Saving for a Child's Future?
Trust Is No Simple Matter
By Albert B. Crenshaw
(c) The Washington Post
Sunday, January 14, 1996; Page H01
It is difficult to pick up a magazine or newspaper these days without seeing something -- an article
or an advertisement -- urging families with young children to begin saving for the youngsters' future.
Few families would argue. College costs, the need for a nest egg to get started in life and the
general economic uncertainty of the times all lend urgency to the message.
But assuming a family has enough income to set some aside -- no small assumption these days --
how should the money be held? Should the savings be in the parents' name or in the child's? What
about a trust?
There are a number of alternatives, each with advantages and disadvantages, and parents, even
those who expect their savings to be modest, should give the subject some thought.
Taxes are a consideration, of course. But so are the child's legal rights to the money -- do you
want to risk seeing the tuition money go for a sports car? There's even college financial aid to
The simplest approach is for parents to save in their own name. This gives them complete control
of the money, and enables them to use it for other things, such as their own retirement, if the child
decides not to go to college, gets a scholarship, or for some other reason doesn't need the money.
In addition, rules for federal student aid -- followed by many colleges for their own aid packages
-- require that a student make available 35 percent of his or her assets for tuition each year. Over
four years, about 85 percent of the student's money would be eaten up. Parents, on the other
hand, are expected to contribute a much lesser portion, and there are protections for retirement
Thus, parking money in the child's name as a tax advantage might not seem like such a great idea if
the family wants student aid. "We often hear that from parents -- That wasn't the kid's money, that
was my money,' " said Patricia McWade, dean of Georgetown University's office of student aid.
Hanging onto the savings, though, means that interest, dividends and other gains are taxed at the
parents' rate, and were the parents to die, the savings would be included in their estate for tax
purposes. For these reasons, many parents opt to put the money into the child's name or in a trust.
Putting money in the child's name is the easiest and cheapest, but in the long run, the parent has
less control that way. Which is right depends mostly on the family situation, said Robert B. Coplan
of the accounting firm Ernst & Young in the District.
The deciding factor for most people "is the amount of control they have over their property."
Here are some of the options:
Custodial accounts. State laws permit parents to open bank, brokerage or mutual fund accounts in
the child's name and name a custodian to oversee the funds. Each parent can give as much as
$10,000 to each child every year without incurring gift tax, thus allowing a couple to shift $20,000
annually to each of the offspring -- more than enough to cover most family transfers.
Custodial estates are regulated by state law. In some jurisdictions, such as the District, the
operative law is the older and more restrictive Uniform Gifts to Minors Act (UGMA), and in
others, including Virginia and Maryland, the Uniform Transfers to Minors Act (UTMA), which is
UGMA accounts are largely restricted to bank accounts and public securities, said Frederick J.
Tansill of the law firm of Verner, Liipfert, Bernhard, McPherson and Hand, whereas UTMA
accounts can be used to invest in almost anything, including a family business or real estate. In the
cases of both kinds of accounts, though, custodial accounts are easy to set up without a lawyer or
accountant and there are no drafting or other costs associated with them, as there would be with a
However, the money becomes the child's outright at age 18 or 21, depending on the law.
Tansill noted that under the gifts act, the money becomes the child's outright at age 18. "They have
complete power and authority, and the risk is your high school senior is going to take it and buy a
motorcycle," he said.
In contrast, under the transfers act, "you can write on it hold to age 21' " and keep it out of the
youngster's hands until he or she is likely to be a college junior or senior, Tansill said. Twenty-one
is as far as you can go, however.
Parents often make themselves the custodian, and usually there is no problem. However, experts
caution that if the amount in the account grows large, or is likely to, it's a good idea to have
someone other than yourself as the custodian. If you die before the child takes control of the
money, it can be kicked back into your estate and might be subject to very high taxes. If this
situation is likely to arise, it's worth consulting a tax expert about choosing the custodian.
In both types, though, the money belongs to the child and at no time can the parent have a change
of heart and take it back.
