Minor’s Trusts Explained: Gifting Strategies for College Planning
When planning for a child's future, a minor's trust can offer families greater flexibility and control over financial gifts while helping support long-term goals like funding a college education.
Today is part three in our series on gifting strategies. You can read the first posts here and here. In the last article we looked at minor custodial accounts in more detail. This week we will dive into the details of a minor trusts.
As a brief refresher, custodial accounts are similar in some ways to trusts. Both place property under the control of a person who isn't the beneficial owner — that is, the person who has the ultimate right to enjoy the fruits of the property. The legal framework for trusts is much more elaborate than for custodial accounts. Trusts provide greater protections and more flexibility. Generally, you should think of using a trust when you expect to transfer tens of thousands of dollars.
Transfers
Minor’s trusts [(IRC Sec. 2503(c)], also known as 2503(c) trusts, can be used for income shifting to a child. The federal gift tax law permits certain gifts to a minor in trust to qualify for the annual gift exclusion even though the beneficiary’s right to use the gift is postponed until age twenty-one.
For the gift to qualify for the annual exclusion, the principal and income of the trust must be available for the child’s benefit during its term, at the trustee’s sole discretion, for the purposes specified in the trust document. In addition, the beneficiary must have the right to a full distribution of all income and principal at age twenty-one (This right may be a continuing right or a right for a limited period, such 30 days after the 21st birthday.) If the child does not choose full distribution after his 21st birthday, the trust may be continued for an additional period specified in the trust. This feature can be attractive if the state of residency, under its UGMA/UTMA laws, gives the beneficiary a right to demand distribution at age eighteen.
If more than one child is to benefit from the trust, a separate share must be set aside for each child. The annual gift exclusion will then be available for each child benefited by the trust.
Tax Implications
If income is accumulated in the trust for future distributions, such as college expenses, the income is taxed to the trust. The disadvantage to this scenario is the trust’s tax rates are highly compressed. Thus, the trust will shelter only limited amounts of income at low tax rates. From a tax perspective, if the beneficiary would pay tax at a lower rate than the trust, the trustee may want to consider accelerating some distributions. Any distribution could be deposited in a UGMA/UTMA custodial account until it must be spent or distributed to the beneficiary. As an alternative to making distributions to the beneficiary, the trust could invest in assets that are expected to appreciate but that will produce little current income (such as growth stocks) or in assets whose income is deferred (such as Series EE bonds) or exempt (such as municipal bonds) and then sell these assets when it is time to pay the child’s college expenses. Since the child should be over 17 years old at this time, the income generated at this time would avoid the kiddie tax.
Trustees
The donor can serve as trustee of the trust. However, this is not recommended because if the donor/trustee has discretionary power to control distributions (i.e., beneficial enjoyment of property) and dies while the trust is in force, the trust property will be included in the donor’s estate. Alternatively, if the donor’s spouse is expected to live longer, that spouse could be named the trustee and avoid gross estate inclusion upon the donor’s death.
Since assets in a minor’s trust do not have to be distributed until the student is 21, the bulk of the trust’s funds may have been expended for college and the student would not receive control of a large amount of assets.
A 2503(b) trust can also be used as an income-shifting device. The income from this type of trust is required to be distributed at least annually to the beneficiary. It also limits the amount eligible for the annual gift exclusion to the value of the income interest. To avoid the income being distributed directly to a child, the distributions could be made to a UGMA/UTMA account.
If you’re interested in learning more about using a trust to help with college planning, schedule a call with us today. Together, we'll build a plan that helps support your family's education goals while keeping your long-term retirement plan on track.
This content is developed from sources believed to be providing accurate information and is provided by GW Financial, Inc. It is not intended to be used as investment, tax, or legal advice. The information presented is for general education and informational purposes only and should not be construed as a solicitation or recommendation. Please consult with a qualified professional regarding your specific circumstances. This article may contain links to third-party websites for your convenience. GW Financial, Inc. does not control or endorse third-party content.
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