Grandchildren: Custodial Account?

For many grandparents, the joy of grandchildren inspires a desire to leave “even a little something” behind for them. Indeed, monetary gifts, no matter how modest, can prove to be life changing. One way to pass on assets to grandchildren is to set up a custodial account. Doing so can be pragmatic and effective, but may have unintended consequences. Read on to understand the pros and cons of custodial accounts, and learn about 529 plans, and trusts too. 

Upon Reaching The Age of Majority

Assets intended for children upon reaching adulthood can be placed in custodial accounts. As attorneys at Harvest Law explain, the Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA) permit adults to retain oversight of assets transferred to children, who receive the assets upon reaching the age of majority, and these custodial accounts have many benefits:

• UTMA and UGMA accounts are both custodial investment accounts to allow minors to own securities and other assets.
• Rather than the minors managing the accounts, designated adults oversee the accounts until the children reach age 18 or 21.
• Any account custodian has a fiduciary duty to take action based on the best interests and benefits of the child.
• After children reach the age of majority, they can manage their own accounts and use them for any purpose they desire.
• …The benefits of UTMA and UGMA accounts include simplicity and flexibility.
• While UTMA accounts allow for a greater variety of assets, such as fine art, patents, or real estate, UGMA accounts can only hold limited financial instruments, including bonds and stocks.

As children cross the bridge into adulthood, funds gifted through custodial accounts can be a big boost with college expenses, a down payment on a first car or apartment, tools needed for trade school, and other life goals. However, before setting up a custodial account, it’s wise to understand some of the potential unintended consequences associated with them. Estate planning experts underscore that “All contributions made to the custodial accounts are treated as completed gifts,” so “the money is considered legally the child’s property.”  Resulting side-affects of custodial accounts that might impact a family’s overall goals and plans include:

• • The donor will have limited control, and the assets will be at risk of being misused by the financially immature recipient in young adulthood.
    • Although income from the account can be taxed at the “kiddie tax” rate for children, portions of the income from the custodial account could be taxed at the marginal rate for the parents if the amount exceeds the allotted threshold. For moderate investments, these accounts can be tax-efficient as portions of the income may be free from taxes or taxed at a lower rate.
    • Another potential issue with UTMA and UGMA accounts concerns how college financial aid applications treat these accounts. The funds in these custodial accounts may count less favorably toward this application than those held by the parents.

Good To Consider: 529 Plans? Trusts?

529 plans offer grandparents, and other relatives, an alternative way to give assets to the next generation without triggering some of the potentially negative consequences of custodial accounts. As the law office of Davis Schilken in Colorado explains, “Establishing or contributing to a 529 savings plan is a tax-advantaged way to support a child or grandchild’s education. These funds can be used for tuition, books, room and board, and even certain K-12 expenses. With careful planning, you can set up a legacy that grows over time and benefits multiple generations.” 529 plans, as Adler, Pollock& Sheehan explain, are “state-sponsored investment accounts that permit parents, grandparents or other family members to make substantial cash contributions (up to $400,000 or more, depending on the plan). Contributions are nondeductible, but the funds grow tax-free and earnings may be withdrawn tax-free for federal income tax purposes (plus state tax breaks in some cases) provided they’re used for qualified education expenses.” For many families, creating a family education trust to hold one or more 529 plans proves to be an excellent vehicle for saving and safeguarding funds earmarked for education, since a trust:

• • • Permits you to maintain tax-advantaged education funds indefinitely (depending on applicable state law) to benefit future generations and it keeps the funds out of the hands of those who would use them for other purposes.
  • • Allows you to establish guidelines on which family members are eligible for educational assistance and direct how the funds will be used or distributed in the event they’re no longer needed for educational purposes. You can also appoint trustees and successor trustees to oversee the trust.
  • • Can accept noncash contributions and hold a variety of investments and assets outside 529 plans. For example, the trustees might invest in hedge funds, private equity funds, life insurance or other alternative investments if they conclude that the increased returns would outweigh the tax cost.

Keep in mind that when you work with a lawyer to establish a trust, you will designate one or more trustees to administer it. Trustees have fiduciary obligations and are held to exceptionally high legal standards, “the most important of which are the duties of loyalty and care, and the duty to act in accordance with the terms of the trust agreement.” Given the seriousness of the role, trustee bonds are often required. Essentially, a trustee bond is a specific type of fiduciary bond that protects the interests of the trust and its beneficiaries in accordance with applicable state law. As a leading national provider of many types of fiduciary bonds, Colonial Surety makes it easy and efficient to obtain trustee bonds: Just get a quote online, fill out the information, and enter a payment method. Then, simply print or e-file the bond from anywhere. 

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