By Kaye A. Thomas
Current as of July 8, 2016
There are many possible strategies for dealing with an unwanted custodial account for a minor.
Just take it
This is not much of a strategy, but as a practical matter, probably the most common way people deal with UTMA regret is simply to pull the money out of the account and divert it to some other purpose. The financial institution where the account is maintained rarely asks any questions. For all they know, the custodian is withdrawing the money to turn it over to the minor or spend it for the minor’s benefit. The Uniform Act includes language protecting the financial institution from liability when they act in accordance with the custodian’s instructions unless they know the custodian is acting improperly.
Although the financial institution is protected, the custodian is not. In the absence of extraordinary circumstances, it’s probably far-fetched to suggest that the custodian has to worry about criminal prosecution. From time to time, though, custodians face lawsuits for failing to comply with the Uniform Act. Legal action may be taken by the minor or by someone acting on behalf of the minor (sometimes the other parent, if this happens during or after a divorce). If the minor has creditors, they could have a claim against the custodian. If the IRS learns of the transaction, it could have tax consequences, too.
Apart from the risk of legal liability, the custodian should consider the consequences in terms of family relationships. Taking money that legally belongs to a child could result in permanent estrangement.
There may be times when this approach seems to be the least evil alternative. I won’t suggest that raiding a custodial account can never be morally justified, but too often the justifications offered for this action are mere rationalizations. This strategy can be the most practical one, but rarely is the most ethical one.
Transfer to trust
Now let’s meet Sara. When she set up an UTMA account for Philip, she imagined that college expenses would eat up the entire account and then some before Philip turned 21. But he dropped out of college after a single semester, when the account still had over $28,000. Since then the account has grown to $37,000 and Philip has had a succession of low-paying jobs, generally of the type that won’t interfere with his social life or his desire to sleep until noon. His only apparent ambition at this point in life is to destroy his parents’ eardrums with indescribably horrible music.
Philip will grow up, eventually, and do something useful with his life. Sara feels quite strongly, though, that turning over the $37,000 that’s in the UTMA account at this point isn’t the right thing to do. Apart from the likelihood he would waste the money, this amount of wealth will destroy whatever minimal incentive Philip now has to be productive. Sara wants him to have the money, but not now. The answer may be a trust.
I generally encourage anyone who is planning to transfer a large dollar amount to a child to consider a trust before setting up a custodial account. It rarely makes sense to put tens of thousands of dollars into a custodial account. The cost of setting up a trust is often quite small relative to the benefits it provides in comparison to an UTMA account when the dollar amounts being transferred are large.
Once the money is in an UTMA account, though, there are some tricky legal issues in trying to get it into a trust. Even if your child will consent to the transfer, the consent of a minor may not be valid. You may not be able to get your child’s consent; you may not even want the child to know what you’re planning. There may be other issues as well, including transfer tax issues. These issues are the province of a knowledgeable estate planning lawyer.
Some of the issues may depend on the laws of your particular state. Be prepared to learn that you can’t properly transfer the UTMA account to a trust. Okay, then, what if I do it anyway? I don’t think Philip is going to sue me. If he does sue me and ends up with the account, I’m no worse off than I am now. What else can happen? These are the kind of tough questions to ask your lawyer.