Estate Planner Sept-Oct 1998
An account created under the Uniform Transfers to Minors Act (UTMA) is one of the most commonly used forms of making gifts to children, grandchildren or other young family members. Virtually all states have adopted some form of UTMA that allows you to make gifts to a minor to be held in the name of a custodian during the age of minority. On reaching the age of majority, usually 21 years, the minor is entitled to all assets held in the account. Sometimes, significant assets build up in these accounts in the name of a minor. This may not always be desirable, however, and careful planning can eliminate or minimize problems that can result from early receipt of assets.
How UTMA Accounts Work
To open an UTMA account, you simply advise the bank of the name of the custodian and indicate how much you wish to place into the account. Unfortunately, UTMA accounts are complicated in their simplicity. First, if you establish the account and name yourself as custodian but then die while still acting as custodian, that account will be included in your estate for federal estate tax purposes. Therefore, when establishing this type of an account, you need to choose your custodian wisely.
Second, as indicated above, the account must vest in the minor when he or she reaches the age of majority (in Washington, the account vests at age 21). If you have been putting away money for your children each year, this can result in a large sum being available to your children at a young age. If this occurs, you need to look at what your options are.
What can you do if you realize that large sums of money will be going to a young person who is not ready? Let’s look at the following example:
Tom and Sue Jones have three children. Beginning at each child’s birth, Tom and Sue make annual gifts to them through UTMA accounts. After realizing they have assets that are going to grow much in value, Tom and Sue decide to make larger gifts to their children; up to the $20,000 joint annual limit for exclusion from gift taxes. By the time the children are 10, 12 and 14, they each have UTMA accounts of $500,000 with Tom as custodian.
Tom and Sue visit their estate planning advisor because they are concerned about how large the UTMA accounts have become. The advisor offers a couple of options. One is to convince the children as they approach the age of majority to establish trusts for their own benefit and place the funds in the trusts. The trusts would be irrevocable, but would be for the sole benefit of the child. The trusts would be established to ensure that transfers into the trusts would not be taxable gifts. This approach can work well, but leaves a lot to chance. A young person might look at the short-term gain of so much money and ignore that in the long run, they may receive no more.
Another option is to form a limited partnership or limited liability company (LLC). The partners or LLC members would be the custodians under UTMA. Tom could even be the general partner or LLC manager. Perhaps Sue could act as custodian and then transfer the assets from the UTMA accounts into the partnership in exchange for partnership interests or into the LLC for membership interests. On reaching the age of majority, each of the children would then hold limited partnership or LLC interests rather than cash or marketable securities. The partnership or LLC assets remain somewhat protected because, after all, how much can an individual do with a limited partnership or LLC interest?
Now Is the Best Time To Plan
If you find yourself in the position of making a decision about your children’s assets, we would be pleased to discuss the alternatives with you.
Two Trust Options
Establishing a trust for the benefit of the minor child or children can protect assets and can offer you more control. The assets can remain in trust for as long as you desire and, if drafted properly, the trust can allow gifts into it to qualify for annual exclusion from gift tax. Two types of trusts are most commonly used: the Crummey trust and a trust established under 2503(c) of the Internal Revenue Code (IRC).
The Crummey trust, named after the case of Crummey vs. Commissioner, is designed so that gifts made to the trust are subject to rights of withdrawal by the beneficiaries. The right of withdrawal generally lasts for 30 days, after which time the right lapses. Under current law, because the beneficiary has a right to withdraw the gift made to the trust, the gift will qualify for annual exclusion from gift tax. The beneficiary must also have notice of the withdrawal right. If the beneficiary of the trust is a minor, notice to a parent is sufficient.
The 2503(c) trust is created specifically under the IRC. Gifts into the 2503(c) trust will qualify for annual exclusion from gift tax. The proviso here is that when the trust beneficiary reaches age 21, he or she must have the right to receive the trust assets. This right need not, however, be an unlimited right. Rather, the beneficiary can be given notice that on reaching age 21, he or she has the right to withdraw all of the trust assets for a period of, say, six months. At the end of that time, if the right is not exercised, the right will lapse. On the assumption that a child will listen to the sound advice of the parent and not exercise the right of withdrawal, upon lapsing of the right of withdrawal, the trust converts to an ordinary trust that can continue for as long as the terms of the trust provide.
Both the Crummey Trust and the 2503(c) trust, however, require the preparation of a trust agreement and also require annual administration of the trusts to ensure that all of the requirements are followed. To avoid this administrative burden, many people establish UTMA accounts instead.