Estate Planning Strategies for Asset Ownership

When your estate planning aims to help a grandchild financially, especially for college, an important question is: Who should own the assets? In fact, answering this question can be harder than determining how much money you should set aside and how it should be invested. Deciding who should own the property means looking at several factors, and there are several estate planning sstrategies to structure ownership.

The grandchild can’t own property outright until reaching the age of majority in his or her state. That means the property has to be held indirectly in the child’s name either through a Uniform Gifts to Minors Act/Uniform Trust to Minors Act (UGMA/UTMA) account or a trust. A trust should be considered only for a substantial amount of money (minimum $250,000 or so) because of the cost of creating it and the annual maintenance expenses (trustee fees, separate tax returns and tax planning). The tax and other factors are going to be mostly the same whether the assets are in an UGMA/UTMA account or a trust. Unless I say otherwise, assume the factors are the same whether the grandchild owns the assets outright in his or her own name or through an UGMA/UTMA account or a trust.

A tax benefit of having the child own the assets is that at least some of the income of the trust will be taxed at the child’s income tax rate, which is likely to be lower than yours or the parents’. But until the child turns age 18 only a relatively small amount of annual income is protected from the higher tax rates. When income exceeds that minimum amount (around $1,700), the Kiddie Tax taxes the additional investment income at the parents’ top rate. The Kiddie Tax applies to capital gains, so assets the child sells to pay for college or make the portfolio more conservative as college approaches could be taxed at the parents’ rate until he or she turns 18.

But having the assets owned by the grandchild in order to net some tax savings could backfire down the road.

If the grandchild might be eligible for financial aid, assets held in the grandchild’s name will count more against him than assets owned by a parent or grandparent.

The financial aid formula usually assumes about a quarter to a third of assets owned by the child are spent for college expenses each year when calculating financial need. But parents are assumed to spend only about 5% of their assets annually for a child’s college expenses. Assets held in a grandparents’ name aren’t counted in the financial aid formula at all.

Another estate planning factor to consider is the grandchild’s ability to spend or squander the assets.

When money is in an UGMA/UTMA account, the grandchild receives unlimited ownership or it after reaching the age of majority, which is 18 in most states. Some parents or grandparents believe they can protect the accounts by making sure the youngster doesn’t know about them or ever see the statements. But legally the custodian has no right to change the account’s investments or take distributions after the grandchild reaches majority. The grandchild can spend the money on a car, travel, or do whatever else he or she wants. You can prevent the grandchild from getting access to the money when you put it in a trust or hold it in your name, but not with an UGMA/UTMA account.

Those are the basic trade offs. There are potential tax benefits from having the money in either a trust or an UGMA/UTMA account. But that could become a penalty when the grandchild applies for financial aid, and there’s the risk the grandchild might waste an UGMA/UTMA account after turning 18.

RW September 2012.