General Practice, Solo & Small Firm DivisionMagazine

Planning an Estate, Protecting a Child

© American Bar Association. All rights reserved.

John F. Thomasset, CLU, ChFC, is an Investment Advisory Associate with EQ Financial Consultants, Inc., and an agent of The Equitable Life Assurance Society in Los Angeles. He is Director of the Professional Advisors Group and specializes in estate planning. He can be reached at 818/587-4298.

Estate planning is the process of planning the accumulation, conservation, and distribution of an estate in the manner that most efficiently and effectively accomplishes a person’s tax and non-tax objectives. Planners tend to focus on the financial aspects and often tend to overlook the nonfinancial aspects. But when minor or special needs children are involved, the nonfinancial aspects are critical.


First, you must ask your clients who will raise their minor children if they die? This question should be asked of dual and single parents alike. If no provisions have been made beforehand and neither parent is living, the court will appoint a guardian to look after the children and manage their finances until they reach age 18. In all states, judges are required to act in the child’s best interest; but they have no way of knowing the parents’ wishes or the family dynamics.

A far better solution is for parents to decide on a guardian in advance and name the guardian in their wills. The court will usually appoint the person designated by the parents as guardian unless, in their view, it is not in the best interest of the child.

Lawyers should consider recommending that parents think about naming an alternate guardian in case their first choice cannot serve for some reason. It is generally not a good idea to name co-guardians in case of later disagreements between them with respect to the children or in case they go their separate ways. The considerations that should be taken into account when deciding on a guardian include: age, time, physical ability, children close to the same age, geography, and shared moral and religious beliefs.

A common mistake made by parents who have taken the time to consider and decide upon a guardian is that they neglect to discuss their decision with the candidate selected. It is prudent to find out if the person selected is willing to take on the responsibility of raising someone else’s children and if he or she will raise them according to the wishes of the parents. Although most parents want their children to stay together, there may be certain situations where different guardians may be best for the children.

Lawyers should also be alert to the possibility that a different guardian will be needed to watch over financial matters. The right person to care for and raise children may not have the abilities necessary to make financial decisions and manage assets.

Children with Special Needs

Guardianship and estate planning issues take on an added importance when a child with either mental or physical disabilities is involved. Providing love and care for the "special needs" child are usually top priorities for parents. Many times they are so involved in the day-to-day needs of the child that they haven’t thought about or planned for the future. The disability may or may not affect the child’s life expectancy. Lawyers need to raise the following questions with parents:

• What happens if the child’s condition worsens and you are no longer able to care for her?

• What happens if your situation, either physically or financially, changes and you are no longer able to provide the level of care necessary?

• What will happen as you get older? Retire?

• What will happen to the child at your death?

• How will you pay for your child’s "special needs" during your lifetime? After your death?

• What federal and/or state programs exist to provide medical assistance benefits? Is your child eligible?

Many of these issues resemble those faced when deciding upon the guardianship of the child, with two important exceptions. First, a greater level of care will be required by the "special needs" child in most cases, and many people are unable or unwilling to take on this added responsibility. The most likely candidates are close family members. Parents should also consider the possibility that the child may eventually have to be placed with an agency that is capable of seeing to the child’s needs and can provide long-term quality care for the child.

The second exception is the manner in which parents plan to care for the "special needs" child financially. A lack of planning could jeopardize the child’s right to receive government-sponsored medical assistance benefits. Parents who fund a disabled child’s economic needs during their lives risk the loss of medical assistance to the child during the parents’ lifetime. The same risk exists if the estate is distributed outright to the child upon their death. A special needs trust may be the solution (see "Special Needs Trusts: Planning for a Child with Disabilities" by Edward Beasley on page 45).

The Education IRA

Another aspect of the planning process is to plan for children’s needs while the parents are still living. A major consideration should be the funding of future educational needs. Parents who are thinking of making financial gifts to children for the holidays or for a birthday now have a valuable new option—the non-deductible Education IRA, which allows for annual contributions of up to $500 per child under the age of 18. If withdrawals are used for qualified, higher-education expenses such as tuition, fees, or books, any earnings on deposits will be tax-free when withdrawn.

The Education Savings Account is a tax-advantaged, accumulation plan that was established by the Taxpayer Relief Act of 1997. The Education IRA became available after January 1, 1998. To take full advantage of the tax-free earnings potential, contributions to an Education IRA should be made as close to the first of the year as possible. It’s also important to remember that unlike traditional IRAs, which allow contributions for one tax year to be made as late as the following April 15, the Education IRA requires that yearly contributions be made no later than December 31. All annual contributions will have to be made during each calendar year.

