The custodian has great discretion to control and use the property in the child’s interest. Among the specific powers the UTMA gives the custodian are: the right, without court approval, “to collect, hold, manage, invest and reinvest” the property, and to spend as much of it “as the custodian considers advisable for the use and benefit of the minor.” The custodian must also keep records so tax returns can be filed on behalf of the minor and must otherwise act as a prudent person would when in control of another’s property. A custodian does not need to file a separate tax return. The custodian is entitled to be paid reasonable compensation from the gift property. No court supervision of the custodian is required.
note: UTMA has been adopted in every state except South Carolina and Vermont.
Trusts for Children
There are two major types of trusts used to provide property management for property left to children: a child’s trust or family pot trust. More complex trusts, such as a special needs trust for a child with a disability or a spendthrift trust for a child who cannot handle money, are discussed later.
With a child’s trust, the client leaves specified property to one child; that property is held separately from any property left for other children. If there is more than one child, the client can create a child’s trust for each child. With a family pot trust, the client leaves property for two or more children in one common fund; any amount of trust property can be spent for any child.
A trust is a legal entity wherein an adult (trustee) has the responsibility of handling money or property for someone else—in this case, a child or children. The child’s property manager is called the trustee or successor trustee. The trust document sets out the trustee’s responsibilities and the beneficiary’s rights.
A child’s trust or a family pot trust can be established by will or living trust. If established as part of a living trust, the property placed in trust avoids probate. If a will is used, the property must first go through probate.
A child’s trust and a family pot trust are legal in all states
. All property left to a beneficiary (child or adult) for whom a trust is established will be managed under the terms of the trust document. If the client creates either type of trust, any property inherited by a minor beneficiary will be managed by the trustee until the beneficiary reaches the age when he/she is entitled to receive the trust property outright (an age determined by your client in the trust document).
The trustee’s powers are specified in the trust document. Normally, the trustee may use trust assets for the education, medical needs and living expenses of the beneficiary or, with a pot trust, beneficiaries. With a family pot trust, the trustee does not have to spend the same amount on each beneficiary; this flexibility is one of the pot trust’s main advantages.
Most family pot trusts last until the youngest beneficiary becomes 18. By that age, with all beneficiaries’ legal adults, it makes less sense to treat them all as one family unit. But one could have a pot trust last until the youngest beneficiary becomes 21, or even older, if the client is sure he/she wants to keep the children’s property lumped together this long. Some pot trusts are drafted so they convert to individual trusts when the youngest child reaches 18.
A pot trust is most often used by parents with younger children. These parents want to keep family money together, capable of being spent on any child as needs require. The trustee, like a parent, decides how much money shall be spent on each child. If one child has a serious illness or other extraordinary needs, the maximum family resources possible are there for him or her. With a pot trust, the trustee may literally be called on to choose between one child’s need for expensive orthodontia and another’s desire to go to a costly college.
If there is a wide age gap between children, a pot trust is less desirable. If one child is 16 and another is two, and the trust ends when the youngest becomes 18, the oldest must wait until age 32 to receive any property outright, which may not be what the parents want. Furthermore, it is harder to balance needs between children of widely varying ages. How much of the pot should be spent for the eldest college needs? How much retained for the youngest? When children are closer together in age, these types of troubling differences are less likely to arise.
Some parents whose children are young and close in age decide a pot trust is best for the children now. Then, when a child grows older—say the eldest reaches 16—the parents (assuming they are still alive) may decide to pull property for that child out of the pot trust and create a new child’s trust or an UTMA custodianship.
Generally, the less valuable the property involved and the more mature the child, the more appropriate the UTMA is because it is simpler and often cheaper, from a tax point of view, than a trust. There are reasons for this:
• Because the UTMA is built into state law, financial institutions know about it and should make it easy for the custodian to carry out property management duties. In states where the UTMA allows for property management until age 21-25, setting up an UTMA custodianship can be particularly sensible if property worth < $100,000 is left to a child. Normally, amounts of this size will be fairly rapidly expended for the child’s education and living needs and are simply not large enough to tie up beyond age 21.
• Another factor can be the age of the child at the time you create your will or living trust. If the daughter is now two years old, it will obviously take far more money to support her until adulthood than if she is currently 17. For instance, $100,000 left to a 2-year old may be used up before she gets to college, but $100,000 left to a 17 year old should cover at least some of her college costs or whatever else she plans to do in the next four years.
• Using the UTMA can also be desirable because trust income tax rates are higher than individual rates. Annual income above $5,000 retained in a child’s trust at the close of its tax year is taxed at higher rates than is property subject to the UTMA, which is taxed at the child’s individual tax rate. Any trust income spent for the child’s benefit during the year will be taxed at the child’s rate, not the trust rate. But for income held in the trust, a higher tax rate applies.
• A child’s trust is desirable when you want to extend the age at which a beneficiary receives property to well beyond when that child becomes a legal adult. As a rough cutoff point, if one is leaving > $100,000 to a child, a child’s trust is desirable.
With a child’s trust, no age limit is imposed by state law. With a family pot trust, any termination age is theoretically possible. Child’s trusts are often established for young adults already older than 18 or 21, when a parent (or other older adult) believes the child is not yet responsible for handling property.
It is rarely wise to leave property to a child that is to be supervised by a property guardian:
• The property must go through the will, which means it will go through probate.
• Property guardians are often subject to court review, reporting requirements and strict rules as to how they can expend funds. All this usually requires hiring a lawyer and paying significant fees, but does little to guarantee the property manager will do a good job. Legal fees come out of the property left to benefit the minor.
• Property guardianship must end at age 18.
Still, a will should still name a property guardian as a backup, to handle property that for some reason is not covered by a trust or custodianship. Naming a property guardian in your will provides supervision in case:
• Minor children earn substantial money after your client dies or receive a large gift or inheritance that does not, itself, name a property manager.
• The client and spouse leave property to each other to use for the children, naming the children as alternative or residuary beneficiaries without bothering to add an UTMA designation or establish a child’s trust or pot trust. If both spouses die simultaneously, the property will be managed by the property guardian.
• The client failed to include in an UTMA custodianship, child’s trust or pot trust some property he/she wanted the children to inherit. This can occur because of oversight or, more likely, because the client did not yet own the property when he/she established a will or living trust and did not amend that document later.
Creating a child’s trust, pot trust or a custodianship under your state’s UTMA is really quite simple to do, so normally the children’s property guardian will be used only for the backup purposes listed above. If the client wants to postpone estate planning or keep it to the bare minimum, it is far wiser to name a property guardian than ignore the issue altogether. Having a minor child’s property supervised by a property guardian named in a will is certainly preferable to having a judge appoint someone.