A Comparison to Trusts

When planning for a minor's financial future, one of the primary concerns is ensuring that assets are managed responsibly until the child reaches an appropriate age. Two common ways to transfer wealth to minors are through the Uniform Transfers to Minors Act (UTMA) and Trusts. While the UTMA provides a relatively straightforward mechanism for transferring assets, it comes with limitations that may make a Trust a more flexible and protective option in certain situations.

What is the UTMA?

The Revised Code of Washington (RCW) Chapter 11.114, known as the Uniform Transfers to Minors Act (UTMA), provides a legal framework for transferring assets to minors without establishing a formal trust. Instead, a custodian manages the assets on behalf of the minor until they reach the age of majority, which in Washington State is 18 years old. This can be beneficial for parents, grandparents, and other benefactors who want a simple way to leave assets to a child without setting up a trust.

Nomination of Custodian

Under RCW 11.114.030, an individual can nominate a custodian to manage assets for a minor. This nomination can be made through a will, trust, or other legal document and becomes effective upon the occurrence of a specified future event, such as the death of the nominator. The nominated custodian is responsible for managing the assets until the minor reaches the age of 18.

Transfer of Assets

Assets can be transferred to a minor under the UTMA through various methods:

• Gift or Exercise of Power of Appointment (RCW 11.114.040): An individual may make an irrevocable gift or exercise a power of appointment in favor of a custodian for the benefit of a minor.
• Will or Trust (RCW 11.114.050): A personal representative or trustee may make an irrevocable transfer to a custodian for the benefit of a minor, as authorized in the governing will or trust.
• Other Transfers by Fiduciary (RCW 11.114.060): In the absence of specific authorization, a personal representative or trustee may still make an irrevocable transfer to a custodian if it is in the best interest of the minor.
• Transfer by Obligor (RCW 11.114.070): A person who holds property or owes a liquidated debt to a minor without a guardian may make an irrevocable transfer to a custodian for the minor's benefit.

Eligibility to Serve as Custodian

According to RCW 11.114.090, the custodian must be an adult or a trust company. The selection of a custodian can be specified by the transferor or, in certain cases, appointed by a personal representative or trustee.

Powers and Responsibilities of the Custodian

The custodian holds significant authority over the custodial property:

• Control and Management (RCW 11.114.090): The custodian has the right to take control of the custodial property and manage it prudently.
• Investment Decisions (RCW 11.114.130): The custodian can invest and reinvest the custodial property as they deem appropriate, adhering to the standard of care that would be observed by a prudent person dealing with the property of another.
• Use of Custodial Property (RCW 11.114.140): The custodian may use the custodial property for the minor's benefit, including education and support, without court order and without regard to the duty or ability of the custodian, or any other person, in efforts to support the minor.

Accountability of the Custodian

While the custodian has broad powers, they are also accountable for their actions:

• Record-Keeping (RCW 11.114.120): The custodian is required to keep records of all transactions regarding the custodial property, including information necessary for tax purposes.
• Liability (RCW 11.114.170): The custodian is liable for any breach of duty or improper management of the custodial property.

It's important to note that the custodianship remains subject to the provisions of the UTMA even if there is a change in the residence of the transferor, minor, or custodian, or if the custodial property is moved out of Washington State (RCW 11.114.020).

Potential Risks of UTMA Accounts

While a UTMA account may seem like an easy solution, it does present some potential risks and drawbacks:

1. Lack of Control After Age of Majority
   Once the minor reaches 18 years old, they receive full control of the assets. At this age, many young adults may lack the financial responsibility or knowledge to handle a large inheritance wisely. Can you imagine what you would spend hundreds, thousands, or millions of dollars on at the age of 18? How long would the inheritance have lasted, or your health?
2. Impact on Financial Aid and Scholarships
   Assets in a UTMA account are considered the property of the minor while being managed by the custodian. This means they will be counted when determining eligibility for financial aid and scholarships, potentially reducing the amount of aid offered or available (think Medicaid eligibility). Make sure to involve a financial planner to ensure that leaving funds for your minor loved one to assist with their education is not having the unintended consequence of removing them from financial aid programs, or the ability to qualify for beneficial scholarships. 
3. Tax Considerations
• Taxes: Income generated by UTMA assets may be subject to the “kiddie tax”, meaning unearned income over $2,500.00 will be taxed at the custodian's tax rate.
• Gift Tax: Contributions to a UTMA account are subject to gift tax limitations, though they qualify for the annual gift tax exclusion.
4. Investment and Real Property Limitations
• The minor cannot legally make investment decisions until reaching 18 years old.
• Holding real property in a UTMA account can be complicated, particularly when the minor reaches adulthood and takes control. Property ownership comes with numerous additional responsibilities beyond financial.
5. Death of the Custodian
   If the custodian managing the UTMA account passes away before the minor reaches 18, the court may need to appoint a new custodian. This process can create uncertainty and administrative burdens. Additionally, the value of the UTMA account may be included in the custodian's estate, which could have unintended estate tax consequences.

How a Trust Offers Greater Flexibility and Protection

Flexibility

A Trust provides a more structured and customizable approach to managing and distributing assets for a minor's benefit. Key advantages of using a trust instead of an UTMA account include:

1. Extended Control Beyond Age of Majority
• Unlike UTMA accounts, a trust can specify when and how a minor receives distributions (e.g., at ages 25, 30, or in installments). Trusts can be as detailed, or vague, as the creator would like them to be. Should you wish to establish a Trust that only disburses funds to your minor child upon reaching age 25, earning a Bachelor's degree in Art, and performing (or attempting to perform) a handstand across the stage to receive their diploma!
2. Greater Protection for Financial Aid Eligibility
• Assets held in certain types of trusts, like an irrevocable trust, may have a reduced impact on financial aid calculations compared to UTMA accounts.
3. Tax Efficiency
• A trust can be designed to minimize estate and gift tax consequences, as well as provide strategic tax advantages for income earned by the trust assets.
4. Customized Investment Strategies
• Trustees can make long-term investment decisions tailored to the minor's needs, rather than handing over control at age 18.
• Real property and complex investments can be managed without risk of early liquidation.
5. Protection from Creditors and Poor Financial Decisions
• Unlike a UTMA account, where funds belong directly to the minor, a trust can safeguard assets from creditors and/or lawsuits due to personal or financial irresponsibility or negligence.
6. Death of the Trustee vs. Death of a Custodian
• If a trustee passes away, a successor trustee (already designated in the trust) can seamlessly take over management without requiring court intervention.
• A well-drafted trust ensures the continuity of financial management. In a UTMA account, a court may need to intervene upon the custodian's death and there is a delay in the administration process of the management of said UTMA account. Any delay is potentially problematic, as bills and general care need to be taken care of for your minor child as initially intended.

UTMA vs. Trusts in Washington State

While UTMA accounts offer simplicity and a straightforward way to transfer assets to minors, they come with inherent risks, including lack of long-term control, financial aid implications, and tax considerations. By contrast, a well-structured Trust provides flexibility, protection, and strategic tax advantages, making it a more effective solution for managing substantial assets for minors.

For parents and guardians looking to make informed estate planning decisions, understanding these differences is crucial. Consult with our estate planning attorneys and help ensure that your assets are managed and transferred in the best interests of the minor, while minimizing risks, and maximizing financial security.