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Minority Trusts Offer Good Alternative to Custodial Accounts
In a previous article, we discussed the few benefits and many drawbacks of using a custodial account created under the Uniform Transfer to Minors Act to make gifts to minors. So, if making the gift via the UTMA is not the best idea for accomplishing the purpose, what techniques might be better? The answer is that depending on the purposes of the gift and any restrictions the grantor wants to impose, there are at least three other ways to create a gift for a minor. Let’s look at one.
The 2503(b) Trust: The 2503(b) Trust affords a grantor more control over the principal of the trust than does the UTMA custodial account. For example, unlike the custodial account, the trust may continue beyond the beneficiary’s 21st birthday. And, on the other hand, the trustee may be given the power to distribute principal to the beneficiary at any time before the trust terminates. Income, however, must be distributed annually to the beneficiary.
Inclusion in the Grantor’s Estate. The common misconception is that the property in the custodial account is no longer in the Grantor’s estate on his death. This is not necessarily the case. The property in the account is includible in the estate of the Grantor, if the Grantor names himself or herself as the custodian and he or she dies prior to distribution of the property to the child.. However, if properly drawn, the principal of a 2503(b) trust, could be excludible from the Grantor’s estate.
Income Taxable to Grantor. The income generated by a 2503(b) Trust must be distributed annually to the beneficiary. That being the case, the beneficiary is always the person who will include the trust’s income in his own tax return. The Grantor of a 2503(b) trust would not be taxed on the income. The income tax consequences for a custodial account are a bit trickier. How? If the custodian, let’s say Dad, uses any of the income from the account to discharge his legal obligations, including the obligation to pay for his child’s education, that income is charged and taxed to him. But, in addition, if the principal is used to pay for his legal obligation, then the principal so used is charged to Dad as his income. So, the use of the custodial account for the common purpose of paying for his child’s income can become a huge tax trap for the custodian.
These comparison’s should make it clear that there are good alternatives to the Custodial account under the UTMA. In a future article, we will discuss other trusts that could meet a grantor’s needs better than the UTMA account.
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Last modified: December 27, 2007
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