Gifting to Children –UTMA, 529 Accounts and Trusts
Parents and grandparents often want to make gifts to minor children and grandchildren but there are different means to achieve this objective, including the set up of custodial accounts, 529 Plans and various Trusts. The Uniform Transfers to Minors Act (“UTMA”) permitted any adult such to establish custodial accounts for a minor child, into which money can be deposited as a gift. Any adult, such as a parent or grandparent may make the gift, and any adult or bank/trust company may act as the custodian.
The custodian of the account may provide to the minor, or spend for the minor’s benefit, as much of the assets as the custodian considers advisable for the use and benefit of the minor. However, the minor has no control over the property until he or she reaches the age of majority, at which time the custodian must turn the money over to the child. The age of majority is 21 for all UTMA accounts in New York unless the individual making the gift stipulates the age of 18.
UTMA accounts are titled in the name of the child, and the income tax (on income generated on the gifted funds) are shifted to the beneficiary up to about $2,000. Your typical minor beneficiary is in a lower tax bracket than the adult making the gift. For children, or students under age 24, annual income below $1,000 is not taxed, income from $1,000 through $2,000 is taxed at the child’s rate, and income over $2,000 is taxed at the rate of the adult who gifted the money to the child. Therefore, income tax savings are not significant and there are other major disadvantages to UTMA accounts.
Once a gift is deposited into an UTMA account, it is irrevocable. In other words, the money cannot be returned to the person who deposited the money. However, the adult gifting the money retains control of the money and decides how it will be invested for the benefit of the minor.
Any money in custodial accounts will be counted as part of the custodian’s taxable estate if the custodian is the legal guardian of the child and if the custodian dies before the child has reached the age of majority.
For children on Supplemental Security Income (SSI)/Medicaid, UGMA/UTMA funds are disregarded when determining Medicaid eligibility, but only until they reach the age of majority. Disbursements from such accounts may be considered countable income to the child if they are used to make certain payments to third parties such as retailers and merchants for goods or services provided to the child. For grandparents establishing UTMA accounts for their grandchildren, the money is not an available asset to the grandparent should he or she ever apply for Medicaid benefits.
Custodial accounts are considered assets of the student and will likely, therefore, affect financial aid. They must be disclosed on FAFSA applications, etc.
The greatest disadvantage to UTMA accounts is that at age 21, the assets in the account are the child’s assets. Many 21 year olds are not equipped to manage funds on their own and the parent or other adult who made the initial gift no longer has any control over how the funds are utilized.
A 529 Plan, named after Section 529 of the Internal Revenue Code, is a different and highly advisable method of gifting to children for purposes of college tuition and education related expenses. 529 Plans are very different from UTMA accounts and expenses from the funds are limited to education. Grandparents or others who wish to contribute to a child's college savings plan may want to open a 529 plan account.
The adult making the contribution to the 529 Plan controls the account, including investment decisions and the distribution of assets. Grandparents, other relatives, or nonrelatives can also gift to an existing account. The account owner can also take advantage of possible gift and estate tax benefits. Once assets are in the account, they are generally considered to be no longer part of the account owner's estate.
The major advantage of a 529 accounts is that earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. The IRS also counts “computer technology, related equipment and/or related services such as Internet access” as qualified education expenses. Contributions to a 529 plan, however, are not deductible for federal tax purposes but a New York state tax deduction can be achieved as discussed immediately below.
The Tax Cuts and Jobs Act, President Trump’s tax bill signed into law on December 22, 2017, provides yet another and very major advantage of 529 Plans for those who (like my husband and I!) pay for private schools, e.g., yeshivas or Catholic schools. In New York (and 29 other states) families can withdraw up to $10,000 a year tax free to use for "public, private or religious elementary or secondary school" expenses. The money does not have to stay in the 529 account for more than a few weeks prior to the withdrawal.
Furthermore, and unlike the UTMA accounts, the account owner maintains ownership of the account until the money is withdrawn.
Withdrawals from a 529 account can be taken at any time for any reason. However, if the money is not used for qualified education expenses, any earnings are subject to federal income taxes at the recipient’s rate. There may also be penalties imposed.
Lastly, Trusts are a great mechanism to provide for minors. Trusts afford the greatest flexibility in terms of controlling the gifted funds, what they are used for including any preconditions the donor may want to apply. Depending on the type of trust, there may be significant estate planning advantages such as minimizing any potential estate tax liability. Individuals do not need to prepare gift tax returns for gifts up to $14,000 a year per donee; with the married couple’s being double at $28,000.
It is advisable to speak with a knowledgeable attorney and financial advisor in order to consider all gifting options and their effect on planning.