Articles of Interest

        Breaking the Myth of the Custodial Account

Many individuals want to set aside part of their assets for their minor children to preserve funds for the child’s education, first home or business venture. Several considerations go into the decision on what kind of form of investment the assets will take.  

The goals:  Most often, parents want any gift to a minor child to qualify for the annual gift tax exemption, currently $12,000 per donee per year.  Another frequent goal is to maintain control over the asset for as long as possible.  Having a simple procedure to follow to open the account is certainly a very attractive feature to consider.

The most used solution is the creation of a custodial account under the Uniform Transfer to Minors Act, or UTMA account, (previously called the Uniform Gift to Minors Act, or UGMA).  Opening such an account is certainly simple enough.  The donor, mom or dad, or grandmother or grandfather, for example,  just goes to a bank or brokerage firm and opens an account that refers to the Uniform Gift to Minors Act.  Voila, the account is opened and the terms of the act are automatically included  in the account agreement.   A transfer to a UTMA custodial account qualifies for the annual gift tax exclusion and the donor can maintain control over the assets in the account until the minor child reaches age 21.  So, if the minor is relatively young, say four or five years old, control can last for 16 or 17 years.  Unfortunately, the transfer of assets to a custodial account carries several drawbacks with it.

The drawbacks: The primary strike against a custodial account is that the assets in the account must be distributed to the minor once he or she reaches 21 years of age.  That’s it.  Whether or not young Charles is ready to handle that $500,000 put away for his financial security, at age 21 it’s his.  Sometimes that’s the last thing a parent would want.  Maybe the child is a spendthrift, or has a drug habit or is a member of a cult, or the account is simply too large to expect a 21-year-old to manage.  Whatever the reason, the potential problem suddenly comes to the fore when the bank officer calls to remind dad that his son’s custodial account will soon need to be re-titled into Charles’s name when he reaches his 21st birthday. (Incidentally, taking the assets back into the dad’s name is not a good solution.  It would leave him open to criminal charges of grand larceny.  He could also be sued for damages by his son.)

The UTMA has other drawbacks.  Principal among these is that the use of the money in the account is restricted by state law.  For example, the money in a custodial account cannot be used to discharge a parent’s obligation to support a minor, such as the payment of college tuition and related costs.  What’s more, its improper use can also cause adverse income tax consequences for a parent-created account.  The use of the money to pay for a grantor-custodian’s support obligation can result in income to the parent.  In addition to possible income tax problems, if the grantor-custodian dies before the minor beneficiary reaches age 21, the value of the account's assets is includible in the grantor-custodian’s estate and can cause a larger estate tax liability for the estate.

The solution: Fortunately, there are many possible alternatives to the UTMA custodial account.  Primarily they include the creation of a variety of trusts that can be designed to meet the particular objectives of the grantor.  There also may be successful strategies to extend the period of control of the assets in the custodial account beyond the child’s 21st birthday.  In future articles we will discuss these strategies and alternative solutions.



                                           

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Last modified: December 26, 2007

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