PDF DownloadTransfers to Trust and Use of UTMA Custodial Accounts
By Bradley R. Coppedge

Probate & Property Magazine: May/June 2009, Volume 23, Number 3

Real Property|Trust & Estate

Bradley R. Coppedge is a partner in the Columbus, Georgia, firm of Hatcher, Stubbs, Land, Hollis & Rothschild.

The Transfers to Minors Act (TMA) of each state, based on the Uniform Transfers to Minors Act ("Uniform Act" or "Act") as adopted by the National Conference of Commissioners on Uniform State Laws in 1986, provides for the management, use, and disposition of property gifted or otherwise transferred to a minor. The provisions of the Act apply to a transfer that makes reference to the Act as adopted by each state (for example, the " Georgia Transfers to Minors Act") in the designation of the transfer. References to the sections of the Act herein are to the sections of the Uniform Act.

The TMA of each state, however, does not specifically apply to transfers to or for the benefit of a minor that do not recite the applicability of the Act under applicable state law. This distinction is relevant in that it is not uncommon for gifts to be made to minors with the parent or guardian informally "holding" the money or asset for the child's benefit. These types of transfers are not technically subject to the Act and are not true custodial accounts. But, for nearly any account that is opened for a minor at a bank or brokerage firm in the minor's name or Social Security number, the account documents will likely provide that it is a TMA custodial account under state law. Uniform Act §§ 3 and 9 set forth the specific requirements of a transfer subject to the Act.

Transfers under the Act are irrevocable and leave the donor with no legal or equitable rights in the property. Rather, title is registered in the name of a custodian for the benefit of the minor. The custodian has broad powers regarding the use of the funds for the minor, as set forth in more detail below.

This article will provide a brief overview on the use of custodial funds generally, along with a more detailed analysis of the custodian's ability to delay distributions beyond age 21 through the conversion of the custodial account to an irrevocable trust, or by other means.

Use of Custodial Funds Generally

Uniform Act § 14(a) provides:

A custodian may deliver or pay to the minor or expend for the minor's benefit so much of the custodial property as the custodian considers advisable for the use and benefit of the minor . . . .

This standard is applied without regard to the duty or ability of the custodian or of any other person to support the minor. (Although the term "minor" is used throughout, it is important to keep in mind that a child reaches the age of majority at age 18 or 19 in each state at which time any legal support obligation generally terminates; however, the custodial account may continue beyond that age, to age 21 or even age 25, in certain states.)

Funds may also be paid without regard to any other income or property of the minor that may be available for his support. In other words, the custodian is not required to (but is allowed to) consider any other income or means of support of the minor in determining the appropriate amounts to distribute. This does not mean, however, that custodial funds may be used in lieu of or in satisfaction of a legal support obligation of a parent or guardian who has adequate funds to provide such support. See, e.g., Weiss v. Weiss, No. 91CIV.5115(KMW)(MHD), 1996 WL 91641 (S.D.N.Y. Mar. 4, 1996), providing liberal use by adoptive father because he had no support obligation. See also Gold v. Gold, 409 N.Y.S.2d 114 (Sup. Ct. 1978). See also comment to Ala. Code § 35-5A-15, providing, "In Alabama, the adequacy of the child's resources does not affect a parent's legal obligation to support the child." In addition, comments to the New York version of the Uniform Act, found at N.Y. Est. Powers & Trusts Law § 7-6.14, provide that a transfer to a child does not relieve the parents of the obligation of support, although the custodian has broad flexibility to expend funds without regard to the parental support obligation or other resources available to the child. Some other jurisdictions have also made this determination. See Sutliff v. Sutliff, 489 A.2d 764 ( Pa. Super. Ct. 1985), finding the custodian/parent breached his fiduciary duty in using custodial funds to make his own court-ordered child support payments for the child.

