When That Bundle of Joy Grows Up to Be a Biker Chick

Within 15 minutes of my daughter Ellie's birth, I not only opened an UTMA investment account for her; I also planned out where she would attend college and what she would do when she grew up. Judging by her high-pitched wailing, I figured either a soprano at the Metropolitan Opera or a trading-floor correspondent for CNBC. Now 3 years old, she has quieted down a bit, and I have realized my dreams

Within 15 minutes of my daughter Ellie's birth, I not only opened an UTMA investment account for her; I also planned out where she would attend college and what she would do when she grew up. Judging by her high-pitched wailing, I figured either a soprano at the Metropolitan Opera or a trading-floor correspondent for CNBC.

Now 3 years old, she has quieted down a bit, and I have realized my dreams for Ellie's future may not play out exactly as hoped. And just in case my daughter does go through a period of moody, sullen irresponsibility (actual cases of this have been documented), I've chosen to put money in vehicles that allow me to keep the leash on the loot a little longer. (See related story on page 129.)

Some of your clients may not have had the benefit of this foresight. They may have opened UTMA and UGMA accounts (Uniform Transfers to Minors Act and Uniform Gifts to Minors Act) long ago and funded them diligently over the years only to find themselves confronted now with the prospect of all that money going directly to someone who thinks “getting home early” means coming home before sunrise.

Parents might believe they can simply cash out the accounts and write themselves a check. However, doing so will be viewed as a tax dodge if uncovered during an IRS audit, and could result in penalties and back taxes. (See our February story Trusts Come to the Rescue.)

Alaska, Here I Come

Placing money in an UTMA/UGMA account represents a completed gift to the child, to be managed by the custodian only until the minor reaches the age of majority. This threshold is dictated by the state in which the account was originally opened — Alaska, for instance, allows parents to block access to the money until the child turns 25.

You don't have to tell clients to pack up and move to Nome just to keep the money out of a perpetual spring-breaker's hands. With a little foresight, the following strategies can allow clients to stick to the letter of the law while preventing their well-intentioned savings from being frittered away by someone who is an “adult” in name only.

  • Liquidate it

    The easiest way to prevent a reckless teenager from depleting the account is for parents to do it themselves before the child reaches the age of majority. Sorry, the money can't be used to buy a Hummer and Botox injections for mom and dad. The rules state that the money must be spent for “the use and the benefit of the minor.”

    But don't despair. That's about as specific as the guidance gets. A broad interpretation hasn't yet been prominently tested, but it would seem that a wide range of expenditures would qualify — braces, a car, summer camp, music lessons, a computer or prep school tuition would all be difficult to argue against.

  • Transfer to a 529?

    Financial advisors' incomes would break new records this year if we were paid just $10 every time a client asked if he could use the funds in an UTMA account to fund a Section 529 college savings plan. The answer is, “Yes, but…”

    It can be done, but if possible, it is better to spend down the UTMA on legitimate expenses and use new money to fund a 529. Doing so will allow the parent to regain control over the account, and a college's financial aid package may be a little bigger since the 529 won't be in the student's name when he or she applies.

  • Transfer the money to a Roth IRA

    If the kid has any earned income during the current year, UTMA/UGMA funds can be transferred to a Roth IRA for the child's benefit in an amount equal to the lesser of the child's earnings or the contribution limit. The clients can do this without the child's knowledge or permission, and the child is still free to spend his or her hard-earned wages. Once the child discovers the destination of his or her parents' generosity, the taxes and penalties (and perhaps the redemption charges on a “B” share mutual fund, where appropriate) may keep the child from tapping the funds until he or she is older and wiser. And since some schools don't include a child's retirement account when calculating the Expected Family Contribution, moving money from an UTMA/UGMA to a Roth IRA may actually increase a college's financial aid package.

  • The last resort

    If the money is too much to spend or divert into a Roth IRA, parents still have one option. Just before the child reaches the age of majority and takes control of the account, parents can place the assets in an immediate annuity based on the child's life expectancy (by using the child's life, they can avoid the early withdrawal penalty). Even $100,000 into such an account might pay out only $400 or so per month — enough for some discretionary cash but not enough to spoil the child with a life of leisure. If the child can support a permanent vacation on this amount, he or she deserves every penny.

Writer's BIO: Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future. kevinmckinley.com

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