving members of a specified class, meaning a predeceasing beneficiary’s share is redistributed among remaining living beneficiaries, not their descendants.

Regularly reviewing and updating beneficiary designations is important. Life events like births, deaths, marriages, or divorces can alter intentions and lead to unintended recipients. Current information ensures assets are distributed according to the account holder’s wishes.

Treatment of Different Retirement Accounts

Retirement accounts have distinct characteristics regarding contributions and tax treatment, influencing how they are handled upon death. Traditional Individual Retirement Accounts (IRAs) and 401(k)s involve pre-tax contributions, which may be tax-deductible. Funds grow tax-deferred, with taxes paid upon withdrawal.

Roth IRAs and Roth 401(k)s are funded with after-tax dollars. Contributions do not provide an immediate tax deduction. However, qualified withdrawals from Roth accounts in retirement are entirely tax-free, including contributions and earnings. This tax-free growth and distribution is an advantage.

Other retirement accounts, like Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs, have specific rules. SEP IRAs are used by self-employed individuals or small business owners, while SIMPLE IRAs are for small employers. These accounts follow similar tax-deferred principles to Traditional IRAs.

The beneficiary inherits the account, subject to specific rules governing inherited retirement accounts. The type of account inherited determines the tax implications and distribution options available to the child beneficiary.

Tax Implications for Child Beneficiaries

When a child inherits a retirement account, funds are held in an “inherited IRA” or “beneficiary IRA/401(k),” distinct from the original. The SECURE Act of 2019 significantly altered tax rules for inherited accounts. This eliminated the “stretch” provision, which allowed many non-spouse beneficiaries to spread distributions over their life expectancy.

For most non-spouse beneficiaries, for accounts inherited from owners who died after December 31, 2019, the SECURE Act introduced a general 10-year rule. This rule mandates the entire inherited account balance must be distributed by the tenth anniversary of the original owner’s death. This accelerates the timeline for withdrawals.

The tax treatment of withdrawals under the 10-year rule depends on the type of account inherited. For inherited Traditional IRAs or 401(k)s, withdrawals are taxed as ordinary income to the child beneficiary in the year they are taken. The amount withdrawn adds to the beneficiary’s taxable income.

In contrast, qualified withdrawals from an inherited Roth IRA or Roth 401(k) are tax-free. Since original contributions were after-tax, earnings and principal are not subject to further income tax, provided the account meets a five-year holding period. This tax-free status offers benefits to the child.

Annual Required Minimum Distributions (RMDs) present a nuance within the 10-year rule. If the original account owner died before their required beginning date (RBD) for RMDs, the child beneficiary is not required to take annual distributions during the 10-year period, only needing to deplete the account by the tenth year. However, if the original account owner died on or after their RBD, the child beneficiary must continue to take annual RMDs based on their own life expectancy for the first nine years, with the remaining balance distributed by the tenth year.

Certain categories of beneficiaries, known as “eligible designated beneficiaries,” are exempt from the standard 10-year rule and can stretch distributions over their life expectancy. These exceptions apply to specific situations, discussed in the next section.

Specific Circumstances for Inherited Accounts

The 10-year rule for inherited retirement accounts has exceptions for specific child beneficiaries. Minor children of the deceased account owner are classified as “eligible designated beneficiaries” (EDBs). For these beneficiaries, the 10-year distribution period does not begin until they reach the age of majority, commonly age 21. Until then, they can take distributions based on their life expectancy.

Managing inherited funds for a minor child often requires establishing a custodial account, like Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts. These accounts allow an adult custodian to manage assets until the child reaches majority. Once the child reaches this age, funds become accessible, and the 10-year distribution clock begins.

Children who are disabled or chronically ill are also considered EDBs under the SECURE Act. This exempts them from the 10-year rule, allowing distributions over their life expectancy. The IRS provides specific definitions for “disabled” and “chronically ill,” generally requiring inability to engage in substantial gainful activity due to physical or mental impairment, or a severe, long-term health condition.

Using a trust as a beneficiary for children can provide greater control and protection for minors, special needs beneficiaries, or those unequipped to manage a large inheritance. Naming a trust as a beneficiary introduces complexities. For a trust to qualify for beneficiary treatment and allow distributions over a life expectancy (or the 10-year rule), it must meet specific IRS requirements as a “see-through” trust.

See-through trusts must be valid under state law, become irrevocable upon the account owner’s death, and have identifiable individual beneficiaries. Documentation must be provided to the retirement account custodian. There are two main types: conduit trusts and accumulation trusts. A conduit trust requires inherited IRA distributions to pass directly to beneficiaries, taxed at their individual rates. An accumulation trust allows the trustee to retain distributions, but retained income can be subject to higher trust tax rates.

When multiple children are named as beneficiaries, the 10-year rule applies individually to each child’s separate share of the inherited account. Each child can manage their portion within the 10-year period, provided the account is split into separate inherited accounts. This allows for tailored planning for each child’s financial situation.