The custodian has very broad discretion to use funds for the benefit of the minor. The Act does not elaborate, and case law in many states provides only limited guidance, on what constitute appropriate expenses. For example, in Brandenburg v. Brandenburg, 551 S.E.2d 721 ( Ga. 2001), a court action was brought by the donor of custodial funds in an effort to limit the use of the funds only to the minor's education. The court refused to impose such a limitation, stating that the funds "may be used for any reason deemed necessary by the custodian for the support, maintenance, education and general use and benefit of the minor." This case appears to be the full extent of reported Georgia case law analyzing expenditures by the custodian but clearly demonstrates the broad discretion of the custodian in the use of custodial funds. See also comments to Ala. Code § 35-5A-15 and Cal. Prob. Code § 3914, both providing that the "use and benefit" standard is intended to include payment of the minor's legally enforceable claims such as tax, child support, or tort claims.

As indicated above, the income or other assets or sources of income of the minor are only nominally relevant in determining the amount to pay. Although the custodian is allowed to pay funds from the account without being required to consider the minor's other income, the custodian is not prohibited from considering such income in determining what amount is necessary for the "support, maintenance and general use and benefit" of the beneficiary. The custodian must use his or her independent discretion in determining the standard of support, for any reason the custodian deems "suitable and proper."

By way of example, it is permissible for the custodian to use the funds to help with the minor's rent, utilities, car payments and repair bills, camps, activities, spending money, and so on, in addition to expenses such as education, medical care, and the child's legally enforceable claims. Although it might be permissible to use such funds as the sole means of support (exclusive of a parent's legal support obligation for a minor), it would appear to be prudent to use the funds for supplemental support. The funds may be distributed directly to the minor, although if he or she is not financially responsible it would certainly be appropriate to pay many expenses directly, such as rent, utilities, car repairs, tuition, and so on. The amount distributed for the minor's benefit is entirely in the discretion of the custodian, although once the minor attains age 14 he or she can bring a court action to ask the court to order a minimum or set amount be paid each month. Uniform Act § 14(b).

The custodian has a fiduciary duty to the beneficiary to invest and manage the funds as "would be observed by a prudent person dealing with property of another." The custodian's standard of care is very similar to that of a trustee or other fiduciary, although the standard is broader when it comes to the selection of investments, because the custodian "is not limited by any other statute restricting investments by fiduciaries." Uniform Act § 12(b).

Transfers by the Custodian from the Custodial Account to an Irrevocable Trust Account for the Minor

In General

What about transferring funds from an existing custodial account into a trust for the benefit of the minor? For example, can the custodian transfer funds from a TMA custodial account to a trust in which the minor does not receive the final distribution until a later age, such as age 25 or 30 or beyond, or is this a breach of the custodian's fiduciary duty?

Arguably, in states that have adopted the Act without any or any significant changes to the model language (including, for example, Georgia, Alabama, Arkansas, Florida, and New York), no legal barrier exists under the Act that would prevent the custodian from transferring property from the custodial account to a separate trust in which the custodial account beneficiary isthe sole trust beneficiary. In fact, some states such as Maryland, Md. Code Ann., Est. & Trusts § 13-314(b)(1), and Florida, Fla. Stat. Ann. § 710.116(2), specifically provide that "a custodian may transfer all or part of the custodial property to a qualified minor's trust without a court order." In both instances, a "qualified minor's trust" is defined as a trust that meets the requirements of Code § 2503(c). It could be argued that, under these states' laws, this is the sole method of transferring to a trust and that this is but one method of the same, because a Code § 2503(c) trust is nearly identical to a TMA custodial account providing for termination at age 21.

If there is any technical legal barrier under the Act, it is the provision to turn over the property at age 21 under Uniform Act § 20. But, even that section provides that "the custodian shall transfer the funds in an appropriate manner upon . . . the minor's attainment of 21 years of age" (emphasis added), leaving open the question of "what is an appropriate manner."

