What if a grandparent wants to leave their minor grandchild a sum of money for their college education? Or what if a minor child is named as the beneficiary of an uncle’s life insurance policy and he passes before the child turns 18? While their intent is sincere, in both situations their wishes are not so easily accommodated. The reason is that a child under the age of 18 who inherits money or property in Texas cannot receive it outright. Nor can the parent of the minor beneficiary collect the money or property on behalf of their child. So is all lost for these benevolent loved ones? Not at all.

To be clear, it’s okay for minors to inherit property. There are just rules to follow to ensure the minor’s best interests are protected. That said, there are a number of ways to accommodate bequests, gifts, and windfalls that a minor receives.

Proactive planning

Ideally, everyone would have done some proactive estate planning to account for these potential events, but that is not always the case. For example, a minor should never be named as a beneficiary under any life insurance policy, retirement plan, or pension plan (more on that later).

There are several planning techniques that can be utilized ahead of time that are less expensive and more seamless than after-the-fact alternatives. And any of these can be used to accept either planned or unexpected funds.

Testamentary trust – For bequests to minors, it is very simple and inexpensive to include in a will the creation of a testamentary trust. Any property inherited under the will by the minor will be put in this trust for their benefit until they reach an age specified by the terms of the trust. The trust, either through its terms or via the appointed trustee’s authority, can also limit or restrict the use of the property in order to prevent the beneficiary from squandering trust assets. This feature is sometimes called a “spendthrift” provision and is commonly used in these types of trusts to encourage a sense of responsibility and maturity.

Pot trust – This type of irrevocable trust can be created in a will or as a stand-alone trust for the benefit of a group of minor children. The funds of the pot trust – visualize a giant pot of money – are distributed by the trustee to the beneficiaries as needed, and not necessarily equally. The trustee has discretion to determine what each child requires, based on their differing medical or educational needs. Generally, this trust will terminate when the youngest beneficiary turns 18, at which time the remaining assets are distributed to each beneficiary.

Section 2503 trusts – Section 2503 of the Internal Revenue Code provides for the creation of trusts for the benefit of minor children, where funds are set aside for the health, education, maintenance, and support of the child. These trusts can be created in a will or as a stand-alone vehicle. A trustee is responsible for managing and distributing trust assets until the trust terminates. These trusts have tax advantages that are beyond the scope of this article, but they can provide significant tax savings when incorporated into a complex estate plan.

In a 2503(b) trust (which can also be used for adults), income from trust assets is distributed annually, up to an amount equal to the annual gift tax exclusion, to a custodial account managed by the trustee for the minor child’s benefit. This trust is irrevocable, and annual distributions continue until the beneficiary reaches age 21, but the principal can remain in the trust until the beneficiary reaches a certain age.

In the more commonly used 2503(c) trust, also irrevocable and often called a “minor’s trust,” both principal and income can be accessed by the beneficiary until they reach age 21, after which any remaining trust assets must be distributed. However, the beneficiary may elect to extend the trust. A key factor in establishing this trust is whether the beneficiary will be fiscally responsible when they turn 21.

Special needs trust (SNT) – Available only for the care of a child with a disability or special needs, this trust is funded specifically for the care and maintenance of the child, while preserving their eligibility for public benefits.

Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts – Direct gifts and transfers to minors can be made to these custodial accounts without having to establish a trust. The accounts are held in the name of the minor, but controlled by a custodian (usually a parent or trusted loved one). Both types of accounts terminate when the minor reaches the age of majority. In Texas, that’s 18 for UGMA accounts and 21 for UTMA accounts.

One benefit of these accounts is that tax liability for income from the account is shifted to the child, who should be in a lower tax bracket than then donor. Gifts to these accounts are irrevocable, but the donor may retain control of the funds and decide how they are invested. The UGMA and UTMA permit only certain types of property to fund the accounts. The UGMA allows cash, life insurance, and other liquid assets to fund accounts, while the UTMA allows these liquid assets as well as real estate or collectibles.

Section 529 plan – Another option created by the Internal Revenue Code, the 529 plan is a qualified tuition program established to allow contributions to fund a child’s higher education. These plans are available in and sponsored by all 50 states, and you can choose to use any state’s plan, no matter where you or the child resides. Earnings accumulate tax-free and distributions are not taxed, as long as they are used for tuition expenses.

Statutory options

If none of the foregoing planning has taken place, and money or property has unexpectedly fallen into the hands of a minor – like, for example, in the life insurance scenario mentioned earlier – the state has created statutory options to solve this dilemma.

Guardianship – Often the least desirable option is the creation of a guardianship for the minor, in which a guardian is named by a court to manage the property intended for the minor. This guardian can be a trusted loved one or, if none are available, someone appointed by the court. The real downside to this option is that it requires a court to establish, so the costs associated with attorneys and the maintenance of the guardianship until the child turns 18 can significantly erode the value of any property intended for the minor.

Section 1301 management trust – Named after a section of the Texas Estates Code, this trust is established after requesting the court to appoint a trustee to manage the funds or property received by the minor child. The trustee can be a financial institution or sometimes a trusted loved one. The trust can be used until the minor child has reached anywhere from age 18 to 25 and can be a cost-effective and timely solution for unexpected windfalls to minors. The trust is less restrictive than a guardianship, so it’s usually the most logical option of the two.

Conclusion

The best way to account for gifts and transfers to minors is to plan ahead. There are plenty of proactive planning techniques to choose from, and they are fairly easy and inexpensive to set up. In addition to ensuring you are prepared for unforeseen events, setting up a trust or investment account for your minor child can impart a sense of responsibility and provide a valuable teaching experience that will serve them the rest of their life.