Setting up a child trust fund provides the opportunity for parents or grandparents to purchase stocks, bonds, mutual funds, and life insurance policies that can be transferred to minor children when they reach legal age.
Assets are placed into a child trust fund because minor aged children are not allowed to enter into contracts. The most common type of trust for children under 18 years of age is a custodial account.
Custodial accounts are governed under the Uniform Gift to Minors Act (UMGA) or the Uniform Transfer to Minors Act (UTMA). UGMA lets minors own securities while UTMA lets minors own other kinds of property including real estate.
With custodial accounts, children are allowed to withdraw funds at trust termination. The age varies by state, but ranges between 18 and 21. Once funds are contributed to custodial funds they become irrevocable and belong to the child.
Another popular child trust fund is the 529 Plan which is used as a college trust fund. This type of trust is not subject to gift tax and oftentimes offers unsurpassed tax breaks for donors.
529 Plans are education savings accounts operated by the state in which it is opened. Some states offers different kinds of college savings trusts, so it’s recommended to talk with a lawyer to determine which kind of trusts are best suited and applicable in your state of residence.
There are two types of 529 Plans which include savings plans and prepaid plans. Savings plans are similar to a retirement plan because contributions are invested in mutual funds or other types of investment products.
Prepaid plans let donors pre-pay all or part of educational costs for in-state college tuition. These plans can be converted if funds are used for out-of-state colleges. Additionally, a Private College 529 Plan can be established to pre-pay tuition at private colleges.
Testamentary trusts can be established to hold property and cash until the child reaches legal age. This type of child trust fund is referred to as a minor’s trust, or a 2053(c) trust. Minor’s trusts let parents contribute up to $13,000 of tax-free income which does not have to be reported to theIRS.
With that said, minor’s trusts have to be qualified by making the minor the only beneficiary. Distributions do not occur until the child reaches age 21. However, the trust can be gifted to others in the event the beneficiary passes away prior to turning 21 years of age.
It’s recommended to appoint a Trustee other than the parents to oversee the trust. When parents are Trustees of minor’s trusts and pass away prior to distribution, funds in the trust could be included in their estate and subject to estate tax.
Creating trusts for children offers parents and grandparents opportunities to provide tax-free money while obtaining tax deductions for their self. However, it can also lead to tax consequences if trusts are not qualified.
It is always a good idea to consult with an estate attorney to learn how to maximize distributions and lessen taxes assessed on trust income and capital gains. Professionals can advise of ways to setup trusts to cover costs of college education or provide funds when children reach milestones throughout their life.
At Craton, Switzer and Tokar we work closely with clients to help them establish the best type of child trust fund for their financial situation. Providing funds for children’s education and to improve their long-term financial status is one of the greatest gifts any parent or grandparent can give. Call us today and let us show you how easy it is to get started.