UTMA Regret: When Custodial Accounts Turn Sour
By Kaye A. Thomas
Current as of July 8, 2016
Many people end up wishing they hadn’t created custodial accounts for minors. Here are some of the reasons, and ideas for dealing with the situation.
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?
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
People have various reasons for wishing they could undo the decision to fund a custodial account. In some cases, the remedy will depend on the reason for the regret.
Student financial aid. One of the most common reasons 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 on assets owned by the child.
In many cases, an effective remedy is to cash in the custodial account and put the money in a 529 account. For purposes of determining ownership and control, the funds continue to be custodial assets governed by UTMA, but the financial aid formula will treat the 529 account as a parental asset, with more favorable results. If this seems like a possible plan, read our series of articles on transfer of a custodial account to a 529 plan. Otherwise, read on for a discussion of other ideas.
Protecting the child’s money. Another common motivation stems from a realization that the child has reached the age when control passes without attaining the maturity to handle a large sum of money. When your child is 8, you may 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.
In this situation, the parent or other custodian isn’t trying to deprive the child of this wealth. On the contrary, the goal is to protect the money for the child’s benefit, until he or she is mature enough to use it wisely.
Special needs. If your child has special needs, the existence of a custodial account may be an obstacle to receiving governmental aid. In this situation you would rather see the money in a special needs trust or an ABLE account.
Siblings. Sometimes parents set up an account for one child before more children come along. Depending on the size of the account and the parents’ current circumstances, it may not be desirable, or even possible, to create accounts of equal size for the younger siblings. Yet custodial accounts have only one owner; there’s no way to make it a joint account among multiple minors.
Parental need. 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.
Misunderstanding. 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.
Pause for reflection
Some of the motivations listed above involve protecting the child’s assets — and others involve depriving the child of assets. You may feel that the circumstances justify such an action, but my advice is to give the issue some careful thought before moving forward. 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.
Next: UTMA Regret: Strategies