The basics of custodial gifting
Whether it’s for a birthday, holiday, or other special occasion, parents, grandparents, and other adult family members and friends love to give gifts to their children in their lives. When does it make sense to give a custodial gift?
What is a custodial gift?
A custodial gift is an easy, efficient way for a gift-giver to give money or property to a minor with the security that the gift will be managed and invested wisely. Also, the custodial gift can be made without the expense and complexity of a trust. The mechanics of the transfer are relatively simple.
The gift-giver (donor) transfers money or property to a named custodian. The adult acting as the custodian holds, manages, and invests the property for the minor’s benefit until the minor reaches the age of majority. This age may vary from state to state. Also, even though a child may be deemed an adult under the law at age 18, some states require that the money or property remain in a custodial arrangement until age 21.
What are the rules?
Since a formal trust with investment powers does not exist, the custodian should look to state law to determine custodial property guidelines or restrictions. In all states except South Carolina and Vermont, the custodial account is structured under the state’s version of the Uniform Transfers to Minors Act (UTMA) South Carolina and Vermont still use the Uniform Gifts to Minors Act (UGMA) as the basis of their laws.
Although the custodian has the account title, the property belongs to the minor. The property shouldn’t be used to pay for expenses (such as food, clothing, and shelter) that the child’s parent or legal guardian normally would be required to pay for. The usual goal is to preserve the account until adulthood. When the child reaches adulthood, he or she may have the right to demand an accounting from the custodian of how the money was invested and managed.
The most common custodial arrangements involve cash accounts, brokerage accounts, and life insurance on the life of the minor or someone else, such as a parent. Ownership and beneficiary designations should always be checked with the appropriate financial institution.
If the minor is the insured, the minor’s estate is the beneficiary of the insurance policy. If someone other than a minor is the insured, then the beneficiary is a custodian for the benefit of the minor.
Custodial accounts should not be established for large amounts of property. Why? Because the minor generally obtains ownership of the account at age 21. Although an adult, a 21-year-old may not have the financial maturity to invest and manage money wisely. Instead, with larger cash gifts or life insurance, it is prudent to consider using a trust that can prevent distributions until the child is much older.
There are two additional factors that are also important to consider in advance:
1. Large custodial accounts may adversely impact financial aid options for college.
2. The custodial account may be subject to the gift tax, which is a federal tax on transfer of assets from one person to another, according to the IRS.1
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