UTMAs vs. Trust Funds

Is It Better to Gift Assets to a Child Through an UTMA or Trust Fund?

Closeup of living trust documents with a
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One of the most important decisions that parents or other generous family members can face when they want to gift wealth to a minor child or children is whether to title the assets under a state Uniform Transfers to Minors Act (UTMA) or to place them in a trust fund. Both options have unique benefits that make them ideal for certain circumstances, and both have their drawbacks.

UTMA Basics 

An UTMA is a special type of ownership arrangement established under a state's Uniform Transfers to Minors Act. Introduced in 1983 as an extension to the Uniform Gifts to Minors Act (UGMA), an UTMA serves as a way for a minor child to own property.

The child is the actual owner of the assets when they're titled under an UTMA statute. The gift is irrevocable—it can't be undone or reversed—but the child has no right to access or manage the funds until they reach the age of majority as specified in the UTMA documents. The property is held in the name of a custodian for the benefit of the child until they reach that age.

Absent a specification in the documents, the age is determined as spelled out in state law and is usually 18 or 21.

UTMAs can be used for nearly any type of asset, including real estate, intellectual property, precious metals, and ownership in family limited partnerships. But the more common purpose is to facilitate a minor's ownership of stocks, bonds, mutual funds, and index funds.

UTMAs have been described as the "poor man's trust fund" because they offer some of the advantages of a trust fund without many of the expenses and upkeep requirements. They're known for ease of administration, low costs, and nearly effortless upkeep.

Establishing an UTMA

The easiest way to establish an UTMA is to open a designated custodial account with a broker-dealer. This can be accomplished at a full-service broker or a discount broker.

An UTMA Example

A Missouri-based father, Thomas Smith, establishes an UTMA for his daughter, Jane Smith. He wants to name himself as custodian and restrict the assets to the latest possible date under the Missouri UTMA statute, which is 21 years old.

Thomas establishes an UTMA custodial account, titling the account and the assets as "Thomas Smith Custodian for Jane Smith Under the Missouri Uniform Transfers to Minors Act Until the Age of 21." He has total control over the property until Jane Smith turns 21 years old. He makes the buy and sell decisions for the investments unless he outsources the job to an asset management company.

Jane has total and complete control over how those assets are used once she reaches the age at which the UTMA ends. Nothing stops her from taking the cash to Las Vegas and spending it all in a weekend if Thomas put money into the UTMA with the expectation that she would use it to go to dental school.

An UTMA Advantage

Remember, these UTMA assets belong to the child, not to the custodian. Unlike a college 529 Savings Plan or a bank account with the parent listed as a joint account owner, the assets aren't considered part of the bankruptcy estate if the parent or custodian files for bankruptcy.

The money is out of the reach of the custodian's creditors as well, should financial catastrophe strike.

UTMA Disadvantages: Student Financial Aid

The value of the assets will count against the child/owner when calculating financial aid eligibility for college—but only if they're the owner, not the custodian. This rule wouldn't affect an adult custodian who wanted to go back to school, according to FAFSA.

Custodial Obligations and Responsibilities

The custodian is obligated by law to act as a fiduciary for the child. This means that they must always put the interest of the minor above their own with regard to the UTMA's assets, even if they were the individual who originally made the gift that became UTMA property.

The minor has certain rights. When they reach the age at which the UTMA ends, they can petition a court to "compel an accounting" from the fiduciary to ensure that the handling of the assets was appropriate.

Were Jane to demand an accounting from her father, Thomas, he would have to produce documents and receipts demonstrating where every penny of the UTMA money went—how much was received, how much was spent, how much was invested, the dates of those transactions, and the performance of the investments.

At least one court has found that expenses Thomas would have to cover as an ordinary part of being a parent, such as medical expenses to save Jane's life, must come from Thomas and not from the money he gifted the UTMA. Using UTMA money would amount to embezzlement from his daughter.

Courts have ordered UTMA custodians to reimburse a child all of the stolen or misappropriated funds plus interest and/or foregone investment income.

Trust Fund Basics 

A trust is a legal entity created to hold assets that are set aside for the benefit of someone who doesn't control those assets. "Inter vivos" or living trusts are created during the life of the "grantor"—the individual who creates and funds it.

