Take-Away: A deceased IRA owner’s minor children are eligible designated beneficiaries under the SECURE Act. That means that if the minor child is named as beneficiary of their deceased parent’s IRA, the minor child can take required minimum distributions (RMD) using their own life expectancy but only so long as they are minors. The problem is that the SECURE Act does not tell us when the child reaches majority which is the event that starts the 10-year payout rule. Hopefully the promised Regulations will answer that question.

Background: The SECURE Act created the new category of eligible designated beneficiary who are beneficiaries who are  not subject to the mandatory 10-year distribution rule. One of the categories is the minor child of the retirement account owner: “Subject to clause (ii), a child of the employee who has not reached majority (within the meaning of subparagraph (F).” [IRC 401(a)(9)(E)(ii)(II).]

  • Loss of Eligible Designated Beneficiary Status: Unlike the other categories of eligible designated beneficiaries, a child loses his or her unique status during life “as of the date the individual reaches majority, and any remainder portion of the individual’s interest to which subparagraph (H)(ii) applies shall be distributed within 10 years after such date.” [IRC 401(a)(9)(E)(iii.)]
  • Reaching Majority Ends Designated Beneficiary Status: Accordingly, a particular age or status must constitute reaching majority, with the concurrent loss of eligible designated beneficiary status for the decedent’s child. Certainty is important when this 10-year clock starts to run when you consider the 50% penalty imposed for the beneficiary’s failure to take a required minimum distribution. Missing the tenth anniversary can be very costly.

Reaching Majority Ambiguity: Several problems exist with a minor child named as beneficiary of their deceased parent’s IRA when the child reaches the age of majority.

States Define Age of Majority: Each state defines its own age of majority, most selecting age 18, but there are a couple of outliers that still use age 21 years. Using each state’s age of majority is not workable for defining when the child’s eligible designated beneficiary status is lost.

Specified Course of Education:  Back in 2004 the IRS provided a Regulation that dealt with defined benefit plans which permit the administrator of a qualified defined benefit plan to treat a child as a minor (a) for the duration of the child’s disability, if the child is disabled at the time of reaching the age of majority, (b) or until completion of a specified course of education (though no later than age 26.) [Regulation1.401(a)(9)-6, A-15.] Unfortunately, specified course of education is not defined in the Regulations. Equally important, course of education is a shifting condition or criteria for eligible designated beneficiary status.

Administrator Discretion: More to the point, the existing Regulation only permits the plan administrator of the defined benefit plan to recognize a delayed reaching majority date for a very narrow purpose. Yet we find this language reaching majority is used to implement a required minimum distribution rule, which cannot be left to the discretion of each IRA custodian to determine.

Lowest Risk ‘Rule:’ Due to this ambiguity in defining reaching majority, the fear is that each IRA custodian will opt to simply enforce an ‘age 18 for everyone’ rule to determine when to stop the child’s eligible designated beneficiary status. That flat ‘age-18’ rule would require each child beneficiary to ‘empty’ their inherited IRA by the time they attain age 28, which is often an age still too young if the child’s deceased parents had a voice in when the retirement assets should be made available to their child.

Trust for the Minor Beneficiary Child: Under the current required minimum distribution rules, the only type of trust that would quality to use a minor child’s eligible designated beneficiary status, i.e. using the child’s life expectancy to determine the required distribution amount for the year,  would be a conduit trust. [Regulation 1.401(a)(9)-5, A-7(c)(3), Examples 1 and 2.] A conduit trust must pay out to the conduit beneficiary-child all distributions that the trustee receives from the IRA. If minority status ends at age 18, at which point the trust then is forced into the SECURE Act’s 10-year payout rule, the conduit trust must withdraw all IRA benefits and distribute them to the child-beneficiary no later than age 28. Again, this is an age most parents do not want to see assets distributed from the trust to their child.

Conclusion: It would be nice if Congress picked a different age for when the 10-year payout rule would commence for a child beneficiary. For example, if Congress selected age 26, that would mean that the inherited IRA would be paid in full to the child-beneficiary no later than when the child attains age 36, which would be an age most parents would be more comfortable with (rather than end distributions at age 28 or 31.) Congress, rather than the IRS, would have to make the change to a ‘no-later-than-[age] but that would provide guidance and probably simplify what Congress intended when it placed children of the deceased retirement account owner into the category of eligible designated beneficiary.