Understanding Pension Inheritance for Children
The ability to pass on a pension to your children depends on the type of pension: a defined contribution (DC) plan or a defined benefit (DB) plan.
The Difference Between Defined Benefit and Defined Contribution Plans
Defined contribution plans, such as 401(k)s, 403(b)s, and IRAs, are investment accounts. The remaining balance at your death can typically be passed on to your named beneficiaries, including your children.
Defined benefit plans provide a fixed monthly income based on factors like salary and years of service. These plans do not have a balance to inherit. They may offer a survivor benefit to a spouse or, in some cases, a limited benefit to a dependent child. Often, the income stream ends upon the death of the annuitant if there is no surviving spouse.
The SECURE Act and Its Impact on Inherited Retirement Plans
The SECURE Act, passed in 2019, changed the rules for beneficiaries inheriting qualified retirement plans after January 1, 2020. It eliminated the "stretch" provision that allowed many non-spouse beneficiaries to spread distributions over their life expectancy.
Most non-spouse beneficiaries, including adult children, are now subject to the 10-year rule. This requires the entire inherited account to be distributed by the end of the tenth year following the owner's death, potentially accelerating the tax burden.
An exception exists for eligible designated beneficiaries (EDBs), such as the account owner's minor children. For these minors, the 10-year period begins when they reach age 21. Trusts are often used for managing assets for minors {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}.
Designating a Child as a Beneficiary
Beneficiary designation forms, not a will, control who inherits your retirement plan {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}.
- For Adult Children: Naming an adult child is simple, but they must be aware of the 10-year distribution rule and tax implications.
- For Minor Children: Naming a minor directly is not advisable as they cannot legally own the assets {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}. Alternatives include:
- Trusts: Establishing a trust allows a trustee to manage assets for the minor. Trusts can be conduit or accumulation trusts.
- Custodial Account (UTMA/UGMA): A custodian manages funds until the child reaches the state's age of majority.
Comparing Pension Inheritance Options for Children
| Feature | Defined Benefit (DB) Plan | Defined Contribution (DC) Plan (e.g., 401(k), IRA) |
|---|---|---|
| Inheritability | Highly restrictive. Survivor benefits typically limited. | Inheritable; remaining funds go to beneficiaries. |
| Distribution Rule (Post-2019) | No direct payout; follows plan survivor rules. | Subject to the 10-year rule for most children {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}. |
| Minor Child Exception | Possible for specific dependents under plan rules. | 10-year rule delayed until age 21 for minor children of owner {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}. |
| Best Practice for Minors | Relies on plan rules. | Use a trust or custodial account. |
| Taxation | Survivor benefits are typically taxable. | Distributions from traditional accounts are taxed as ordinary income; Roth accounts are tax-free {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}. |
Conclusion
Defined contribution pensions can generally be passed to children by naming them as beneficiaries. For minors, using a trust or custodial account is recommended due to legal restrictions on direct ownership. The SECURE Act introduced a 10-year distribution rule for most non-spouse beneficiaries, including adult children, but provides an exception for minor children of the account holder. Defined benefit plan inheritance is limited by plan-specific survivor provisions. It's crucial to update beneficiary designations and consult with a professional to align your estate plan and manage tax implications {Link: Greenbush Financial Group https://www.greenbushfinancial.com/all-blogs/minor-child-inherited-ira-retirement-account}.
- For more information on inherited retirement accounts, please visit the official IRS website on Retirement Topics - Beneficiary.