The grantor sets aside property, which can include cash, real estate, securities, or other assets, to benefit another person or group of people who are referred to as the beneficiaries. The grantor can direct that this property is to be managed in a specific way, on a specific set of terms.

Establishing a Trust Fund

Trust funds are created when the grantor's attorney draws up a legal document known as the trust instrument. This document spells out the provisions of the trust, which might include instructions as to how the money is to be invested and the conditions on which funds can be distributed to the beneficiary.

The trust instrument also names a trustee, an individual or institution to manage the assets for the benefit of the beneficiary. The trustee must also act in a fiduciary capacity. 

A trust will also sometimes name a "trust protector," often a close family friend, who has the ability to remove the trustee or perform certain other functions to serve as a check on the trustee's power.

Revocable vs. Irrevocable Trusts

Usually, but not always, the grantor will act as trustee during their lifetime, naming a successor trustee to take over when they die or become incapacitated. A trust that allows this kind of arrangement is called a revocable trust, and it has the added advantage of avoiding probate of the assets it holds.

The grantor can't change or undo the trust if it's irrevocable. The trust is registered for its own tax identification number, and it files its own tax returns with the federal and state governments. It pays taxes on certain non-distributed earnings.

An irrevocable trust is an entity separate and apart from the grantor. It avoids probate, and it avoids estate taxes on the value of its assets as well because the trust owns them, not the grantor.

Trust fund tax rates are compressed, so trusts hit higher tax brackets much more quickly than with individual or corporate tax filings.

Advantages of Trust Funds

A major advantage of using a trust fund is that it can easily be personalized to meet your needs. You can tailor its terms to almost any situation provided that it's not so egregious as to go against public policy.

For example, you can't condition trust fund payouts on the beneficiary remaining a member of a certain religion, marrying someone of the same race, or forbidding them to marry someone of the same sex.

You can create an "incentive trust" that makes payouts based upon the beneficiary reaching certain life milestones, however, such as graduating from a four-year university in a time period of no more than five years with a certain minimum grade point average. Or you might match money they put into retirement accounts on a dollar-for-dollar basis, providing them with spending money to enjoy.

Disadvantages of Trust Funds

Trust funds have one big downside: their cost. They require time and effort, and there's some liability exposure for the trustee. Professional trustees are often compensated.

You could use the services of an asset management firm if you have a fairly straightforward trust fund—for example, you leave behind $500,000 for a niece or nephew with 3% payouts to begin on their 21st birthday. You'd lose much of the ability to buy individual securities, but your total costs except for taxes would probably run about 1.5% per year of principal—a fairly attractive deal.

Those fees could be a lot higher, however, if you had a much more complicated trust.

UTMA vs. Trust Fund—Which Is Best?

Determining whether an UTMA or a trust fund is better in any given situation depends upon a number of factors:

  • The amount of money you're considering setting aside for the child: Generally, but not always, it's more likely that you're going to use an UTMA if the amount is smaller.
  • The restrictions you want to place on the money: An UTMA is not going to be ideal if you want to insist that the funds must be used for a specific purpose—again, within the public policy limits permitted by law.
  • The need for asset protection: A good attorney can often use trust funds in intelligent ways to protect beneficiaries beyond what might be possible with an UTMA.

This is an area you should absolutely discuss with qualified advisors, such as an estate attorney, a CPA who's familiar with trust taxation, and—depending upon the assets—perhaps an investment advisor. This is particularly true if you're dealing with significant amounts of money.

Article Sources

  1. Social Security Administration. "Uniform Gifts To Minors Act (UGMA) And Uniform Transfers To Minors Act (UTMA)." Accessed March 27, 2020.

  2. United States Office of Government Ethics. "UGMA or UTMA Account." Accessed March 27, 2020.

  3. Federal Student Aid. "Asset Net Worth." Accessed March 27, 2020.

  4. IRS. "Retirement Plan Fiduciary Responsibilities." Accessed March 28, 2020.

  5. American Bar Association. "Revocable Trusts." Accessed March 27, 2020.

  6. ABA Law Info. "A Primer on Irrevocable Trusts." Accessed March 27, 2020.