Transfers To Minors–How To Get The Outcome Your Clients Want

The parent who leaves his son enormous wealth generally deadens the talents and energies of the son.

–Andrew Carnegie

By John J. Scroggin

The client was furious. For over 20 years he and his son had placed money in a custodial account for the benefit of his grandson. The child had flunked in and out of college for several years and was now in the grandfathers office at age 21 demanding distribution of the $220,000 in his custodial account. His purpose? To travel to Europe to discover himself over the next year.

The client had also received a letter from his grandsons attorney demanding distribution of the funds. I told the client that he had no legal choice but to distribute the money. Unfortunately, the money did exactly the opposite of what it was intended to do. Instead of encouraging the child to attend college, it provided him the resources to leave school.

As planners we often tell our clients of the tax advantages of passing gifts to children and grandchildren using the $10,000 ($11,000 in 2002) annual exclusion. Many clients have placed these gifts in custodial accounts under either the Gift of Minors Act or the Transfers to Minors Act. In many cases (i.e., because of the significant distributions and/or investment return on these assets) the value of these custodial accounts are significant.

Unfortunately, both of the foregoing acts require the distribution of the custodial assets to the custodial ward by age 21. Many 21-year-olds such as my clients grandson do not have the maturity or skill-sets to handle such funds.

In order to provide greater administrative flexibility than is available in custodial accounts, many clients have set up minors trusts under Internal Revenue Code Section 2503(c). Unfortunately, such trusts also require the distribution of the trust fund to the trust beneficiary no later than age 21, creating the same distribution problem as a custodial account.

What is the alternative? For years we have used Crummey withdrawal rights to fund irrevocable life insurance trusts. This same approach can be used to create a Crummey Minors Trust. These trusts offer a number of benefits over both custodial accounts and 2503(c) trusts, including:

1.) While a custodial account and a 2503(c) trust can only have one custodial beneficiary, a Crummey Minors Trust can have multiple beneficiaries, each of whom has a separate Crummey withdrawal right–increasing the total gifts to a common trust fund. For example, suppose parents want to pre-fund their childrens college education. With a Crummey Minors Trust, if one child did not attend college, the funds could be used for the benefit of other children who did, effectively terminating the beneficial rights of the child who decided not to attend college.

2.) The Crummey Minors Trust allows the trusts creator to delay corpus distributions until after age 21, giving the trustees the ability to delay distributions until the trust beneficiary has matured. For example, the trust grantor can set the manner in which a beneficiary will receive any corpus distributions from the trust, such as one-third at ages 25, 30 and 35, or distributing all of the trust funds equally to the children when the youngest child reaches age 25.

3.) Few children under 21 contemplate the drafting of a will. Morever, in many states there is a minimum age for the creation of a will (e.g., age 14 in Georgia). With a custodial account, the parent/donor may be the sole or primary intestate heir of a deceased child. IRC section 2503(c) trusts require that the trust fund either be paid to the estate of the child or be subject to a general power of appointment–effectively moving the asset into the childs estate. Unlike custodial accounts or 2503(c) trusts, the creator of a Crummey Minors Trust can provide that the trust assets never revert to grantor.

In those states in which the state inheritance tax is not tied to the federal state tax credit (because of the 2001 tax bill this will be a growing number of states), the assets in the custodial account or 2503(c) trust could be subject to a state inheritance tax. A properly drafted Crummey Minors Trust can avoid the imposition of this tax.

What are clients to do when they have already created significant value in a custodial fund or a 2503(c) minors trust? They cannot transfer those funds into a trust that delays distribution beyond age 21. The law simply does not permit such a transfer. However, there are a couple of opportunities, including the following:

1.) The client might provide that all future gifts be made through a Crummey Minors Trust and then deplete any existing custodial or trust accounts in funding distributions for the child. Obviously, the client needs to be careful not to make distributions that satisfy the parents legal obligations of support for the child. If funds are used to satisfy a parents support obligation, the IRS may rule that the parent is taxed. For example, in Brooke v. United States 468 F2d 1155 (9th Cir. 1982), the court ruled that because the custodian was required by local law to use the custodial income to provide for the support of the donors child, the donor was taxable on the income received by the custodian. A distribution might be made for other purposes, such as private school, first car or college education. By depleting these accounts first and not touching the Crummey Minors Trust, the impact of potential distributions at age 21 can be reduced.

2.) The client (if permitted by state law) might consider transferring the assets in the existing accounts into an investment that is not readily liquid, reducing the childs capability of obtaining cash at age 21. For example, the funds might be placed in a family partnership with other family investments or might be invested in the co-ownership of real property. The custodial manager or trustee will have to be careful, though, that they do not place additional restrictions on the funds that inherently delay the use of the asset beyond age 21.

Most transfers to a minor are made with the intent of helping to fund education or other worthwhile efforts for family members. But without careful planning, the transfer may actually create a different outcome–to the harm of the heir and the consternation of the donor.

John J. Scroggin, J.D., LL.M. is an estate planning attorney in Roswell, Ga. and author of “The Family Incentive Trust,” published by The National Underwriter Company. He can be reached via e-mail at jeff@scrogginlaw.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.