What Happens When A Minor Child Inherits A Retirement Account?

There are special non-spouse beneficiary rules that apply to minor children when they inherit retirement accounts.  The individual who is assigned as the custodian of the child will need to assist them in navigating the distribution strategy and tax strategy surrounding their inherited IRA or 401(k) account.  Not being aware of the rules can lead to IRS tax penalties for failure to take the required minimum distributions from the account each year.

Minor Child Rule After December 31, 2019

Congress changed the rules for minor children as beneficiaries of retirement accounts when they passed the Secure Act in 2019.  If the Minor child inherits a retirement account from someone who passes away after December 31, 2019, the minor child is subject to the new nonspouse beneficiary rules associated with the new tax law.  The new tax law creates a blend of the old “stretch rule” and the new 10-year rule for children that inherit retirement accounts.  It also matters who the child inherited the account from - a parent, or someone other than a parent. 

Minor Child Inherits Retirement Account From A Parent

If a minor child inherits a retirement account from their parents, and the parent that they inherited the account from passed away after December 31, 2019,  the minor child will need to move the 401(k) or IRA into an Inherited IRA before December 31st of the year after their parent passes away, and then begin taking annual Required minimum distributions (RMDs) from the inherited IRA each year until they reach age 21.   Once they reach age 21, they are then subject to the 10-year rule, which requires the minor to fully deplete the account within 10 years of turning age 21. 

Age of Majority is 21

Different states have different ages of majority, some 18 and others 21.  But the IRS released clarifying final regulations in July 2024, stating that for purposes of minor children moving from the annual RMD requirement to the 10-year rule would be the age of 21 regardless of the state the child lives in and regardless of whether or not the child is a student after age 18. 

Here is an example: Richard passes away in a car accident in March 2024, the sole beneficiary of his 401 (k) at work is his 10-year-old daughter, Kelly.  Kelly’s guardian would need to assist her with setting up an inherited IRA before December 31, 2025, and rollover Richard’s 401K balance into that Inherited IRA account.  Since Kelly is under the age of 21, she would be required to take annual required minimum distributions from the account, which are calculated based on her age and an IRS life expectancy table beginning in 2025. When she receives those annual RMDs for the Inherited IRA, she has to pay income tax on them, but does not incur a 10% early withdrawal penalty for being under the age of 59 1/2 since they are considered death distributes. 

Kelly will need to continue to take those RMD's each year until she reaches age 21. At age 21, she is then subject to the new 10-year rule associated with non-spouse beneficiaries which requires her to fully deplete that inherited IRA balance within 10 years of reaching the age 21. 

Tax Strategy For Inherited IRAs for Minors

The guardians of the minor child will need to assist them with the tax strategy associated with taking distributions from their inherited IRA account, since any money withdrawn from these accounts is considered taxable income to the child.  While the IRS requires the minor child to take a small distribution each year to satisfy the annual RMD requirement, they are allowed to take any amount they would like out of the inherited IRA which creates a tax planning opportunity since most children have very little taxable income, and are in very low tax brackets. 

However, distributions from inherited IRAs are considered “unearned income” subject to Kidde tax so the custodian’s of the minor’s inherited IRA have to be very careful of taking distribution above the current $2,700 amount which then triggers the Kiddie tax.

FAFSA Warning

Another factor to consider one taking distributions from a minor’s inherited IRA is the impact on their college financial aid if they are college bound after high school.  Distributions from these inherited IRA accounts are considered income of the child which is the most punitive category within the college financial aid award formula.  A child’s income, over a specific threshold, counts approximately 50% against any college financial aid that could potentially be awarded.  So, if a child processes a distribution from their inherited IRA for $20,000, while it might be a good tax move, if that child would have qualified for need based college financial aid, they may have just lost $10,000 in aid due to that IRA distribution during a determination year.

When a FAFSA application is completed for a child, the determined year for income purposes of the financial aid award looks back 2 years, so there is a lot of advanced planning by the guardian of the child that needs to take place to make sure larger inherited IRA distributions do not adversely affect the FAFSA award.

Example: If the child will be entering college in the fall of 2025, the FAFSA calculations looks at their income from 2023 to determine how much college financial aid they qualify for.

