5 Reasons UTMA Accounts Are Bad

Parents and grandparents sometimes look for easy ways to give money to younger family members. The challenge arises when the recipient is a minor (minors cannot own property in their own name until 18, with some exceptions) and when the donor wants to minimize legal fees.

A Uniform Transfer to Minors Act [“UTMA”] account, which leaves funds to the child when he/she turns 21, used to be viewed as an appropriate way to leave funds to a minor now that would be paid out later when he/she reached a more mature age. UTMAs are inexpensive: You only need to set up the account at a financial institution, name an adult custodian for the account, and let the custodian buy a suitable investment; no complex trust documents are necessary. In addition, UTMAs are taxed at the income tax rate of the child, who tends to have a low-income tax rate.

The problem is that UTMAs do not protect the beneficiary from him/her self, his family detractors, creditors or future changes in the law. In my professional experience, UTMA accounts almost never fulfill the donor’s desired end-result for any one of the following reasons:

  1. BAD CUSTODIANS: The named custodian either makes transferring the funds an unimportant activity, does not invest UTMA funds appropriately, or feels the beneficiary is not responsible enough to receive the funds and chooses to not inform the beneficiary of the account when the beneficiary turns 21 (and because not informing the beneficiary is a breach of the custodian’s fiduciary duty, they could be subject to legal liability).
  2. BAD FOR WAYWARD BENEFICIARIES: Usually, 21-year old’s have always been / are / will always be too young to responsibly receive substantial funds without supervision.  In addition, the beneficiary may have substance abuse or creditor issues…and the funds are now theirs without restraint – the beneficiary can legally compel the custodian to transfer the funds – meaning the UTMA proceeds will not be spent in a way the donor would have approved.
  3. BAD FOR BENEFITS:UTMA funds are includable on a FAFSA form, so significant amounts in an UTMA can hurt student aid. But 529 Plan assets owned by anyone other than a parent do not affect aid; if education funding is the primary goal of the transfer, better to leave funds in a 529 Plan – UTMA beneficiaries can’t be changed – if worst comes to worst 529 Plan beneficiaries can be changed. If the beneficiary is receiving Medicaid or some other benefit when he reaches 21 (remember, some illnesses such as bipolar disorder and clinical depression don’t manifest until adolescence) the UTMA funds will be included in the beneficiary’s resources, thereby cancelling Medicaid benefits.
  4. BAD FOR ESTATE TAXES: Beneficiaries do not hold constructive title in UTMA funds while they are minors. Because the custodian controls the funds until this time, the assets in UTMAs are included in the estate of a deceased custodian for estate tax purposes. This is the opposite of 529 Plans, where the funds can still be withdrawn from the plan (with penalties) and are typically outside of the owner’s estate for estate tax purposes.
  5. BAD FOR KEEPING TRACK: Because the custodian is the sole recipient of UTMA account statements, if the custodian dies or does not update address changes, the beneficiary may never find out about the account. Remember that the financial institution usually does not ask for the beneficiary’s address and does not send them a statement, so UTMA accounts can hang in the lurch for years.And there are other reasons: UTMA accounts may generate enough money that the child will need to file federal and state income tax returns, UTMA custodianship may be contested in a divorce of the child’s parents, death of the beneficiary often leads to the UTMA becoming the child’s only asset in their estate, and any one of several other unforeseen issues. Except for the most-minimal of transfers, UTMA accounts almost never fulfill the desired end-result of properly transferring wealth to another individual.

While I appreciate that clients want to save funds by not having to pay legal fees for every substantial gift they make to a beneficiary, UTMAs are another example of attempting to be penny-wise and pound-foolish. A suitable trust, which allows for written contingencies and future flexibility, always trumps the staunch-and-inflexible rules governing UTMA accounts.

 

 

 

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DISCLAIMER: Attorney Advertising. Please note that prior results do not guarantee a similar outcome. This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent legal counsel for advice on any legal matter.