When you set aside large amounts of money for your young children to control, you are surely working on the best intentions. What could be wrong with a minor having so many finances? The truth is that there is a right and a wrong way to do something that seems so simple and intuitive. As a general rule of caution, you should never allow minors – anyone under the age of 18 in California State law – to own any assets or be the beneficiary of any account plan. And here’s why:
Minor Children Cannot Own Assets
Although you may think it would be great to open a savings account for your grandchild or name your youngling as a beneficiary in your 401(k) or life insurance plan, it is rarely a good idea. Children cannot come into ownership of any assets until they turn 18. Therefore, even though they may technically be the owners of the funds before that age due to your workings, the funds must be managed by a custodian or guardian until the child turns 18.
UTMA and UGMA Accounts
When the account is a bank account, it is known as an UTMA (Uniform Transfer to Minors Act) or UGMA (Uniform Gifts to Minors Act) account. Both names refer to legislation that allows accounts to be set up for minors, and custodians to be appointed to manage those accounts for the benefit of the minors. However, one huge pitfall of these accounts is that the child receives unregulated access to the entire account when they turn 18. If there is a considerable amount of money there, they might not be financially prudent enough to spend or manage it wisely. In layman’s terms, the well could dry up fast.
Additionally, an UTMA or UGMA account has the potential to reduce the amount of financial aid available to the minor when applying for colleges. There could also be unforeseen tax consequences triggered upon the parents who created the account. Lastly, once you put money into such an account, there is no way to get it back until the child turns 18, even if the child consents to reverse the transaction.
Naming a Child as a Beneficiary
It is often a bad idea to name a minor as a beneficiary to any accounts or insurance plans because they cannot directly access the funds until they turn 18. Should any troubles occur, the court may direct the child’s guardian to liquidate the account and create an UTMA or UGMA instead. Not only does this have all the problems mentioned in the above section, but it also loses the investment growth potential of an IRA account.
Is There a Right Way to Set Aside Money for a Child?
If you need to give a significant to your young child or grandchild, the best method is to create a child’s trust account, which is basically a living trust that names the minor as the beneficiary and you as the trustee; you should also use such a trust when listing the beneficiary to a retirement account or life insurance plan. The greatest benefit of a child trust account is that they can be tailored to your exact intentions for the assets in question, including:
- Type of investment
- Amount and frequency of distribution
- Age at which the child takes responsibility
Thus, if any unforeseeable events occur and you need to take back some of the trust property, you can.
If you would like to know more about the best way to create financial gifts for your children or grandchildren, contact Hannah Sargent, Alameda County probate and estate planning attorney today for a free case evaluation.