No one likes to think about their own death, especially if they have minor children. The big questions are this:
- Who will raise my children?
- Will my children have enough money?
- Who will manage the money for them until they become adults?
The first question must be answered by writing a valid Will. In the Will, you can request a guardian for your child(ren). The court, during the Probate process, will either grant your wish for guardian or provide for another. Guardianship of the estate can also be handled this way, through a Trust, or by using the Uniform Transfers to Minors Act (UTMA).
How Does UTMA Work?
The Uniform Transfers to Minors Act is simply a way for a minor to own property, such as securities. Under the UTMA, similar to the Uniform Gift to Minors Act (UGMA), you may choose someone to manage property you are leaving to a child. This person is called a custodian. If you die when the child is still under the age set by your state’s law, the custodian will step in to manage the property.
In most states, an UTMA custodianship ends when the beneficiary is 21. But a few states end them at 14, and a handful allow you to extend the age to 25. If you don’t want the beneficiary to get the property so young, you may want to use a Trust instead.
An UTMA is a Trust like any other Trust except that the terms of the Trust are set in the state statute instead of being drawn up in a Trust document. As with a Trustee of a Revocable Living Trust, should a Trustee fail to comply with the terms of the UGMA, this would expose the Trustee to the same actions as a Trustee who fails to comply with the terms of a special drawn-up Trust.
Why Is UTMA Useful?
The UTMA offers a straightforward way for a minor to own securities. In most states, minors do not have the right to contract. So a minor could not be bound by any broker’s account agreement. Prior to the UTMA, brokers, and fund companies refused to take minor’s accounts. UTMA was basically a way of providing a form of ownership that got around this problem without forcing people to go through the expense of having an attorney draw up a special Trust.
How To Create an UTMA
To set up a custodianship, all you need to do is name a custodian and the property you’re leaving to a young person. You can do this in your Will or Living Trust, or when you name a beneficiary for an insurance policy, if you’re leaving life insurance proceeds to your children.
You register it as:
[Name of Custodian] as custodian for [Name of Minor] under the Uniform Transfers to Minors Act – [Name of State of Minor’s residence]
For example, your Will might state, “I leave $10,000 to John Smith as custodian for Jane Brown under the Uniform Transfers to Minors Act – North Carolina.” That would be enough to create the custodianship.
You use the minor’s social security number as the taxpayer ID for this account.
The money now belongs to the minor and the custodian has a legal fiduciary responsibility to handle the money in a prudent manner for the benefit of the minor. Handling the money “in a prudent manner” means that the custodian can buy common stocks but cannot write naked options. The custodian cannot “invest” the money on the horses, planning to donate the winnings to the minor.
Problems With the UTMA
When the minor reaches the age at which the UTMA becomes property of the minor (who is either 14 or 21 depending on the state and not a minor any longer), the minor can claim all of the funds, even if that’s against the custodian’s wishes. Neither the donor nor the custodian can place any conditions on those funds once the minor becomes an adult.
The Trustee can transfer funds between UTMA accounts at will. The custodian is managing the funds on behalf of the minor, and part of management is deciding where to place the funds and with which bank, broker, or other fiduciary. However, the custodian must be certain to maintain a paper trail showing that every dollar withdrawn from one account was transferred to another account.
Given all the warnings above, there is a way to give money to a minor and restrict the minor’s access until you feel he or she is ready. The mechanism is not a UTMA, however, but another sort of Trust.
Taxes and UTMA
At one time, wealthy families could save a great deal of money by transferring investment assets to minor children. This meant that the investment income produced by these assets would be taxed at a lower rate. Congress decided to limit the tax benefit from shifting income to children, so we now have a law that says children under 14 who have more than a small amount of investment income have to pay tax at their parents’ tax rate. Tax pros call this rule the “kiddie tax.”
You don’t have to worry about this rule until your child has investment income greater than a threshold amount, which is two times the amount allowed as a standard deduction for a dependent who has only investment income. For 2016, the kiddie tax begins to apply when your child has more than $1,050 of unearned income.
The rule does not apply if your child reached age 14 by the end of the year. A child 14 or older gets the full benefit of the lower tax rates, even when investment income exceeds the threshold amount.
All the income is on the child’s tax return and he or she is taxed as an entity unto himself/herself. Always check the Form 1040 instructions for the appropriate number to use for a given tax year. Also note that IRS regulations require all minors 14 or older to sign their own tax returns. Finally, please note that these tax rules are for earned and unearned income for a minor; there is no special tax treatment for UTMA accounts.
Understanding the implications of the UTMA account is very important when planning your estate. If you have special concerns or desires pertaining to your assets after you are gone, a Revocable Living Trust or a Will which creates Trusts may be a better tool. To determine which kind of Trust is best for your family’s needs, talk with a qualified estate planning attorney.