As with other types of IRAs, income phaseout limits govern contributions. However, the Education IRA is unique in that the limits apply to the contributors rather than the beneficiaries. Thus, even if the parents’ income is too high for them to contribute to an Education IRA, grandparents or other adults can contribute if they fall under the income limits. Couples who file joint returns and have adjusted gross incomes of less than $150,000 can contribute up to $500 a year, though contributions from all sources still cannot exceed $500 per year. The $500-a-couple limit gradually drops to zero as income increases to $160,000. Couples earning more than that cannot contribute. For single taxpayers, the $500 maximum is phased out as income increases from $95,000 to $110,000.

Although an unlimited number of people can set up and contribute to a child’s Education IRA, annual contributions can total no more than $500 per child. Though the $500 amount may not seem that significant, the Education IRA offers the irresistible benefit of generally no income tax on any investment earnings, either during the year they are earned or when money is withdrawn from the account for higher education purposes. Earnings in traditional IRAs are taxed as income upon withdrawal.

Another important fact to remember is that the rules have not been finalized on how the money in an Education IRA will affect overall financial aid eligibility. But no contribution may be made by any person to an Education IRA during any year in which any contributions are made by anyone to a qualified state tuition program on behalf of the same beneficiary.

Remember, there is no income tax on earnings if the account is used according to the rules to pay full- or part-time higher education expenses. Earnings that are not used for education are subject to income tax and a 10 percent IRS penalty. Under the new law, money can also be withdrawn without penalty from a traditional or Roth IRA for education purposes even if the account holder is not yet 59_; but tax must be paid on withdrawals attributable to earnings and any deductible contributions that had been made.

The beneficiary of an Education IRA must be under 18 when contributions are made and must use all proceeds of the account by his or her thirtieth birthday, or pay tax and the penalty on the remaining balance. The Education IRA can, however, be rolled over tax-free to another family member if the rollover is made before the older beneficiary reaches age 30.

Finally, a note on proposed adjustments to the Education IRA by the technical corrections legislation: Congress voted to maintain the annual contribution limit to Education IRAs at $500, but may at some point in the future increase the contribution limit. In addition, there is a proposal to expand the types of expenses for which tax-free withdrawals may be made to include certain expenses for primary and secondary schools, as well as the currently permissible qualified higher-education expenses.

The current proposals before Congress also contain favorable rules for beneficiaries with "special needs." In particular, the proposed changes would allow contributions to be made after age 18, and would not require distribution by age 30 for "special needs" beneficiaries. The proposed legislation does not define "special needs" but indicates that a definition would be provided through regulations. The pending legislation would clarify that corporations may contribute to Education IRAs. (These proposed changes had not been considered by Congress at the time this article was written, but may have been decided by the time of publication.)

Leaving Property to Children

Except for property of little value, the law requires that an adult manage property inherited by minors until they are 18 years old. If parents don’t make arrangements for inherited property to be managed, the probate court will appoint a "property guardian."

The following are generally the simplest ways to arrange to leave property to minor children:

Name a custodian under the Uniform Transfers to Minors Act (UTMA). Gifts can be made to a minor by transferring property to a custodian under the Uniform Gifts to Minors Act (UGMA) or the UTMA. Because the UGMA places restrictions on the types of property that can be the subject of a custodial gift, most states have now adopted the UTMA.

Transferring property to a minor can be as easy as naming an adult custodian and the property that is being transferred. Property transferred under either act qualifies for the annual gift tax exclusion. If the donor appoints herself as custodian, the property will be included in her taxable estate if she dies while serving as custodian. There can be only one beneficiary per custodial account, and therefore separate accounts must be established for multiple beneficiaries. Likewise, each account can only have one custodian.

In most states, a UTMA custodianship ends when the beneficiary reaches age 21. Lawyers should check an individual state’s statute since age varies from state to state. Also, the instructions of the donor or the nature of the transaction that created the custodianship may determine when the UTMA ends. If parents or donors don’t want the minor beneficiary to get the property so soon, they may want to use a trust instead.

Establish individual trusts. Parents can set up a trust for each child, using either a will or a living trust to name a beneficiary. The trustee, usually a trusted relative or friend, will handle the money or property until the child reaches a certain age. If the trust beneficiary is already over the specified age at the parent’s death, the trust never comes into being and the property goes straight to the beneficiary. Generally, the trustee is given the power to spend assets for the minor child’s health, education, and living expenses. A trust is more work than an UTMA because the trustee must file an annual income tax return for the trust. In addition, since a trustee’s powers are limited to what is allowed in the will or trust document, the trustee may have to provide documentation permitting a specific type of transaction to the party with whom he or she is dealing.

Establish a single trust for all the children. Another option is to set up a common trust with all of the children as beneficiaries. When the youngest child reaches a certain age, usually 18, the trust ends. This type of arrangement has the advantage of offering greater flexibility to the trustee. The major disadvantage is that the older children can’t get their share of the inheritance until the youngest child reaches the age specified in the trust.

Name a property guardian. Parents can simply use their wills to name a property guardian. The property guardian will manage the property if there is no other mechanism such as a trust to do so. CL


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