The Uniform Transfers to Minors Act (UTMA) provides for a convenient way to make gifts of money and other items to minors through the use of a custodial account. Created in 1986 by the Uniform Law Commissioners, nearly all states have adopted the UTMA. The UTMA is sometimes still referred to by its predecessor, the Uniform Gifts to Minors Act (UGMA). Regardless of which act applies, the basic concepts of each are the same.
UTMA Account vs. Trusts
Like trusts, an UTMA custodial account places property under the control of a person who is not the beneficial owner of the property. However, in the case of a trust, a trustee manages the property for the benefit of the beneficiaries, whereas in the case of a custodial account, a custodian manages the property for the benefit of the minor.
Generally speaking, trusts are more expensive, complicated and time-consuming than custodial accounts. That said, there are good reasons to use trusts in many situations because trusts provide greater protections, more flexibility than UTMA accounts, and the ability to allow the trust to exist long after the child reaches the age of majority.
One specific example in which a trust provides more flexibility than a custodial account is if the child should die before the account terminates. In that instance, if the deceased child has assets in an UTMA account, those assets will pass according to the law of the child’s state. Often the result is not what is wished, especially if the child has siblings. However, if a trust is used, provisions can be made to plan for this possibility.
Although there can be many considerations when deciding between the two, typically the overarching rule of thumb is that a trust should be used when large dollar amounts are involved, like tens of thousands of dollars, while an UTMA account is best for smaller dollar amounts.
Property held in a custodial account is owned by the child. Even though the child will not have control of the property until later, the child is the owner as soon as property is transferred by the transferor to the account. This means that as soon as the transfer is completed, a gift has been made and therefore cannot be taken back. This also means that any income generated by the assets is income to the child, not to the custodian.
A custodial account belongs to only one child, so assets may not be transferred from one child’s custodial account to an account owned by a different child.
Because the child is the owner of the UTMA account, it can cause a reduction in financial aid for the minor. Under current law, assets owned by the child (including any assets in a custodial account for the benefit of that child) count much more heavily than parental assets in determining how much financial aid the child qualifies for.
An UTMA account terminates when the child reaches a specified age. The age depends on state law and may depend on the type of transfer. Some states will allow for a different age than the one that automatically applies, but the law will impose a limit on the age chosen. When the account terminates, the custodian transfers the property to the child, who can use it in any way he or she chooses.
A transfer to a child under UTMA or UGMA requires the involvement of a custodian. A custodian is an adult who will manage the property in an account until the child reaches the age when control passes to the child. The person transferring property to the child can act as custodian or name another adult to act in that capacity. In general, the custodian manages the property, makes decisions concerning buying and selling, and reinvests earnings. The custodian may also take money from the account to spend for the benefit of the child.
There are a few things to keep in mind regarding the custodian. First, if the person making the transfer and the custodian are the same person and this person dies before the account terminates, then the account will be included in the custodian’s estate. This is true because the custodian retained the power to determine how the gift would be applied for the benefit of a child, even though the transfer to the account are considered completed gifts. To avoid this situation from occurring, the transferor and the custodian should be two different people.
Second, because a parent has a legal obligation to support his or her child, if income of the custodial account is used to satisfy that obligation, whether or not the parent is custodian, the IRS may contend that the income be taxed to the parent, not to the child.
Given all of the advantages and disadvantages of an UTMA account, definitely consult an attorney or financial advisor before transferring a gift to a child.
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