Some states, such as Ohio, arguably do not provide this flexibility. Ohio Rev. Code Ann. § 5814.04(D) provides: "[T]he custodian shall deliver or pay the custodial property over to the minor on the minor's attaining the age of twenty-one years . . . ," without any reference to delivery in an "appropriate manner" as appears in the language of the Uniform Act. In states that have adopted Uniform Act § 20 as drafted, it certainly can be argued that a transfer of custodial funds to a trust for the minor's protection and benefit is "suitable and proper" and a transfer "in an appropriate manner." The comments to the Act provide no further direction on what constitutes an "appropriate manner." One could certainly argue that the drafters of the Act could have provided that the funds or assets in the account be delivered "outright" to the beneficiary on attaining age 21 if that were the only option. Likewise, state legislatures could have removed the language "in an appropriate manner" (as the Ohio legislature did), giving rise to a clear implication in such states that delivery at age 21 should be outright. But state legislatures that have adopted the Act without change to this section statutorily provided instead for delivery "in an appropriate manner," supporting the argument that flexibility exists in the method of the delivery of the funds or assets to the beneficiary. Somewhat surprisingly, there appears to be no case (or statutory) law in many jurisdictions defining, in any context, the phrase "an appropriate manner." Perhaps it can be assumed that an "appropriate" manner is a "reasonable" manner. See 3A Words and Phrases (Cum. Supp. 2003), with "reasonable" being determined under the facts and circumstances.

In light of the foregoing, because the transfer of custodial assets to a trust appears to be, or arguably is, legally permissible in states that have adopted Uniform Act § 20 without substantial change, then it can be made without any court order under Uniform Act § 14(a). In addition, Uniform Act § 13 provides that a custodian, acting in such capacity, "has all the rights, powers, and authority over custodial property that unmarried adult owners have over their own property," subject of course to the fiduciary duty owed by a custodian. Provided the child is the sole beneficiary of any such trust, in keeping with the segregation requirements under Uniform Act § 12(d), and provided further that the provisions of the trust as drafted are consistent with the provisions of Uniform Act § 13 (discussed above) by providing, for example, that

the Trustee shall pay so much of the net income or principal (or both) of this Trust to or for the benefit of [the child], as the Trustee may deem necessary or appropriate in the Trustee's judgment to provide for the child's proper support, maintenance, medical care, education (including college, post-graduate and vocational education), and general use of [the child], taking into account any other means of support the child may have to the knowledge of the Trustee,

then it can be argued such a transfer is permissible. Because the trust provisions concerning payment of funds to or for the benefit of the child would be consistent with the guidelines for custodians regarding the use of custodial property set forth at Uniform Act § 13, the transfer of the assets from a custodial account to such a trust arguably is appropriate and within the custodian's power under state law, unless a particular state has legislatively, or through case law, specifically commented on this issue. In addition, it also can be argued that a transfer to the trust is consistent with the custodian's duty to invest the property and preserve the capital as would "a prudent person," in keeping with the custodian's duties set forth at Uniform Act § 12(b).

Concerns

Assuming a custodian is comfortable making a transfer from a TMA account to a trust, are there concerns? Are there any steps the custodian undertaking such an action can take to protect itself from a subsequent claim by the minor?

Yes and yes. Under the Act as discussed above, it can certainly be argued that the custodian has the legal right to make such a transfer. After all, a custodian under the Act has the same rights and authority over the property "as unmarried adult owners have over their own property." The concern, however, is whether such a transfer is effectively a breach of fiduciary duty considering that by statute, the funds are to be turned over at age 21 "in an appropriate manner." Although the custodian may have numerous well-grounded reasons for desiring to delay the distribution including, for example, legitimate planning for creditor protection purposes (or protecting the child from his own lack of judgment), the fact remains the custodian would effectively be terminating what would otherwise be the child's right to obtain the funds at age 21, and the question arises whether such delay constitutes a delivery "in an appropriate manner." So, is there a way to minimize or avoid entirely this concern? However appropriate it may seem at the time, no custodian wishes to open the door for a potential fiduciary claim when the child reaches legal age or the custodianship would have otherwise terminated. In the end, the test should be whether the fiduciary acted in the beneficiary's best interest. But there are ways to further insulate the custodian from such a claim.

