Reviewed or updated July 8, 2016
Here are some more strategies for dealing with a situation where you regret having set up a custodial account under the Uniform Transfers to Minors Act.
Illiquid investments
If your UTMA regret springs from a fear that an immature child will waste the assets of the account, one possible solution is to put the money in an illiquid investment. The idea is to comply with the law by turning custodial assets over to the child, but make it difficult, for the time being at least, for the child to convert the assets to cash that may be wasted. Some people have used family limited partnerships; more recently I have heard of annuities being used for this purpose. These ideas can be effective, yet they raise tax and legal issues:
- Is this just a transparent way to defeat one of the basic requirements of the Uniform Act? If so, is it possible a court will require the custodian to replace the illiquid asset with a liquid one — perhaps even from the custodian’s own assets, if it isn’t possible to unwind the existing investment?
- Is this a violation of the duty of the custodian to invest the assets in an appropriate manner for the benefit of the minor? If so, is it possible a court would declare the custodian personally liable for the poor performance of this investment?
- Does this action cast doubt on whether the original transfer was a gift of a present interest for gift tax purposes? If so, does that mean the annual gift tax exclusion is not available for the transfers?
These are questions, not answers. Most people who use this technique are trying to preserve assets for the benefit of the minor rather than trying to do something improper. And the possible problems mentioned above may come up rarely or never. Still, it’s worthwhile to think about these issues, as well as the issue of having your child feel he or she was cheated out of an opportunity to gain access to what was rightfully his or hers.
Return gift
Suppose your child wants to make a handsome gift to someone who has helped her a great deal. A rare book costing $150 for an inspirational teacher, for example. I don’t see why the child can’t make that gift, and I don’t see why you couldn’t provide the money for that gift from an UTMA account. You’re allowed to transfer money from the account to the child even before the child is 18.
Can we extend that thought to the possibility of the child making a gift of the entire account — to you? Your child might be willing to do this if she sees that you are in need, or if she expects to receive gifts from you in the future. But is this a valid way to undo an UTMA account?
The answer may depend on circumstances. If you and your child are collaborating on an attempt to cheat on a student financial aid application, you may be buying some trouble (student aid fraud can be a criminal offense), and you’re certainly teaching your child an unfortunate lesson. The answer could be different in other circumstances, for example, if the reason for the transfer is to help the family through an unexpected financial crisis.
Note: In some states, the custodial account may continue until the child turns 21, even though the child is legally an adult at age 18. Presumably an 18-year-old’s consent would be valid.
If you’re talking about a lot of money, it’s a good idea to consult with a lawyer. For one thing, a gift tax return may be required for a transfer of more than $14,000. For another, unless a guardian has been appointed for the special purpose of providing the consent, the child may be entitled to rescind the gift upon reaching the age of majority. It’s best to understand the legal consequences and document your actions properly.