MINI-COURSE SERIES
ESTATE PLANNING Part II
Copyright Š 2012 by Institute of Business and Finance. All rights reserved.
ESTATE PLANNING
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MANAGING A MINOR’S ASSETS There are four basic options for leaving property to a minor: [1] a custodianship, under the UTMA, [2] a child’s trust, [3] a family pot trust, or [4] a property guardianship.
The Uniform Transfers to Minors Act Property can be left to a child in a will or trust under the Uniform Transfers to Minors Act (UTMA), a law adopted by every state except South Carolina and Vermont. Under UTMA, a child’s property manager is called a custodian. The custodian’s management ends when the minor reaches age 18 to 25, depending on state law. In either the will or living trust, the client identifies the property and the minor that assets are being left to (e.g., real estate, securities, bank accounts, etc.). The client appoints an adult custodian to be responsible for supervising the property until the age the child must receive the property (see next page). He should state that the custodian is to act “under the [state’s] Uniform Transfers to Minors Act.” The client should strongly consider adding the name of a successor custodian in case the first choice cannot do the job. 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. Each gift under the UTMA can be made to only one minor, with only one person named as custodian. A child who reaches the age UTMA specifies for termination gets the remaining balance. The custodian must also furnish an accounting of all funds distributed. If the children are already teenagers and the estate is substantial, the client may want property management to last longer. If so, a trust should be considered.
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States That Use the Uniform Transfer to Minors Act State
Gift Released at Age
State
Gift Released at Age
Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware DC Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Maine Maryland Massachusetts Michigan Minnesota Mississippi
21
Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York N. Carolina N. Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island S. Dakota Tennessee Texas Utah Virginia Washington W. Virginia Wisconsin Wyoming
21 21 21
18 (up to age 25) 21 21 (down to 18) 18 (up to age 25) 21 21 21 18 (up to age 21) 21 21 21 21 21 21 21 21 18 18 (up to age 21) 21 21 18 (up to age 21) 21 21
18 (up to age 25) 21 21 (down to 18) 21 21 21 (down to 18) 21 21 18 (up to age 21) 21 (up to age 25) 21 (up to age 25) 21 18 21 (up to age 25) 21 21 18 (up to age 21) 21 (up to age 25) 21 21 21
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.
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Child’s Trust 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 sets out the trustee’s responsibilities and beneficiary’s rights.
Family Pot Trust A child’s trust or a family pot trust can be established by will or a living trust. If established as part of a living trust, property placed in a 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 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 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 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.
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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. 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 2, 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’s 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 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 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 the will or living trust is created. 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. PART II
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A child’s trust is desirable when one wants to extend the age at which a beneficiary receives property to well beyond when that child becomes a legal adult. As a rough estimate, 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.
Property Guardian It is rarely wise to leave property 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. Legal fees come out of property left to benefit the minor.
Property guardianship must end at age 18.
A will should still name a property guardian as a backup, to handle property not covered by a trust or custodianship. Naming a property guardian in the 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 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 established a will or trust and did not amend that document later.
Creating a child’s trust, pot trust, or a custodianship under a state’s UTMA is simple; 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. A page at the end of this chapter summarizes the rules for and reasons to use each of the four major methods for leaving gifts to minor or young adult children.
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CHILDREN AND LIFE INSURANCE If assets are limited, the best way to be sure cash will be available for the children is to purchase term life insurance. Term is the cheapest form of life insurance. Younger parents can obtain a significant amount of coverage for relatively low cost, for the obvious reason that statistically they are unlikely to die soon, so the risk to the insurance company is low. If your client names children as beneficiaries (or alternate beneficiaries) of a life insurance policy and the client dies while the children are minors, the insurance company cannot legally turn over the proceeds directly to them. If the client has not arranged for another method of adult supervision over the proceeds, court proceedings will be needed to confirm the children’s property guardian. This means this property guardian can become involved in the court requirements state laws typically impose. It also means the property guardian can only spend money under the terms of state law. Here are your options for avoiding problems:
Name the children as policy beneficiaries and name a custodian under the UTMA. Most insurance companies permit this and have forms for it. The client will fill out a separate form for each minor, providing the usual UTMA information—the beneficiary’s and the custodian’s name, state and age of termination, if one gets to choose. If the client wants the proceeds to go to more than one child, he will need to specify the percentage each one receives.
Leave proceeds to a child or children using a child’s trust or a pot trust as part of a living trust. Name the living trust (or the trustee, if that is what the insurance company prefers) as the policy beneficiary in the living trust. In the trust, name minors as beneficiaries of any insurance proceeds that trust receives and create the child’s or pot trust to handle those proceeds. The client will need to give a copy of the living trust to the insurance company.
It may not be possible to leave insurance proceeds to a child’s trust established by a will. Some insurance companies balk at this, on the grounds the trust will not come into existence until after death, and the policy beneficiary must be in existence when named. Rather than try to persuade an insurance company that this can be done, it is better to use the UTMA or create a living trust to achieve one’s goals. A living trust avoids this problem because the trust is effective as soon as it is created and funded.
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THINGS TO DO Your Practice Set up a meeting with clients who have children along with the grandparents. During the meeting, discuss methods that can be used to fund education, special needs, or simply the financial security of those children. The Next Installment Your next installment, Part III, will cover wills. You will receive Part III in a few days. Learn Are you ready to take your practice to the next level? Contact the Institute of Business & Finance (IBF) to learn about one of its five designations: o o o o o
Annuities – Certified Annuity Specialist® (CAS®) Mutual Funds – Certified Fund Specialist® (CFS®) Estate Planning – Certified Estate and Trust Specialist™ (CES™) Retirement Income – Certified Income Specialist™ (CIS™) Taxes – Certified Tax Specialist™ (CTS™)
IBF also offers the Master of Science in Financial Services (MSFS) graduate degree. For more information, phone (800) 848-2029 or e-mail adv.inv@icfs.com.
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