If You Spend Your Child's UTMA Money, You're Probably Breaking the Law
Touch that College Fund and You Could Go to Jail or End Up Financially Destroyed
Given the importance of teaching your kids about money, we've spent a lot of time discussing the topic over the years, especially as it pertains to the most popular form of non-trust gifting mechanisms, the UTMA; from making a cash gift via the UTMA to transferring shares of stock under the UTMA laws, we've covered the waterfront. I've even explained, much to the shock of many parents, you cannot undo a gift to a minor because of how UTMA is written in the fifty states.
There is no un-ringing the bell after the check has been deposited, the shares have been transferred, or the mutual funds transactions have been recorded. Unfortunately, many people don't seem to be getting the memo. A refresher course seems to be in order in the hope that it saves even one of you from making what could be a life-altering mistake that tears your family apart and ends up financially devastating you.
Hypothetical UTMA Situations In Which a Parent Might Be Tempted to Spend the Child's Money
Imagine you open a savings account for your child at the local bank, depositing $10,000 in the hope he will someday use it to pay for college. You put his name on the account while simultaneously naming yourself custodian, not bothering to think much of the fact that, for all intents and purposes, every single financial institution that permits this sort of setup structures the title as a "UTMA" account, which stands for "Uniform Transfer to Minors Act" account.
The next week, you get hit with an enormous medical bill that threatens your solvency; you might even 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 son's account, and figure you'll replace it later. Does this sound reasonable to you?
Or how about this scenario: Your mother passes away and leaves your five-year-old daughter (her granddaughter) $150,000, naming you as successor custodian to a brokerage account she established, stuffed with blue chip stocks like Coca-Cola, Colgate-Palmolive, Johnson & Johnson, Hershey, and Procter & Gamble. When your daughter is thirteen 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. Does this sound reasonable to you?
Finally, 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 own checking account, not thinking anything of it other than a rough back-of-the-envelope calculation so you have a decent idea of what should be available. 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 ...", writing a smaller check.
Does this sound reasonable to you?
If so, congratulations on your new life of crime. You've broken the law in a very significant, and serious, way. In the process, you've opened yourself up to everything ranging from criminal prosecution to civil lawsuits that could result in 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 exponentially higher than the money you used. This often comes as a surprise to those who didn't grow up in affluent or financially literate families; who don't understand the nature of ownership as it pertains in minors in the United States, a country in which children's money does not belong to the parents or guardians.
The Reason Your Child's UTMA Assets Are Protected from You
Specifically, two things occurred the moment assets were gifted under the UTMA law in whichever state the donor knowingly or only half-knowingly opted to control the transfer:
- It became an immediately-vested, irrevocable gift. Neither you nor any other donor can take money deposited into a UTMA back for any reason (this is true even if the child dies because the UTMA funds are part of their probate estate and need to be settled accordingly!). In fact, the funds must be handed over to the child on the age of maturity, which can be specified at the time of gift up to a certain maximum age or else defaults to the state law (18 in a few states, 21 in almost all states, 25 in a handful of states). It doesn't matter if you think the funds are too much for them to handle; whether they plan on taking their college savings and running off to Las Vegas to gamble it all away, you have no choice. It's beyond your control or influence. Anything you do to stop them from getting their hands on the capital is going to put you in hot water as the money is entirely, unquestionably, indisputably theirs. Don't even think about attempting to transfer it into another account because the lawsuit alone is going to turn it into one of, if not the, most expensive mistakes of your lifetime. You will not win this. It will end in disaster for you.
- As the custodian of the account, you owe what is known as a fiduciary duty to your son or daughter, to only use the money in his best interest (which cannot include things that are your responsibility to provide as a parent, even if they are necessary), investing it in a manner consistent with the prudent man rule. As part of this fiduciary obligation, you are required to keep detailed accounting records, down to the penny, of every cash flow into or out of the account. If the child requests it - even decades after it was first established (as is often the case for babies or young children who are gifted stock) - and you do not provide it, you're going to be compelled by the courts to produce it. If you can't, you're going to have an extraordinarily bad time.
You would think these would be fairly straightforward. They aren't that hard to understand yet I see parent after parent, family member after family member 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, oblivious to the fact they are blatantly committing misappropriation and are on the wrong side of the law. This incorrect information is even repeated on personal finance forums by ignorant posters who have no idea how the rules work. For example, I recently saw someone tell a parent who had received checks on behalf a child that the donor couldn't obligate the parent to follow the UTMA rules even though the checks were made out to them in the capacity of a custodian, which is simply flat-out foolish. By cashing the checks, the parent agreed, 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. The parent would lose. Likewise, I've seen people say, "Transfer the UTMA money into a regular 529", which is also illegal because the UTMA money belongs to the child; it isn't the parents' cash to put into an account that has the child as a beneficiary. If the child decides to sue you over it, you will lose. Why open yourself up to this kind of liability?
The Case Law Is Full of Rulings in Which a Parent Is Sued By an Adult Child and Loses Their Savings and/or Goes to Jail Due to Spending UTMA Money
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 setup 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 who not only lost, but suffered the ignominy of being carted off to jail for contempt.
Look at the case of Carlson v. Wells in 2011 from the Supreme Court of Virginia in which the Carlson children sued their father and uncle after the latter refused to provide detailed records about the UTMA funds that had been setup for them. The court ended up discovering 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 even had to pay his kids' legal bills on top of his own!
Look at this case out of North Carolina, in which 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 duty of the parent to pay for those things as a matter of basic child support; not the responsibility of the minor to cover them. He was ordered to pay restitution, plus the amount of investment income the girl would have enjoyed under a reasonable compounding scenario, plus all of her legal fees. Additionally, he was removed as custodian due to his mishandling.
Another case, Hoffenblum v. Hoffenblum in Michigan, also found a father was in the wrong when he relied upon a financial adviser, who advised him to remove $18,305.43 from his children's UTMA assets to reimburse himself for their medical costs, saying, like the other court, it was his obligation as a dad to provide for the child's medical needs; that the financial adviser was wrong.
On and on it goes, case after case. The next time you hear someone say it isn't a big deal, or there is only a remote possibility of the child, niece, nephew, or other family member suing you, don't buy it. Are you really prepared to face a significant legal penalty that could wipe out years of your savings, if not throw you into bankruptcy, as well as a protracted court battle that you have no hope of winning given how blatantly inappropriate your actions are under the rules, all for access to a bit of money that doesn't belong to you even if you feel like it (morally) does? It's a stupid risk to take. Don't be stupid. Don't spend the child's money. Don't comingle it with your own. Keep perfect records. On their appropriate birthday, promptly turn it over without being asked. Anything else and you run the risk of them discovering their rights - an easy thing to do in a world of widespread Internet access, unlike, say, the late 1980's - so they can wipe you out with a call to an attorney. This might sound alarmist to you but I'm doing this for your sake; to let you know precisely the risk you are running so that if you do proceed and steal from your kid, even if you think it is in their best interest, you can't say you weren't warned.