The beneficiary designated on a Roth IRA will inherit the assets in the account regardless of what the decedent’s will says. In some cases, the beneficiary of the IRA is a minor under the age of 18. Minors cannot legally own financial assets, so certain rules must be followed to transfer the plan correctly.
Inheriting a Roth IRA
Beneficiaries of a Roth IRA must begin taking out distributions starting in the year after the plan is inherited. A beneficiary other than a spouse cannot become the owner of the IRA or transfer the assets into his own plan. When a minor inherits a Roth IRA, he will have full access to the plan when he turns 18 unless measures are taken to protect the funds.
A minor beneficiary of a Roth IRA must have his legal guardian control the fund until the beneficiary becomes of age. It is the guardian's responsibility to ensure that the required minimum distributions are taken. These distributions can then be put into a 529 or other tax-advantaged college fund if they are not needed by the beneficiary. Once he turns 18 and takes a job, he can set up his own IRA and make contributions using the distributions from the inherited IRA.
Required Minimum Distributions
The Internal Revenue Service sets the required minimum distributions (RMDs) on Roth IRAs. Minor beneficiaries are allowed to use their estimated lifespan to calculate withdrawals. IRS Publication 590 contains the chart used to calculate RMDs. For example, if the inherited plan is valued at $50,000 and the minor beneficiary is age 6 in the year after the inheritance, his life expectancy according to the IRS chart is 76.7 years. This means that the required annual distributions from the IRA will be $50,000 divided by 76.7, which is $652. These distributions are not taxable.
Setting Up a Trust
One of the main drawbacks of designating a minor as an IRA beneficiary is that the child will have full access to all the funds when he turns 18 – an age when he might not act responsibly with a large sum of money. One way to solve this while the IRA owner is still alive is to set up a revocable trust and make the trust the trustee of the funds. The trust documents then dictate when the beneficiary receives the money and how much. Trusts should always be set up with the assistance of an experienced tax attorney or CPA to ensure that all tax implications have been contemplated.
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