UTMA Regret, Part I


First in a series on escaping from custodial accounts.

I get this question all the time. Someone set up a custodial account for their child under the Uniform Transfers to Minors Act ("UTMA") and then decided it was a mistake. It comes up so often I've given it a name: UTMA regret. Is there any way to undo an UTMA account? Or delay turning control of the money over to the child?

Background

When people want to transfer assets to a child, they often set up custodial accounts under the Uniform Transfers to Minors Act. This is the successor to the Uniform Gifts to Minors Act ("UGMA"), and some people still refer to them as UGMA accounts although nearly all states now have the newer act. When you put cash or other assets in an UTMA account, the child becomes the owner immediately, but doesn't gain control of the assets until the child reaches the age specified in the law for that state — usually 18 or 21. Most of these accounts are set up by parents, but other relatives or non-relatives can set them up, too.

Reasons for wanting out

The most common reason for regret over a custodial account is a realization that the child may not handle a large sum of money in a mature way at the age when control passes. When your child is 8, you imagine he or she will be a thoughtful young adult when the account passes to the child's control. Ten years later you realize that your child still has a lot of growing up to do.

The second most common reason for UTMA regret is learning how the account will affect eligibility for financial aid. Often the original motivation for the account was college savings. Ironically, using UTMA to put college savings in your child's name can make it more difficult to finance higher education, because the financial aid formula in effect imposes a penalty for assets owned by the child.

There's a third reason for UTMA regret. Sometimes the parents put a good chunk of money into the account and then find that they need it. Maybe they're trying to come up with a down payment for a new home. Possibly they've simply run into hard times. It's hard to stare a legitimate financial need in the face knowing the cash you need is sitting right there in the child's account.

Another problem that sometimes comes up: parents set up an account for one child and now there are other siblings. If the parents don't have enough wealth to establish comparable accounts for the younger brothers and sisters, they're likely to regret having made the oldest child so wealthy.

Finally, I sometimes hear from people who simply had no idea what an UTMA account was until after they set it up. They thought it was a way of designating a future gift, which they could change at any time before control passed to the child. No one told them they were making a current, irrevocable gift when they transferred cash or other assets to the account.

Hawks and doves

When this issue comes up on our message board, it often provokes a harsh response from the experts. They'll tell you it's stealing if you try to take the money back. Dire consequences, perhaps even criminal prosecution, will follow if you abuse the account. Your actions may be seen as fraud by the IRS or whoever polices the student loan process.

These comments are made with good intentions by people who care about the integrity of these accounts and the rules that apply to them. Let me express firm agreement with the notion that UTMA accounts should not be abused. They exist as a way to transfer ownership of assets to children, not as a way to cheat creditors or the IRS. What's more, the fact that you are a parent doesn't give you a license to take for your own use property that belongs to your child.

I feel equally strongly that in nearly all situations where the parent expresses regret over an UTMA account, no abuse was ever intended. Banks, mutual funds and brokers will cheerfully set up UTMA accounts for you without providing any information whatever about what they are or how they work. There is no disclosure of the tax consequences, the effect on student financial aid, or even the simple fact that a transfer to the account is a  current, irrevocable gift to the child.

Furthermore, the parent nearly always has the child's best interests at heart when they're searching for a way to undo the UTMA account. Just look at the reasons I've listed above for UTMA regret. Is it evil to want to protect your child from wasting a valuable asset? Or to want to maximize the student financial aid available to the child? How about correcting an honest mistake?

I'm not suggesting that parents should be free to unwind UTMA accounts whenever they want. The exact opposite is true. For tax reasons and other reasons, it's important to respect the integrity of UTMA accounts. Yet the parent/custodians who suffer from UTMA regret generally deserve better than to be branded war criminals. I think of them as ordinary folks who made a mistake and now want to know what, if anything, they can do about it. That is the premise for the rest of my discussion.

Examine your motives

Before you move forward with an attempt to deal with UTMA regret, try to see the issue from all angles. Especially when dealing with your own child, you don't want to appear selfish or dishonest. There's more at stake than the money: there's also the question of what you're teaching the child with your actions. Sometimes the best approach to a mistake is to admit you made it and move on.

If, after reflection, you feel that corrective action is desirable, there are a number of approaches to choose from. My next column provides pros and cons for some of the possibilities.