Remedy

One way to avoid a potential claim of fiduciary breach may be to give the child a withdrawal power over the funds in the custodial account. In this manner, the custodian or third party would create an irrevocable trust, which could extend well beyond age 21. But the trust terms would include a withdrawal right, which would provide for notice to the child, on attaining age 21, of the assets in the trust and give the child a one-time window of 30–60 days in which to elect either to withdraw some amount (up to all in the child's discretion) of the trust on attaining age 21 or allow it to be held under the terms of the trust.

The only downside to providing a withdrawal right is the fairly well-settled position that some portion or all of the trust assets would thereafter be reachable by the child's creditors, because the trust would almost certainly be considered a "self-settled" trust from that point on. Once the child has had the "right" to all of the funds, he is likely treated as the settlor of the trust for creditor purposes. By way of analysis, note that Uniform Trust Code § 505(b)(2) provides that "upon the lapse, release, or waiver of [a withdrawal] power, the holder is treated as the Settlor of the trust . . . to the extent [of] the value of the property affected by the lapse, release or waiver." With this concern in mind, it becomes a question whether to make the transfer to the trust with no withdrawal right (and possibly risk future litigation from the child) or to make the transfer and include the withdrawal right (and risk the assets being subject to claims of creditors thereafter). In the end, many clients may still prefer either of these possible scenarios to an outright distribution at age 21 if funds have accumulated significantly. Furthermore, even if the inclusion of the withdrawal right does subject the trust to potential creditor claims, it is likely nonetheless more protected than if it were in the child's name, because a creditor must (1) discover the existence of the trust and (2) take additional steps to attach and acquire the property in the trust.

Other ways to avoid making a large cash transfer to the child at age 21 include, for example, a voluntary self-settled trust at majority age (perhaps invoking the "golden rule," that is, "he who has the gold rules"), investing in income-producing real property, purchasing an annuity, transferring the funds to a 529 plan, or other means, but these are outside the scope of this article. Still other alternatives can include the custodial account investing in an LLC or family partnership. Each of these alternatives may raise its own concerns, such as liability issues associated with owning real property.

The Restatement (Second) of Trusts § 227 cmt. o (1959) indicates that a trustee should not make an investment that cannot readily be liquidated and converted to cash at the time of trust termination. Query this as may relate to an investment by the custodian in a life or term annuity that has no provision for immediate cash-out. Further, there could be some concern in investing in an LLC or family partnership about whether the segregation requirements of Uniform Act § 12(d) have been met, because while the same may be considered a tenancy in common there could be some question about whether the interest held is "fixed," depending on internal provisions relating to capital calls or debt guaranties. Many commentators, however, are quite comfortable with this investment alternative. A final alternative may be simply to spend down the balance in the account "for the use and benefit of the minor" before the child attains age 21.

It also may be appropriate to consider each of these alternatives from a practical view. In each, the custodian is not trying to prevent the child from having the money or attempting to use it improperly for the custodian's own benefit. Rather, the custodian is trying to preserve and protect the funds from possible waste by delaying the distribution. Practically speaking, what is the risk or likelihood that the child will actually bring suit for a purported breach? This may depend on the amount, the child, and the "economic risk" to the child (that is, "If I sue, will mom/dad/other donor cut me out of their will?"). In the end, this decision must be made through careful analysis on a case-by-case and state-by-state basis and on advice of legal counsel, being aware of the possible ramifications.

Gift and Estate Tax Issues

Selection of Trustee. For estate tax reasons, the parent-donor should not serve as custodian of a TMA account if the parent has a taxable estate. If the parent who is the donor/custodian dies while serving in such capacity, the account will be included in his or her gross estate under Code § 2038 because of the custodian's power to pay or withhold income and principal. Likewise, resignation as custodian within three years of the custodian parent's death may result in inclusion under Code § 2035. In theory, the same inclusion arguments also can apply if the funds are transferred to a trust and the donor/parent serves as trustee, unless perhaps the trust language prohibits using the funds in the discharge of any legal support obligation. But, as a practical matter, if the custodian parent has no taxable estate or perhaps only a small taxable estate, the estate tax consequences would range from nonexistent to minimal.

