Parents, grandparents and others who want to invest in the future of a child they love are often drawn to the idea of opening UTMA custody brokerage accounts to give them a financial head start.
UTMA accounts, named after the Uniform Transfers to Minors Act that governs them, offer a tax-efficient way to donate assets to minors without the expense of setting up a trust. (And by the way, UTMA is pronounced “ut-muh.”) Money paid to a UTMA is exempt from gift tax, up to a maximum of $ 15,000 in contributions per year. And income earned on paid funds is taxed at the tax rate of the minor to whom the funds are offered.
When beneficiaries reach adulthood (usually at age 21, but this varies by state), they can use the money for whatever they want. Please note that your adult child may not choose to spend the money as you see fit. It is now their “money”.
The assets of UTMA can be used for tuition fees, and this is a common goal. But the funds could also be used to pay for a trip to Europe, a wedding, a honeymoon, a down payment on a house… or a Corvette.
The flexibility gives UTMA accounts an advantage over other savings strategies, such as 529 plans and Coverdell Education Savings Accounts (ESA), which can only be used for qualifying education expenses .
Another difference: a UTMA account can contain more than cash and securities. Gifts on the account can also include real estate, paintings, royalties, and patents.
But there are restrictions on UTMAs that can make them less appealing than they first appear.
A custodian (a parent or other adult) manages the account for the benefit of the minor until they reach legal age, but the child is the owner of the account. And there is no recovery. Attempting to bypass this restriction could result in potential legal action against the guardian by the child.
The family may have encountered unexpected financial hardship and the parents may need money to pay medical or other bills. They may have had more children and want to divide the assets they have deposited into the UTMA account fairly among them. Or they might worry that the recipient, while legally adult, is not as mature as they had hoped (at least for the money) and that they are mismanaging the account.
Or maybe, like many families, they realize a bit late that a UTMA account is seen as a child’s asset, not a parent’s, when it comes to securing financial assistance for university and could limit the amount of university scholarships their student can receive. Receiving fewer grants often results in more student loans, both for the student and for the parents.
I recently spoke with a couple who had the opposite experience. They opened a UTMA account for the purpose of paying for their child’s college education, but he received a full scholarship and does not need the UTMA money for college. The couple now want to use the assets of the UTMA account to strengthen their retirement savings. Unfortunately, with a UTMA, they can’t just call a do-over and withdraw the money, because it’s not theirs.
If possible, you may want to start by having a heart-to-heart discussion with the child whose name is on the account, so that there aren’t any surprises or hard feelings down the road about the changes you are making. might decide to bring.
It’s also a good idea to work with a lawyer, financial advisor and / or tax specialist who is familiar with the rules that govern UTMAs to ensure that any movements you make are legal.
One option that these professionals will likely suggest is to transfer the funds from UTMA to another type of account better suited to your goals. For example, if you are concerned that your child is not spending the UTMA money on school fees as expected, or that the UTMA money affects the child’s status when applying for help financial, you can transfer the funds to a 529 account, which can only be used for education expenses.
As a “qualified tuition plan,” a 529 offers its own tax breaks. And the money saved is credited to the parent on the financial aid forms, not the minor, so this type of account has less of an impact on the amount of federal aid the child can receive.
Another alternative could be to use a substitution strategy – swap all expenses made for the child (beyond expenses normally paid by parents, such as accommodation, food and clothing) for funds from the account. UTMA. A UTMA custodian has the power to withdraw and spend money for the benefit of the child account holder.
But it is important to note that custodians have a fiduciary role, which means they must manage assets responsibly with the child‘s best interests in mind. This can be a complex concept to stick to, so it may be helpful to speak to a professional about any past or potential expenses that you plan to reimburse from the account.
And, of course, you’ll want to keep complete records and keep all receipts. If an unhappy adult child can make a reasonable claim in court that you breached your babysitting duty and decides to sue, you could end up in court.
If your child has reached the legal age to take over the management of the account and you are concerned about where the money will go when that happens, you may decide to offer an incentive to keep things on track. .
You can suggest transferring the assets of the UTMA to another account in both of your names, such as an annuity or a family limited partnership (FLP), with the assurance that there will be a reward in the future – can -be in the form of a larger inheritance from your estate.
But this strategy, too, can be tricky, so careful parents will want to work with a knowledgeable professional. The rules for these accounts vary from state to state, and it’s critical that any changes you make are legal and the language is clear.
Of course, another way to avoid any potential issues with a UTMA account is to work with a lawyer, financial advisor, and / or tax specialist up front, to make sure your savings and investment strategy is the right one. good for the child you love… and for your whole family.
Kim Franke-Folstad contributed to this article.