A valuable feature of an Individual Retirement Account (IRA) or a Qualified Retirement Plan (401k, 403b, etc.)(QRP) is the ability to invest without incurring contemporaneous taxes on the investments held in the account. This benefit is available to both the original owner of the account and to designated beneficiaries who inherit the account after the owner’s death. For this reason and others, it is very important to name appropriate beneficiaries for an IRA or a QRP account.

The beneficiaries of an IRA or QRP often include one or more minors, who are defined under New Jersey law as individuals under the age of 18 years. There are hidden costs and risks associated with naming minors[1] as direct beneficiaries that can have substantial adverse effects on the value of the account. To address these issues and provide greater structure for your beneficiaries, a trust should be considered to hold and manage the assets for the minor’s best interest.

Minor Beneficiaries Will Likely Require a Guardian and a Bond

The first issue with designating a minor beneficiary is that the minor’s guardian will likely be required to post a bond for the account. This is the case even if the guardian is a surviving parent of the minor child. Suppose that a 12 year-old child’s parent dies after designating the child as beneficiary of a $100,000 401k account. The child’s surviving parent will be required to be appointed as guardian by the Surrogate and post a bond for the value of the account – even though the surviving parent is the child’s natural guardian.

The purpose of the bond is to protect the assets of the minor beneficiary. Certain issues affecting the minor’s account may result in a court requiring the bonding company to reimburse the minor’s account for the loss. Many minor’s accounts have no such issues and no recourse to the bond is necessary. However, the surety company providing the bond will need to be paid even if no issues arise. The cost of the bond will depend on the value of the account and the number of years for which a bond is required. In our example, the minor inherited the 401k at age 12 and the bond premium is typically paid on an annual basis for a period of 6 years (i.e. until age 18). The cost of a bond, over time, can be expensive.

If the guardian has credit or other issues, the guardian may not qualify for a bond. In these circumstances, the guardian may be required to withdraw the entire account and deposit it to the Surrogate’s Intermingled Trust Fund. This option results in the loss of any remaining tax deferral period and management of the account by the Surrogate. If the IRA or QRP is a traditional account, then the withdrawal of these funds from the account will also incur an up-front income tax obligation.

Unrestricted Access Can Have Substantial Adverse Results

The single biggest issue with designating a minor beneficiary is that the minor will have full, unrestricted access to the assets at age 18. Unless the minor beneficiary has special needs, a guardianship terminates at age 18 and the guardian is required to pay-over all of the minor’s assets. Similarly, the minor is entitled to request and receive all of the funds held by the Surrogate upon reaching age 18.

Many beneficiaries are not ready to responsibly handle valuable assets at age 18, and unrestricted access may result in losses that are regretted later. In some instances the costs of these decisions can result in expenditures that far exceed the taxes or administration costs of the account.

Trusts Can be Implemented for IRAs and QRPs

To address these issues, a trust designed to manage these assets can be designated as the beneficiary. The trust names a trustee to undertake the investment, management, and distribution functions on the minor’s behalf. The trustee will control the account for the minor’s benefit, and the trust instrument can provide for the timing and manner of distributions for the minor’s benefit – eliminating the issues associated with underage persons managing valuable assets. Unlike a guardian, the trust instrument can waive the requirement of a bond for the trustee, saving this cost and expense.

In summary, there are hidden risks and costs associated with designating minor beneficiaries to an IRA or QRP. Depending on the value of the account and the number of years for which a bond is required, the costs can be substantial. The administration and management issues posed by designating a minor as beneficiary can, in some instances, be even more concerning than the costs and administrative expenses. A trust drafted to manage IRAs and QRPs should be closely evaluated as an alternative to designating a minor beneficiary for the account.


[1] Similar issues apply to other beneficiaries who have creditor issues, an inability to manage assets, or who face divorce or addiction problems.