A short review of techniques for parents to make monetary gifts to their minor children.
Most parents who’ve experienced some good fortune in their lives are interested in passing along some of it to their families. Those parents may ask the age-old question, “How can I give assets to my minor children now, but still make sure that the gifts won’t be wasted or squandered?” For them, there are some tried-and-true techniques.
Method One: Uniform Transfers to Minors Act Account
A gift to a minor, held in a Uniform Transfers to Minors Act account, is a simple technique where a parent can open an account at a bank or brokerage firm to hold gifts made to a minor child. In California, these accounts may be established to hold one or more gifts for a minor child until age 18 or 21, whichever the parent designates. Gifts to a Uniform Transfers to Minors Act account, often referred to as a custodianship account, may qualify for the annual exclusion from gift tax, meaning that the first $12,000 of the gift will not be a taxable gift.
It’s usually quite easy for a parent to open a custodianship account for a child at a bank or brokerage firm. An adult is named as the custodian, or manager, of the account. That person has the power to invest and distribute the account assets. The custodian could be the parent or any other trusted adult. The assets may be used any time for the benefit of the child, with the discretion of the custodian.
However, this type of gift is irrevocable. If the parent is the custodian, and dies while the account is in effect, the account’s assets will be included as part of the parent’s taxable estate. And watch out: the account will terminate when the child reaches the designated age on the account, and he or she will receive all of the account assets at that time. An 18- or 21-year old may not be mature enough to deal with the receipt of such assets.
Method Two: 2503(c) Trust
One way a parent can provide for the management of gifted assets beyond the age of 21 is to create a Section 2503(c) Trust for a child’s benefit. Here, a parent creates the trust and then makes one or more gifts to the trustee, which is a person or institution selected by the parent to hold, manage and distribute the gifted assets according to the terms of the trust. For instance, the trust may direct the trustee to distribute income to the child on a regular basis or to hold the income to a later, designated date. The trust may also provide that principal may be distributed for any number of specific purposes, such as paying for a child’s education, or health or housing expenses.
However, to comply with the provisions of Section 2503(c), the trust must provide that its assets will be distributed to the child upon reaching the age of 21, or that the trust assets will be distributed to the child at age 21 only if the child demands a distribution. If the child doesn’t demand a distribution of the trust assets at age 21, then the trust may continue on for the child’s benefit, even until the child’s death.
This type of trust has the potential to continue well past a child’s 21st birthday, simply by giving the child a right to demand the assets at age 21. The time frame during which the child may exercise the demand right may be limited; for instance, the trust could provide that the child must exercise the right during the 60 days following his or her 21st birthday, after which the right would expire. Gifts made to a Section 2503(c) Trust while the child is under the age of 21 will generally qualify for the gift tax annual exclusion.
If a parent chooses this type of gift, he or she will incur legal expenses for the trust’s preparation and implementation, the expense of a gift tax return to report any gift over the annual $12,000 exclusion amount, and the ongoing expense of an annual income tax return for the trust. The trust is irrevocable after it’s created, and it may not be modified or amended by the parent. Therefore, the parent should be careful in designing the trust, taking into account a child’s changing circumstances while the trust may be in effect. If the parent designs the trust to last beyond the age of 21 by giving the child a demand right at age 21, there’s always the chance the child will exercise the right.
Method Three: The Gift Trust
A parent may also create a more standard Gift Trust for a child, which can last to any age, or until a child’s death. Under a standard Gift Trust, there’s no requirement for a child to be given a demand right over the trust assets upon reaching the age of 21, or any age. As with the Section 2503(c) Trust, a trustee manages and invests the trust assets, and distributes the assets for the child’s benefit according to the terms of the trust as designed by the parent.
Gift Trusts are often designed to benefit a child during his or her lifetime, after which the trust may continue on for the benefit of his or her own children (the original parent’s grandchildren). Gifts to these types of trusts don’t generally qualify for the annual gift tax exclusion, because the child doesn’t have the right to immediately use and enjoy the gifted assets. If it’s important to qualify the gifted assets for the annual exclusion, then the trust can include a “Crummey” withdrawal power, which lets the child withdraw the gift from the trust for a particular time period after the gift is received, usually about 30 to 60 days.
A benefit to this type of trust is that a parent can design one to meet a child’s particular needs, without them having to give the child access to the trust assets at age 21. Some trusts are designed to make significant distributions to a child upon achieving certain successes in life, such as a college degree. Some provide assistance for a child to purchase a home or start a business. The trust can provide income and principal for a child’s support for any number of years selected by the parent, or for a child’s lifetime. The trusts can be designed to continue on for the benefit of grandchildren after a child’s death.
On the other hand, the expense of creating the trust and preparing tax returns is the same as that for the Section 2503(c) Trust. Again, the trust is irrevocable and cannot be modified or amended by the parent after it’s created and implemented. Because the trust is irrevocable, the parent should take time to carefully design it for the long-term benefit of the child—and, perhaps, future grandchildren. Due to the potential length of time the trust may be in effect, the selection of a trustee is all the more important.
The parent shouldn’t serve as trustee of a Gift Trust to avoid having the assets included in the parent’s taxable estate at death. Gifts to such a trust won’t qualify for the gift tax annual exclusion unless the child is given a power to withdraw the gift soon after it’s made to the trust. In addition, if the potential exists that the trust assets will eventually pass to grandchildren or below, then the parent should allocate generation-skipping tax exemption to the gifts as they’re added to the trust.
If you’re interested in these techniques to make gifts to minor children, or if you’d like to explore others, you should contact your estate planning attorney or tax adviser for more information. Your adviser will need to know more about your family, your assets and your attitude about making gifts to your children to design a gift plan that works best for you.
