Twice in the span of a week I was asked my thoughts on titling of children’s assets. It wasn’t asking how they should invest their children’s investments, or more specifically, their clients’ children’s assets, but rather how should the accounts be actually titled. I am of the opinion that money can do good things and money can do bad things, so the actual titling of the assets is a very important issue to consider.
It should be noted that even the term “children’s investments or savings” may have different meanings to different people. In my particular case I am referring to money that I am gifting my son (i.e. I am not looking for it back), and gifts made to him by others wherein they felt it was alright for me to keep tabs on it for the next two decades (at least two decades – as discussed below).
What is a Uniform Transfer to Minor’s Account?
An UTMA account is one which a custodian operates a child’s savings or investments, or as investopedia puts it,
An act that allows a minor to receive gifts such as money, patents, royalties, real estate and fine art, without the aid of a guardian or trustee. Under UTMA, the gift giver or an appointed custodian manages the minor’s account until the latter is of age (usually 18 or 21). The Uniform Transfer to Minors Act also shields the minor from tax consequences on the gifts (up to a specified value).
It is a very simple and natural way to set up the account. The common thought process is, “It is their money I’ll act as some type of fiduciary-custodian for it and when he or she hits 21 it is theirs.” However, I don’t believe that is in the best interest of the child.
Why I Don’t Like UTMA Accounts
There is one minor reason and one very major reason why I dislike that type of set up (as well as the UTMA’s cousin the 2503(c) trust account). The minor reason has to do with college planning. Under current law assets in an UTMA are counted as a student’s assets for purposes of financial aid (as opposed to a parent’s assets). When calculating eligibility for financial aid it is much more detrimental to have assets in a child’s name. This is a huge deal for most. So why is it a minor one reason? Only because the next reason I dislike UTMAs is so much more important.
In most states the UTMA becomes the property of the child at age 21 (there are a few States which have held onto the 18 age). Do you think “21 year old you” should have received any amount of money? How long do you think you would have held on to it before it was gone? Maybe it is because I am surrounded by children under the age of 5, but this seems like a much more pressing issue than financial aid planning.
How I have Titled My Son’s Assets?
My son’s savings account is titled jointly between The Wife and I (and appropriately and clearly labeled as such in our easy to use Capital 360 Account) while his investment account is titled in my name alone. The investment accounts I set up for my nieces are set up in my name with one of their parents as beneficiary should I prematurely predecease (the parents also get a copy of the statements). This type of arrangement only works if you really see yourself as a fiduciary in the strictest sense of the word.
My goal one day is to use the accounts as either teaching tools or to hand over clear and free one day, but that day will be when The Wife and I decide he is ready (or in the case of my nieces – when their parents decide).
The obvious negative regarding this type of set up is that I’ll be paying tax on those investments until control is fully relinquished. Unfortunately, the accounts aren’t large enough to worry about the unrealized gains just yet (and the way the kiddie tax laws are set up right now it isn’t going to matter all that much in the future).
How have you titled your Children’s Savings and Investments?
Maybe I’m missing a more legal definition of “titling”, but I’m thinking of the label that my bank account allows me to give his savings account.
I’m more interested in whether we should be investing this money. At the age of 21 months, he doesn’t have much use for it. It’s all gifted money (he’s not earning much of an income yet) that didn’t come with instructions.
“Maybe I’m missing a more legal definition of “titling”, but I’m thinking of the label that my bank account allows me to give his savings account.”
– Exactly what I mean.
“I’m more interested in whether we should be investing this money. At the age of 21 months, he doesn’t have much use for it. It’s all gifted money (he’s not earning much of an income yet) that didn’t come with instructions.”
– I wrote this a few years ago:
http://myjourneytomillions.com/articles/how-i-invested-my-childs-money/
For me leaving it in cash seemed like the wrong thing to do. Of the course of the next two decades inflation will destroy the generous gifts made to him. Similarly, putting it into the next big tech stock seems irresponsible at best. In the end I chose two low expense ETFs creating a 70/30 blend. Since that post I also bought some Disney in his account (which as the post indicates is titled solely in my name).
I like that 70/30 blend idea. I may grant the kids some downside protection if there’s a crash that never recovers. This why there is really no way that they lose the gift, but they can learn how awesome daddy was to take advantage of this thing called compound interest.
Good article,
I thought about the same issues when I became a father. Everyone kept telling me that I should setup a children’s savings account and a 529 account for college, but believe both options were bad for the reasons you pointed out above and because 529 investment options are so limited. I can do a better job managing the funds myself until my kids can prove that they are fiscally mature. Yeah, I’ll get hit with more taxes, but I also have more deductions than my kids do.
For what it is worth, each State’s 529 is a bit different. For New York if you use the direct option we have a basked of cheap vanguard funds which is nice.
Interesting insights.
Have you thought about setting up a Roth for them? Or even a traditional IRA? If the money to be transferred to them at some future is in an IRA, would it be counted against the kid when it comes to college funding?
And what if it’s in a trust? How does that affect the chase for financial aid?
Some years ago, I did set up a Roth for my son. It grew pretty nicely. He used it to help purchase his first house — as it develops, that is one of the reasons you can withdraw money from a Roth without penalty.
So, let’s say sheltering gifts of money in a Roth would shelter it from college financial aid scrutiny, but, once the financial aid was procured, you could then use it to buy a condo for the kid, thereby covering the cost of housing while at college and possibly leaving him with an asset he could convert to a rental or sell at a profit. Would that work, or am I out in left field?
I’ve thought about opening a Roth IRA for my son, but the money has to come from earnings, not from a gift. It is hard to find any legitimate earnings for a 22-month old kid. Modeling is about the only thing I can think of.