Effect on Annual Exclusion Gifts. A detailed discussion of the gift tax consequences of gifts to minors is beyond the scope of this article. It is important to note, however, that funds transferred by a donor to a TMA account qualify for the gift tax annual exclusion ($12,000 for 2008; $13,000 for 2009) as a present interest gift. See Rev. Rul. 59-357, 1959-2 C.B. 212; Rev. Rul. 73-287, 1973-2 C.B. 321. The gift tax laws provide for at least three kinds of trust-type transfers to minors that each qualify for the annual exclusion: (1) transfers under a TMA or a predecessor Gifts to Minors Act, (2) Crummey trusts, and (3) Code § 2503(c) trusts, which terminate at age 21. Under each of these gifting scenarios, an amount gifted will qualify as a present interest gift for purposes of the gift tax annual exclusion under Code § 2503(b).

Does a subsequent transfer by the custodian of TMA assets to a trust have any retroactive effect on the qualification of the prior gifts for the annual exclusion? Or, if the custodian does have the right under state law to transfer funds to a trust, as this author suggests, will this right be sufficient to protect the prior transfers as annual exclusion gifts? Stated differently, does the conversion of a TMA account into a trust that does not terminate until after age 21 change the character of the original gift for federal gift tax purposes to that of a future interest and, as such, make it retroactively ineligible as an annual exclusion gift?

When the child is given a withdrawal right at age 21, the prior transfers should not be in any jeopardy of losing their status as having been present interest gifts. See Treas. Reg. § 25.2503-4(b)(2), which provides that a gift will not be considered a future interest merely because the donee may elect to extend the term of the trust. The "election" by the donee is not substantially different than giving the child the withdrawal right; failing to exercise such right would be equivalent to the child electing to extend the trust. See also Rev. Rul. 74-43, 1974-1 C.B. 285. If the child is not given a withdrawal right, the answer becomes uncertain. Again, however, it may be important to look at practical application. Many TMA accounts are either of such relatively nominal value or the donor custodians do not have taxable estates such that, even if the gift tax annual exclusion is challenged and retroactively lost, it has no or nominal effect from a federal estate or gift tax standpoint. For those rarer exceptions when this is not the case and either inclusion in the donor's estate or potential loss of the gift tax annual exclusion would be relevant, further analysis should be considered.

Finally, even if the status of a prior TMA gift as within the annual exclusion is challenged, might it be remedied with a retroactive allocation of lifetime credit?

As a final thought, there is one other factor to consider. Namely, who is the real transferor of custodial funds to a trust? The funds in a TMA account have been irrevocably gifted to the child, although held by a custodian in a fiduciary capacity. Regardless of who creates the trust (donor, custodian, third party), the assets being transferred from the TMA account are already the child's beneficial property. As such, there would appear to be some question whether a Code § 2503(b) analysis even needs to be undertaken.

Summary

As a general rule, custodial accounts under the TMA should not be used for significant gifts or for a series of gifts that will grow over time. The general rule is that the child is entitled to such funds at age 21. If the funds are significant in amount, the child may not be fiscally responsible enough to handle a large windfall. But the size of contributions, the growth of the custodial account assets, and the financial maturity of a child cannot always be anticipated. For planning purposes related to larger custodial accounts, it may be appropriate for the custodian or a third party to consider creation of an irrevocable trust that would extend beyond age 21, although in such a case it must be determined whether to include a withdrawal provision on the child reaching age 21. The trade-off, however, is that the trust will likely become subject to creditor claims from that date if such a provision is included.

If a trust is created to hold the custodial funds beyond age 21, there are basically two options: create a trust with no "withdrawal right" at age 21, cognizant of the risk that the beneficiary could perhaps bring suit for fiduciary breach or to void the transfer; or, alternatively, create the trust with a "withdrawal right" at age 21, cognizant of the fact that the creditors of the beneficiary would likely thereafter be able to reach trust assets. This latter result, however, is no different than had the assets been delivered at age 21 or a withdrawal right been granted to the child. In the end, many clients still will prefer the potential risks of one of these alternatives to the child's receiving a substantial sum outright at age 21.

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