Your parents love your children, their grandchildren. They want their grandchildren to remember them after they are gone. And they may want to help reduce some future financial burden for you. In a lightbulb moment, grandma and grandpa determine that they are going to leave some of their assets to their grandchildren. “What a legacy!” they think. They have nothing but your and their grandchildren’s best interests at heart.
As generous as this is, what does this really mean for you and your children. First off, it means that the money is really theirs (your children’s) … not yours, but theirs. This has different implications depending on the age of the child. For an adult child, this is great news! They can choose to use this inheritance however they choose … a new car, new clothes, college, an exotic trip, etc. If you worry that your adult child will go on a spending spree, they might and they can.
For a minor child, it’s a little different. Minors are not able to gift money to others so the inheritance must be held “in custody” for the benefit of the minor. There are two common options if the inheritance is cash or securities:
Custodial 529 College Savings account – the asset is considered to be the child’s asset, but an adult acts as the custodian. The funds must be used for education.
UTMA (Uniform Transfer to Minors Act) or UGMA (Uniform Gift to Minors Act) account – this is often set up at a bank or financial institution. An adult (often the parent) is listed as the custodian. When the minor child reaches the age of majority (18 or 21 depending on your state of residence), the assets must be handed over to the now-adult child to use in whatever manner they choose.
As the custodian of the account, you have a fiduciary duty to use these funds in the best interest of your child. (See “What is a Fiduciary?”) Fiduciaries must apply the Prudent Man Rule when determining how to manage assets. The Prudent Man Rule instructs the fiduciary to invest these funds as a prudent man would invest his own property addressing the following questions:
What are the current and future needs of the beneficiary?
Is there a need to preserve the original deposit?
What are the income needs (amount and frequency)?
Custodians of UTMA accounts cannot use the funds to purchase anything that is a parent’s responsibility to provide (food, shelter, clothing, medical costs, etc.). If these funds are mismanaged, misused or spent by the custodian, legal action can be taken against the custodian.
We are often asked how to position custodial assets so that they do not negatively affect a minor child’s ability to secure financial aid for college. Unfortunately, since the assets have been irrevocably gifted to the minor, they are the minor’s assets and must be disclosed as such.
It’s important to note that student and parent assets are counted differently on the Free Application for Federal Student Aid (FAFSA) when applying for student loans. Colleges expect families to use up to 20% of a student’s assets to pay for college education and up to 5.64% of parents’ assets. It makes a difference who owns the asset.
So, if your minor child has inherited assets, they must report it on the FAFSA as their asset, not yours. Of the two options mentioned above, an UTMA account will offer more flexibility than a custodial 529 account. For example, funds from an UTMA account can be used before applying for financial aid to purchase computers, attend summer camps, buy a car, or used for any expense related to college visits, etc. This will deplete the UTMA so that there are fewer assets reported on the FAFSA in the minor’s name. A custodial 529 account must be used for education and will be counted as the student’s asset.
As generous as an inheritance is, improper planning can negate all of the good intentions of the inheritance. If possible, try to find an opportunity to talk to your parents about their wishes. If they plan to leave money to your children, be gracious for their generosity and kindly explain the possible ramifications of gifting money outright to their grandchildren. There are legal tools that can be used to accomplish the same goals that may have better outcomes for all involved. Hopefully, understanding how to manage assets inherited by a minor child will help guide you (and your parents) to make the best decision for your family and for your parents’ legacy.
Securities offered through The Strategic Financial Alliance, Inc. (SFA), Member FINRA/SIPC. Advisory Services offered through Strategic Blueprint LLC. and The Strategic Financial Alliance, Inc. SFA and Strategic Blueprint are affiliated through common ownership but otherwise unaffiliated with Keen & Pocock.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. The SFA or Keen & Pocock do not provide tax or legal advice.