Question: Can I name my 10 year old grandchild as beneficiary on my IRA?
Answer: Before the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), naming a grandchild on an IRA was an excellent planning strategy, if done correctly. The benefit of naming a much younger beneficiary was that the account could grow tax deferred over a much longer life expectancy. The rule of thumb is that the account will be worth approximately thirty (30) times its value if distributions are taken over the life expectancy of a grandchild. However, the SECURE Act eliminated this lifetime stretch for all beneficiaries except for a surviving spouse, disabled or chronically ill individual, beneficiary no more than 10 years younger than the IRA owner, or a minor child of the IRA owner (not a grandchild). By leaving the IRA to your granddaughter, she would have to take distributions on the entire balance of the IRA by the tenth anniversary of your death, the 10-year rule.
Even before the SECURE Act, you would not directly name a minor as the beneficiary of an IRA account. Since your granddaughter is not an adult, she could not own the asset. The only way to access the account is for the court to appoint a guardian for the property of the child, usually the parent. First, this is a costly and unnecessary proceeding. But the result is even worse. The Court would direct the Guardian to distribute the entire IRA and pay the income tax on it within ten years. If your granddaughter was not yet 18, the income tax would be based upon her parents’ income. In addition, the monies that are left after paying the income tax will be deposited in a bank account earning very little interest. If that isn’t bad enough, the account will be turned over to the child upon attaining the age of 18. This will obviously impact the child’s financial aid when he or she applies for college. If your granddaughter was 18 or older at the end of the 10 year rule, she would get all of the money at once – after paying the income taxes according to her tax bracket. This is a financial disaster either way.
The lesson, do not name minors as beneficiaries on IRA accounts, annuities, insurance policies, bank accounts or any other account. Any and all distributions for a minor should be distributed to a trust that is drafted for the benefit of the child. This is a common mistake and the results are costly.