McClellan Legal LLC Estate Planning & Tax Assessment Blog

Tuesday, January 27, 2015

Trusts for Minor Children (Article 2 of 8)

It is a common myth that minors cannot inherit property.  Minor children may inherit equitable title in property but cannot hold legal title until they reach the age of majority (21 years old in Pennsylvania).  Equitable title simply means that the assets must be used for the benefit of the child.  Legal title is directed to how the assets are managed.   Since a minor cannot hold legal title, a custodian or trustee will manage the assets for the child’s benefit.

There are two primary ways to manage inherited assets for minor children:

  • Uniform Transfers to Minors Act (UTMA)

  • Child’s Trust

Uniform Transfer to Minors Act

If a parent with minor children passes away without a Child’s Trust set up in an estate plan (either in a Will-Based Plan or a Revocable Living Trust-Based Plan), then the minor child could alternatively inherit the assets via the Uniform Transfers to Minors Act (UTMA).  UTMA was adopted by many states (including Pennsylvania) and is intended to be an efficient way to transfer assets to minors without the use of trusts.  Generally, a UTMA custodian has wide discretion to use the assets for the benefit of the child and must transfer legal title to the child when the child reaches 21 (could be delayed until 25 in Pennsylvania).  While transfer to minors via UTMA is intended to be simple, it does not include sufficient flexibility to allow a parent to customize the terms of the child’s withdrawal rights or define the custodian’s discretionary terms for managing the assets. 

Child’s Trust

As a more flexible alternative to transferring an inheritance to a minor child than using the UTMA, parents often draft Child Trusts in their Will or Revocable Living Trust.  Using a Child Trust allows for highly customizable withdrawal rights, including tiered withdrawals.  In lieu of the UTMA’s automatic withdrawal right by the child at 21, many people prefer to gradually grant their children withdrawal rights as they mature.  Holding inherited assets in a Child Trust is meant to protect the assets from creditors, failed marriages, and the child’s own financial maturity. 

A reasonable indicator of financial maturity is the child’s age.  For example, it is common for parents to set up tiered withdrawal rights for their children as follows: one-third of the assets at 25 years old, one-third at 30, and the remaining balance at 35.  Since age alone is not always a good indicator of maturity, the trustee may be instructed via the Child Trust to delay or fast-forward the tiered withdrawal rights dependent on other factors (e.g., recent history of drug/alcohol abuse, credit history, mental/medical conditions, marriage issues, continued higher education, etc.), which may serve as a better indicator of the child’s financial maturity.  

A Child Trust also allows the parents to define clear rules regarding how the trustee manages the assets for the child.  For example, a Child Trust may provide that trust assets are to be used for certain discretionary expenses, such as private school.  The UTMA simply does not provide this level of flexibility for parents to customize their child’s inheritance.  At some point, parents may also want to appoint their child as co-trustee or sole trustee of their Child Trust in order to encourage the child continue to protect the assets within the trust.

Pot Trust for Multiple Children

If a parent has more than one child, the parent may want to consider initially managing the children’s inheritance in a single Pot Trust instead of automatically splitting the total inheritance into individual Child Trusts.  At some later point in time, the Pot Trust will be split into individual Child Trusts upon the occurrence of a triggering event (e.g., the youngest child graduates from college or turns 25 years old).  If the parents survive the triggering event, then the Pot Trust will never be implemented and each child’s share will be immediately distributed to an individual Child Trust. 

The rationale for the Pot Trust is that older children may have already received a substantial “gift” (e.g., college tuition, wedding expenses, etc.) prior to their parent’s death, because older children often reach expensive life events before younger children.  Therefore, a Pot Trust manages all of inherited assets in a single pot to reduce the administrative burden and to ensure that each child’s individual share is fairly distributed.

If your children are minors or young adults, there is nothing more important than properly planning for their well-being.  By utilizing trusts for your children, you will have the tools to design the right balance between asset protection that children need and the beneficiary control that children desire.

If you have any questions regarding utilizing child trusts in your estate plan, please call our office at (610) 444-5552 to schedule an appointment.

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McClellan Legal LLC is located in Kennett Square and serves clients throughout the areas of Avondale, Chadds Ford, Coatesville, Downingtown, Landenberg, Oxford, Phoenixville, Pottstown, West Chester, & West Grove.

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