Setting aside funds for minors: What are the best options?
Frequently parents, grandparents, friends, and other relatives will want to set aside funds for a minor child. Here are a few of the most popular options and some pros and cons of each one. This list is not meant to be exhaustive but to highlight some of the most important features of the options presented.
Uniform Transfers to Minors Act (UTMA) Accounts
These accounts are simple to set up and can be established at a wide variety of financial institutions. It is important to note that the donor is making an irrevocable gift to the minor. The property belongs to the minor at the time the gift is made. The account uses the minor’s social security number, and a parent or other adult serves as the custodian.
Pros:
A UTMA account is simple and inexpensive to establish.
Assets can be given to a minor without the need for a trustee.
Assets can be gifted to a minor up to the annual exclusion amount ($17,000 In 2023) without having to file a gift tax return.
Income earned within the account is taxed at the kiddie tax rate by the IRS up to the allotted threshold of $2,200. Earnings above that amount are taxed at the adult donor’s marginal tax rate.
Cons:
The gift is irrevocable and must be surrendered to the minor when he or she reaches 21 years of age.
If the donor dies while serving as custodian, the assets in the UTMA are counted as part of the donor’s taxable estate until the minor takes possession.
Because the property is owned by the minor, this may make the minor less eligible for need-based college scholarships and other similar programs.
Trusts for the Benefit of a Minor Child
Establishing a trust for a minor child allows the donor the greatest degree of flexibility and control over how the trust funds can be used, what the distribution criteria will be, and when the minor child has the right to receive funds directly. Trusts can be very personalized based on the donor’s wishes. Trusts also provide creditor protection until the time the beneficiary has the right of withdrawal.
Pros:
A trust can be customized.
There is no requirement to surrender funds to the minor at age 21.
Assets can be gifted to a minor up to the annual exclusion amount ($17,000 In 2023) without having to file a gift tax return. Assets can be gifted to the minor up to the donor’s lifetime exclusion amount if the donor is trying to transfer assets out of the donor’s estate for estate tax planning purposes. The transfer is irrevocable at the time it is made and would not come back into the donor’s estate.
Assets are not owned by the minor.
Cons:
A trust is more expensive to set up, but once established operates similarly to a UTMA with the trustee acting as the custodian.
Income earned and retained by the trust will be subject to trust tax rates, which are higher than the marginal tax rates for individuals with lower incomes. However, trusts can be structured with the donor being responsible for paying the income taxes, thereby preserving a greater portion of the income for the beneficiary and contributing to the transfer of wealth in a way that is not subject to gift taxes.
529 Savings Plans
These are tax-advantaged savings accounts that are designed to be used toward the minor’s education costs. Income or gain earned within the account is not taxed and can be withdrawn tax-free if it is used for education expenses, such as tuition or room and board.
Pros:
Earnings can grow free from federal tax and are not taxed when the money is withdrawn to pay for certain college and other qualified education expenses.
529 Plans have relatively high maximum aggregate limits.
Donors can front-load contributions of annual exclusion amount gifts ($17,000 in 2023) for up to five years at once ($85,000 in 2023), as long as one doesn’t make any additional contributions for that beneficiary for five years.
The account owner controls the account and can withdraw the funds for any reason, subject to income tax and a 10% penalty tax.
Cons:
Account owners must choose a specific plan with set investment choices. There is a wide variety of plans and choices, but some feel that the investment options are limited.
Unlike UTMA accounts and trusts, there is no option for self-directed investments.
The funds must be used for education. If the minor does not attend college, the beneficiary can be changed to another qualifying family member or to the account owner to further his or her own education. If the funds cannot be used for education, the account owner can withdraw the funds and would have to pay tax on the income earned and the 10% penalty tax.
Saving for a minor child is a wonderful gift that can take many forms or can be a combination of different options depending upon a family’s needs and estate planning considerations.
Please let us know if you have any questions as you consider what savings options may be best for you.
