Minors Owning IRAs
By Andrew Ostlund, CISP, CHSP
Can a minor own an IRA?
The IRS sets very few restrictions on owning IRAs. For a Traditional IRA, an individual need only have earned income and be under age 70½ when making contributions, whereas a Roth IRA requires earned income and caps contributions for those above certain modified adjusted gross income (MAGI) thresholds. Child actors, models, minors who do lawn care, etc., may have the earned income that makes them eligible to contribute to an IRA.
The challenging aspect of a minor owning an IRA is the contractual nature of an IRA. To open an IRA, an individual must execute a plan agreement, which is the legal contract between the IRA owner and the financial organization. State laws generally restrict minors from entering into contracts. To overcome this challenge, many states require a parent or guardian to co-sign the IRA application. The parent or guardian then makes decisions about the IRA until the minor reaches the age of majority, which varies from state to state.
Why would a minor want to own an IRA?
If the minor is eligible to contribute even $2,400 a year from age 5 to age 60 (for example), the results can be enormous. Considering the time value of money, contributing $200 each month ($2,400 annually), with 7 percent growth, equals $1,382,229.00 by age 60. Taking it a step further, if we invest the 2019 annual contribution amount of $500 a month ($6,000 annually) at a rate of 7 percent, the minor will have $3,455,572.00 at age 60. And if these amounts were contributed to a Roth IRA all the money would come out tax free.
Not all minors have the ability to contribute to an IRA, but if they have the option to start saving early, Traditional and Roth IRAs are smart choices for long-term, tax-deferred growth.
Can a minor inherit an IRA? If so, are there any special distribution options for minors?
Yes, minors can and do inherit IRAs. If the plan agreement lists the minor as the beneficiary, then the minor truly inherits the assets. Financial organizations will need to look at what type of IRA the minor inherited and when the IRA owner died. More specifically, for a Traditional IRA, look to see if the IRA owner died before or after his required beginning date (RBD) for receiving required minimum distributions (RMDs), which is April 1 following the IRA owner’s 70½ year. Roth IRA owners are considered to have died before the RBD because Roth IRA owners do not have an RBD.
If the IRA owner died before the RBD, the minor can elect to distribute her portion
as a lump sum,
according to the five-year rule, or
as nonrecalculated life expectancy payments that must begin by December 31 of the year following the year of the IRA owner’s death. (These life expectancy payments are minimums; more can voluntarily be taken.)
If the IRA owner died after the RBD, the minor can elect to distribute her portion as a lump sum or over the beneficiary’s nonrecalculated (reduced-by-one) life expectancy.
Keep in mind that the first few years of life expectancy payments would not be very large because the minor is young. As an example, a 5-year-old inheriting a $100,000 IRA in 2018 would have a first year life expectancy factor of 76.7 (assuming the attained age in 2019 is 6). That means that the first payment, due in 2019, would be $1,303.78, or about 1.3 percent of the IRA.