Traditional IRA vs Roth IRA

It does matter whether the child inherits a Traditional IRA or a Roth IRA. The RMD rule and the 10-year rule are the same, but the taxation of the distributions from the IRA to the child are different.  If the child has an Inherited Traditional IRA, the guardian has to be more careful about making distributions to the minor child because all distributions are considered taxable income.  If the child has an Inherited Roth IRA, by nature of the Roth IRA rules the distributions are not taxable to the minor child. However, Roth IRA's are extremely valuable because all the accumulation within the inherited Roth IRA are tax free upon withdrawal, so typically the strategy is to keep the account intact as long as possible so the child receives as much tax free appreciation as possible at the end of the 10 years.

Minor Child 10-Year Rule

Once the child reaches age 21, the rules change to the 10-year rule, which requires the child to deplete any remaining balance in the inherited IRA within 10 years of turning age 21.  The child has full discretion on the amounts that they wish to withdraw from their inherited IRA each year.

Minor Child Inherits A Retirement Account From A Non-Parent

If a minor child inherits a retirement account from someone other than their parents, the inherited IRA rules are different.  The child is no longer allowed to take RMD’s from the inherited IRA each year until age 21, and then switch to the 10 year rule.  If the child inherits a retirement account from someone other than their parent, they are treated the same as any other non-spouse beneficiary, and are immediately subject to the 10 year rule.  They may or may not be required to take RMDs each year IN ADDITION to being required to deplete the account within 10 years, but that depends on what the age of the decedent was when they passed. 

When the decedent passed away, if they had already reached their Required Beginning Date for RMDs, then the minor child would be required to continue to take annual RMD’s from the inherited IRA in addition to the 10-year rule starting immediately. If the decedent has yet to reach the required beginning date for RMDs, then the minor child is just subject to the 10-year rule.

In either situation, a minor child immediately subject to the 10-year rule requires detailed tax planning to avoid adverse and toxic consequences of poor distribution planning to avoid the loss of college financial aid due to the taxable income assigned to the child associated with those distributions from the inherited IRA. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What are the special inheritance rules for minor children who inherit retirement accounts?
When a minor inherits a retirement account, the account must be transferred into an inherited IRA, and the child’s custodian must ensure required distributions are taken each year. The Secure Act of 2019 created specific rules for minors that combine annual required minimum distributions (RMDs) with the 10-year depletion rule once the child reaches age 21.

How do the inherited IRA rules differ if the minor inherits from a parent versus a non-parent?
If the child inherits from a parent, they must take annual RMDs until age 21 and then deplete the account within 10 years after turning 21. If the inheritance comes from someone other than a parent, the child is treated as a standard non-spouse beneficiary and must follow the 10-year rule immediately, with RMDs possibly required depending on the age of the deceased.

What did the 2024 IRS guidance clarify about the age of majority for inherited IRAs?
In July 2024, the IRS confirmed that for inherited IRA purposes, the age of majority is 21 nationwide, regardless of state laws or student status. This means the 10-year distribution clock begins when the child turns 21, not earlier.

How are inherited IRA distributions for minors taxed?
Distributions from inherited traditional IRAs are taxable income to the child, though they are exempt from early withdrawal penalties. These withdrawals count as unearned income and may trigger the Kiddie Tax if annual unearned income exceeds $2,700.

How can inherited IRA distributions affect college financial aid?
Withdrawals from an inherited IRA are counted as the child’s income for FAFSA purposes, which can significantly reduce need-based financial aid. Because FAFSA reviews income from two years prior, guardians should time distributions carefully to avoid lowering aid eligibility.

Do inherited Roth IRAs follow the same rules as inherited traditional IRAs?
Yes, both types are subject to RMD and 10-year rules, but Roth IRA distributions are tax-free. This makes inherited Roth IRAs especially valuable if left to grow for the full 10-year period, allowing for maximum tax-free appreciation.

What steps should guardians take when managing a minor’s inherited IRA?
Guardians should ensure the account is properly set up as an inherited IRA, monitor RMD compliance, and plan withdrawals to balance tax efficiency, Kiddie Tax exposure, and college aid implications. Proper planning helps avoid penalties and unnecessary loss of financial aid.