Given the importance of teaching your kids about money, you may have spent a lot of time discussing the topic with your family over the years, especially as it pertains to a common form of non-trust gifting mechanisms, the Uniform Transfers to Minors Act (UTMA). Whether you're making a cash gift via the UTMA or transferring shares of stock under the UTMA laws, this is a popular tool for families.
However—much to the shock of many parents—you can't undo a gift to a minor, because of how UTMA is written. There is no un-ringing the bell after the check has been deposited, the shares have been transferred, or the mutual fund transactions have been recorded.
Many people don't seem to be aware of the law, and they're tempted to break the UTMA's withdrawal rules. Doing so constitutes UTMA custodian fraud. A refresher course may be in order. Hopefully, this will save someone from making what could be a life-altering mistake—threatening to tear your family apart and leave you financially devastated.
- Under the Uniform Transfers to Minors Act (UMTA), money deposited into a UTMA account can't be withdrawn for any reason—except by the child at the appropriate age.
- In the United States, a child's money does not belong to the child's parents or guardians.
- If you're thinking about spending your child's UTMA money, think again. You could face a significant legal penalty that could wipe out years of your savings, if not throw you into bankruptcy.
Hypothetical UTMA Situations in Which a Parent Might Be Tempted To Spend the Child's Money
For example, say you open a savings account for your child at a local bank, depositing $10,000 in the hope they will someday use it to pay for college. You put their name on the account and name yourself as the custodian. Every single financial institution that permits this sort of setup structures the title as a "UTMA account." The next week, you get hit with an enormous medical bill that threatens your solvency—you might have to declare bankruptcy unless you can work something out. In a panic, you go back to the bank, withdraw the $10,000 you put in your child's account, and figure you'll replace it later.
Or how about this scenario? Your mother passes away and leaves your 5-year-old daughter (her granddaughter) $150,000. She names you as successor custodian to a brokerage account she established, stuffed with blue-chip stocks such as Coca-Cola, Colgate-Palmolive, Johnson & Johnson, Hershey, and Procter & Gamble. When your daughter is 13 years old, she breaks her leg in a sporting accident at a time when you are unemployed and have no health insurance. You decide to withdraw a few thousand dollars to pay her medical bills out of her account.
Here's one last hypothetical: Your brother decides to give your son (his nephew) a check for $1,000 each Christmas to help pay for college. The check is made out to "[Your name] as custodian for [nephew's name]." You deposit the money in your checking account and make a rough back-of-the-envelope calculation, so you have a decent idea of what should be available for your son. Over the years, your brother gives you a total of $18,000. When your kid reaches adulthood, he asks for his money. You have $7,000 in your checking account and tell him, "We used it on the family over the years, but here's what I can give you right now." You write a smaller check.
Each of these scenarios breaks the law in a significant, serious way. In the process, you've opened yourself up to everything ranging from criminal prosecution to civil lawsuits. Legal proceedings could result in the restitution of the funds you took, payment of foregone investment income that should have been generated, attorney fees, and a host of other expenses that can (and probably will) be more costly than the money you used. This may come as surprise to those who don't spend a lot of time considering financial law, but in the United States, a child's money does not belong to the child's parents or guardians.
The Reason Your Child's UTMA Assets Are Protected
Legally speaking, two things occurred the moment assets were gifted under the UTMA law, whether or not the donor was fully aware of UTMA restrictions on withdrawals.
It became an immediately vested, irrevocable gift
Neither you nor any other donor can withdraw money deposited into a UTMA back for any reason (this includes cases in which the child dies; the UTMA funds are part of their probate estate and need to be settled accordingly). The funds must be handed over to the child at the age of maturity, which is determined at the time of the gifting, and it can be as high as age 25. If no age is predetermined, then it defaults to either 18 or 21, depending on state law.
There's no scenario under which you can take that money back. It doesn't matter if you think the funds are too much for them to handle. They can tell you they plan on dropping out of college and gambling away the rest of their savings in Las Vegas—that's their choice, and it's their money. Anything you do to try to stop them from spending the money how they want is going to put you in a legally precarious position.
As the account custodian, you owe a fiduciary duty to your child
"Fiduciary duty" means you can only use the money in their best interest. You must invest it in a manner consistent with the "prudent person rule." You also can't use the funds for necessary expenses such as food or shelter, because you are legally obligated to provide those as a parent. As part of the fiduciary obligation, you are also required to keep detailed accounting records, down to the penny, of every cash flow into or out of the account. If the child requests accounting records, even decades after it was first established (as is often the case when babies or young children are gifted stock), you'll be compelled by the courts to produce it (if you don't do so voluntarily).
You would think these rules would be fairly straightforward. Yet, parents continue to wrongly state, often with conviction, that they are perfectly within their rights to spend a child's money, undo a previous transfer, or somehow stop an irresponsible child from accessing UTMA principal. By cashing checks on behalf of a child, the parent agrees, knowingly or unknowingly, to take on the obligations and liabilities of custodianship. The donor or the child could easily come back and sue the parent if the parent mismanages those funds. Even without malicious intent, it's illegal to do anything with the money that the child doesn't ask for. A child could technically sue for something as simple as moving the UTMA money into a regular 529 college savings plan.
Case Law Rulings in Which a Parent Is Sued by an Adult Child
If you need the motivation to do the right thing, the case law is full of enough to send ice water through your veins.
Look at Whitman v. Whitman in 2012 from the appeals court in Ohio. A licensed attorney set up several accounts, including a college fund, for his son. When his son went to use it and couldn't figure out where all the cash was, he sued his dad. His dad not only lost but was carted off to jail for contempt.
In the case of Carlson v. Wells in 2011 from the Supreme Court of Virginia, the Carlson children sued their father and uncle after the latter refused to provide detailed records about the UTMA funds that had been set up for them. The court ended up discovering that the father had spent some of the money, speculated on an airline stock with much of the rest, and even transferred a chunk to his personal Vanguard Health Care account. In addition to the restitution he owed, he also had to pay his kids' legal bills.
In North Carolina, a man gifted cash from the proceeds of a sale of the family business to his granddaughter, naming his son as custodian. The son used some of the money to pay for the daughter's medical and dental bills, among other things. When his daughter sued him for raiding her accounts, he lost because it is considered the duty of the parent to pay for those things as a matter of basic child support. Legally, it isn't the responsibility of the minor to cover medical and dental bills. He was ordered to pay restitution, the amount of investment income the girl would have enjoyed under a reasonable compounding scenario, and all of her legal fees. Additionally, he was removed as custodian because of his mishandling.
The Bottom Line
The next time you hear someone say that making UTMA account withdrawal isn't a big deal, or there is only a remote possibility of the family member suing you, don't buy it. Are you prepared to face a significant legal penalty that could wipe out years of your savings, if not throw you into bankruptcy? The law is clear, and if someone decides to take you to court, you will have virtually no hope of winning.
Don't spend the child's money. Don't mix their savings with your own. Keep perfect records. On their appropriate birthday, promptly turn it over without being asked. Anything else could run the risk of them discovering their rights—an easy thing to do with the Internet at their fingertips.
Frequently Asked Questions (FAQs)
What is a custodial account?
A custodial account is a financial account that an adult controls for a minor (a person younger than 18 or 21, depending on state law). It can also refer to any account maintained by one party on behalf of another. In either case, the custodian is required to act in the best interest of the beneficiary of the account.
What is a UTMA account?
The Uniform Transfers to Minors Act (UTMA) is state legislation that allows gifts to minors. These gifts can be held until they reach the age of majority without having to set up a trust. The money put into this type of account is an irrevocable gift to the minor, which means that it can't be taken back.