Off to a Good Start
Three Ways to Gift Money to Children and Grandchildren
BY JOANNA K. MURPHY
Senior Vice President
One of the most joyous moments in life is learning that you are to be a parent — or, even better, a grandparent. Soon enough, hopes for the new child’s future will motivate parents and grandparents to think about saving for that hoped-for future. There are many ways to save and invest for a child’s future needs and security. In this article, we will look at a few of the more common techniques.
Uniform Transfer to Minors Accounts (UTMA)
Many people have had personal experience with the Uniform Transfers to Minors Account. More commonly referred to as a UTMA, this account has a designated custodian (the individual who controls the account) who is responsible for managing the funds for the benefit of the minor child. Opening a UTMA is as easy as walking into your nearest bank, brokerage, or …trust company. While funds gifted to a UTMA must be used only for the benefit of the minor child, there are no restrictions on the types of expenses these funds can pay. It is the simplicity and flexibility of these accounts that make them popular.
That simplicity and flexibility does, however, come at a cost. At age 18 (or age 21 if the agreement specifically states this), control of the funds shifts to the child. The inability to delay the distribution of the funds is the most significant disadvantage of the UTMA. Especially for those who plan to make more substantial gifts, this restriction can make these accounts unappealing. In addition, because the UTMA is owned by the minor, assets in these accounts can negatively impact a child’s eligibility for financial aid.
Another popular method for saving for a child’s future is the 529 plan. These state-sponsored investment plans are designed to encourage savings for education. While 529 plans are most commonly used for college expenses, in recent years, the definition of qualified expenses has expanded to include K-12 education tuition. A limited amount may even be withdrawn to pay student loans without penalty.
Like the UTMA, opening a 529 plan account is straightforward. Once the account is open, gifts may be made each year and the funds invested to grow for future education expenses. The funds in a 529 plan may only be used for qualified education-related expenses and so lack the flexibility of the UTMA. However, if the child does not use the funds for education, the owner may transfer the unused funds to another child or certain other relatives without penalty. These plans also have tax advantages that the UTMA does not. Contributions to a 529 plan may provide a state income tax deduction for the contributor, and the assets grow tax free and can be withdrawn tax free as long as all withdrawals meet the specified criteria. Unlike UTMAs, funds in a 529 plan have a lesser negative impact on the child’s eligibility for financial aid.
Gifting Through Trusts
While the UTMA and 529 plan are both useful savings vehicles for minors, especially because they are simple to establish and administer, many parents and grandparents choose to create a trust as the savings vehicle for a minor child. A properly drafted trust can provide the needed flexibility and the desired control over when and under what circumstances the minor can access the funds, a feature both the UTMA and 529 plan lack. Two types of trusts are commonly used in these situations. Both are irrevocable, meaning that once established, the terms of the trust cannot be easily altered. Both have certain rules that must be followed to ensure that gifts made qualify for the annual gift tax exclusion ($17,000 per donee in 2023).
The first type of trust is the 2503(c) minor’s trust, named after the Internal Revenue Code section that created it. This type of trust can have only one beneficiary. Until the beneficiary turns 21, principal and income may be used for the child’s benefit. At age 21, the child must be given the unrestricted right to withdraw any funds remaining in the trust. This one-time right of withdrawal allows gifts made to the trust to qualify for the annual gift tax exclusion. The trust must be drafted to provide that, should the child choose not to withdraw the funds, the trust income will be distributed to the child periodically. The trust principal will continue for the child’s use under whatever terms the trust’s grantor (generally a parent or grandparent) determines. This mandatory withdrawal right, and the fact that income accumulated in the trust prior to age 21 is taxed at less favorable trust rates, are the two biggest drawbacks of this type of trust.
The second type of trust commonly established as a savings vehicle for minor children is the Crummey trust. The Crummey trust gets its name from the court case that created it. This type of trust is much less restrictive than the 2503(c) minor’s trust in that there is no mandatory withdrawal at age 21 and trust income need not begin distributing to the child after age 21. Also, unlike the 2503(c) minor’s trust, a Crummey trust may have multiple beneficiaries. While the Crummey trust may allow the grantor broad latitude in how the trust is drafted, it does bring with it additional administrative burdens that can make it a less attractive option. For contributions to the trust to qualify for the annual gift tax exclusion, the child beneficiary must be allowed to withdraw the newly contributed funds for a limited period of time. If the child chooses not to exercise this right of withdrawal, the contributed assets will become a permanent part of the trust. The trustee of a Crummey trust must keep careful records to document that the beneficiary, or beneficiaries, of the trust were given the opportunity to exercise this withdrawal right.
A carefully considered saving plan using any one, or more than one, of the above techniques can be the start of a long-term, financially secure future for a minor child. At Trust Company of Oklahoma, we have years of experience in administering and overseeing accounts for minors. If you have questions about saving for a child or grandchild, we would welcome the opportunity to talk with you.