New Yorkers who wish to create a nest egg for minor loved ones have a variety of choices—from Uniform Transfers to Minor Accounts (UTMAs) and NY 529 College Savings Plans (529s) to trust funds—but how is a generous donor to navigate the options? A brief discussion follows.
UTMAs are inexpensive to create and offer flexibility in how funds are spent, yet this lack of structure is problematic if the child is irresponsible: Once the minor turns 21, they can withdraw funds for any purpose. Additionally, these monies, now the child’s property, can adversely affect their eligibility for financial aid and are reachable by their creditors. Transfers to UTMAs are also irrevocable: The gift cannot be reversed nor can the beneficiary be changed.
529s, which are managed by Vanguard in NY and designed to finance higher education (e.g., college tuition, room and board), provide more structure. The contribution limit is $520,000, and these tax-deferred funds may be used for “qualified” expenses, such as eligible public and private universities, vocational schools, and apprenticeship programs. Unqualified withdrawals, however, like those for K-12 expenses, are subject to State and federal income taxes as well as a 10% federal penalty. Although the beneficiary can be changed if the original beneficiary doesn’t attend college, when there’s no other eligible beneficiary or you move outside of NY, taxes and penalties abound. Notably, 529s owned by a parent still count as assets for their child’s financial aid eligibility.
An Irrevocable Trust (IT) offers a happy medium. The IT’s creator delineates how funds are used (e.g., for any legal purpose including the child’s health, education, maintenance, and/or support) and the age at which the child receives funds outright. Alternatively, the trust may continue for the child’s lifetime or until a certain event occurs. Where the IT provides for an outright distribution at a particular age but it’s not in the child’s interest to distribute the funds at that juncture (due to substance abuse issues, divorce, bankruptcy, etc.), the Trustee may withhold them. Indeed, the assets are protected from claims by the child’s creditors as well as those by creditors of the IT’s creator. Conversely, if the child fiscally matures before the age of outright distribution, the Trustee may release the funds sooner.
IT funds aren’t restricted to use for higher education, but can be allocated to K-12, trade school, business ventures, downpayments on a house, or travel. Also, where 529s are limited to Vanguard’s investment offerings, no such limitations exist with ITs. An IT isn’t tax-deferred but can be drafted so its creator is responsible for paying income taxes on dividends and interest generated by trust assets at their personal income tax rate, avoiding higher trust tax rates and allowing the assets to grow without payment of income taxes.
There are many factors to consider when choosing a vehicle to plan for your minor loved one’s future, but the IT, superior in balancing structure with flexibility, can be customized to address the ever-changing needs of a child/grandchild without compromising the values of the donor.