Earnings in a custodial account are taxed at the parents' rate if they exceed $1,300 and the child is
under 14 -- the so-called kiddie tax, enacted by Congress in 1986. Thus, it is a good idea to
invest the funds in growth assets, such as stocks, that gain in value but do not generate much cash
income, at least until the child turns 14, Tansill said.
2503(c) "Minor's Trust." Named after a section of the tax code authorizing them, these trusts allow
parents to keep money out of the child's control until age 21, and if he or she agrees, even longer.
For a gift to qualify for the $10,000 annual gift-tax exclusion, it has to be a "present interest" -- the
immediate right to the asset. Thus, the gift of the right to have money in the future usually doesn't
However, under Section 2503(c), a gift to a trust established for a minor does qualify if the child
has a right to the money at age 21. In turn, that right of access can be restricted to 30 days after
the child turns 21, and if it is not exercised, the money remains in the trust as long as the parent
These trusts can invest in most assets, can be partners in things such as real estate ventures or a
family business -- useful features for residents of UGMA states. Income can accumulate in the trust
or be distributed to the beneficiary.
There are two important disadvantages to these trusts. First, there are the lawyers' fees and other
costs of setting them up and administering them. Second, they are taxed at trust rates. These rates
are the same as for individuals, but the brackets were greatly compressed by Congress a few
years ago. As a result, trusts pay 28 percent on income over $1,550 and hit the top bracket of
39.6 percent at $7,650 of income.
2503(b) Trust. This trust allows you to keep the assets locked up until the child is well into
adulthood and still qualifies most of your gift for the gift-tax exclusion. The trust is required to pay
out its income each year, either to the child directly or to a custodial account where it could be
accumulated or used for the child's benefit.
The right to the income qualifies as "present interest"; the remainder would be subject to gift tax.
The value of the right to the income is calculated based on the age of the recipient and current
interest rates. According to Ernst & Young, if you put $10,000 into one of these trusts for your
3-year-old in November to be held until the child turned 40, about $9,300 would qualify for the
gift-tax exclusion and $700 would be subject to gift tax.
This device is useful for housing some unusual asset, such as shares of a family business, that the
parent would want out of his or her estate but not completely in the child's hands. These trusts can
hold assets for as long as you want; there is no requirement for access at age 21, as there is with a
2503(c) trust. And since the income is paid out, the trust tax rates are not an issue.
The disadvantage of the 2503(b), in addition to the setup costs and kiddie taxes, is that distributing
the income might limit growth of the trust principal, which is not usually desirable.
Crummey Trust. Named after a court case, this trust provides a way of qualifying your gift for the
tax exclusion, but requires cooperation from the child.
By giving the child a 30-day right each year to withdraw that year's gift, the parent converts the gift
to a "present interest" and gets the exclusion. These withdrawal rights are called "Crummey
powers," which the child is supposed to waive each year in writing.
Obviously, when the child gets older, he or she might decide not to waive the withdrawal and take
the money, but the parent is not without leverage: "As soon as the child does what he's not
supposed to do once, nothing else goes into the trust," if the parent so deems, said Ernst &
Once the power has been waived or lapses at the end of 30 days, assets may remain in the trust as
long as the parent has specified, with no age limit. The parent can be the trustee with powers to
make distributions from the trust for the benefit of the child long after the child has grown up.
In addition, Coplan said, after the withdrawal rights have lapsed, the Internal Revenue Service
views the assets as taxable to the power holder -- the child -- and not the trust. This can be a
considerable tax advantage to the parent if the child is 14 or older and has little other income.
As with all trusts, there are the setup and maintenance costs, and in the case of a Crummey trust,
there is the cumbersome annual waiver, plus the chance that the child will not cooperate.
Verner Liipfert's Tansill said where UTMA accounts are available, they are adequate for most
people. Where they are not, or in more complicated cases, he recommended a custom trust drawn
up by a lawyer to fit the exact circumstances.