Financial Advice for Retirement, Social Security, IRAs and Estate Planning

Avoiding A Surprise When Estate Planning Gifts To Grandchildren

Published on: Feb 01 1998
Estate Planning

Leave it to the law to make an unpleasant situation worse. Here’s one they didn’t teach in law school, but you need to know about it. We only stumbled upon it when Renee and I were reviewing our own Estate Planning. An unfortunate combination of events could lead to an unpleasant surprise for grandparents who made gifts of cash, stock, or mutual funds to their grandchildren. Fortunately, there are actions you can take to ensure you won’t be one of the few who face the unpleasantness.

Longtime readers know that I am not a big fan of using Uniform Gift to Minors Act (UGMA) accounts for gifts to grandchildren or children. Yes, there are advantages to the accounts. UGMAs are easy to set up. Virtually every financial institution has the accounts as part of its standard application. And using the UGMA account guarantees that your gifts qualify for the annual gift tax exclusion. Plus an adult will control the account until the grandchild reaches the age of majority.

Those are the estate planning advantages. But once the grandchild reaches the age of majority, he or she automatically has full legal control of the account. No one can prevent the grandchild from spending the money on a car, home theater system, drugs, and alcohol, or from gambling it away. An UGMA also can hurt the child when applying for financial aid to college. For those reasons, I favor trusts for any meaningful gifts to grandchildren or minor children.

Here’s another reason to favor a trust.

Suppose your adult child gets divorced. You continue to make gifts to the grandchild, either directly or through an UGMA. Now suppose tragedy strikes and the grandchild dies while still a minor. The grandchild cannot have a will, because anyone under the age of majority is not legally competent to write a valid will. The parents or other guardian cannot write a will for the grandchild.

That means state law controls how the grandchild’s estate will be distributed. In most states, when an individual dies without a spouse or children, the estate is inherited equally by the deceased’s parents. That means that your adult child and his or her ex-spouse will split the grandchild’s estate. It doesn’t matter that the money originated from your side of the family or that one of the last things you might want is for the ex-spouse to get part of that money. The natural parents will split the money if the child dies after the age of majority, did not write a will, and does not have a spouse or children.

In fact, even after the age of majority, if the grandchild actually writes a will and is on good terms with both parents, the odds are that both parents will share the estate under the will, even if you don’t want the money going to your former in-law.

Using a trust, instead of straight gifts or an UGMA, to make gifts to a grandchild avoids this problem. You set up the trust and determine how the money is distributed after the grandchild dies. The trust also controls when money is distributed during the grandchild’s lifetime. You can put controls on the trust to ensure that the money won’t be wasted and won’t be distributed if the grandchild is having gambling, substance abuse, or other problems.

What if your estate planning already allocated money into UGMAs for a grandchild? If the grandchild should die, the grandchild’s estate can be used to pay for a funeral, charitable gifts, a scholarship fund at school, and other expenses. If someone on your side of the family is executor of the estate, he or she might decide it is more appropriate to spend most of the estate on those items rather than leaving it for the parents.

One of the purposes of estate planning is to ensure that your life’s wealth is distributed according to your goals. I hope none of you faces this situation, but the odds are some of you will. Hedging against that possibility is another reason to use well-crafted trusts when making meaningful gifts to grandchildren.

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