The answer for families with significant wealth is often all three; please read on to find out why.
Especially at the beginning of the year, parents (and grandparents) might wonder how best to fund accounts that benefit the family’s younger generations. But then they are often caught between two conflicting instincts:
#1. To set the children up for success by opening an account for them.
#2. Concern about the loss of control over the funds and the child’s privacy. Banks require a child’s Social Security number to set up an account. This drives many to use their accounts and within those earmark funds for children.
Oh, but wait… there’s another stumbling block to contend with: indecisiveness. There are a dizzying number of options out there. How do you select the best one? Should we open a custodial account? Or a 529 plan? Perhaps establish a trust? We typically advise clients that there are many ways to financially support younger generations, and they all make sense for different reasons. The following is a quick summary of the types of vehicles we recommend most often to clients. Please note that the choices are definitely not mutually exclusive.
Trusts
- The major benefits of setting up a trust and naming your children beneficiaries are control, privacy, potential transfer tax savings and asset protection from creditors. You, the grantor, can decide how your children/grandchildren will interact with your wealth, over a long period of time. Trusts allow for the most customized distribution terms and the ability to choose at which age(s) the beneficiaries can access the funds and for what purpose. Access to the funds (and the amount) can be staggered — for example, at ages 21, 30 and 45. Interestingly, the name/title of the trust can be quite generic and not include the names of the children it will benefit.Keep in mind that where a trust is based greatly determines how it functions. Trusts based in South Dakota, for example, can operate forever (aiding with multi-generational wealth transfer) and can be created and operate in “silence,” unbeknownst to the beneficiaries or anyone other than the trustee.
- Trusts are a bit more complicated to set up and administer. The trust document must be drafted by an attorney; you need to name a trustee to administer the trust (you and your children can be co-trustees along with a corporate trustee such as LNW); and annual tax returns are required. For many high-net-worth families, the great flexibility and control provided by a trust far outweigh the extra effort involved.
Custodial Accounts (UTMAs)
- The big benefits here are ease of setup and simplicity. Custodial accounts are opened much like an individual bank or investment account, except that an adult custodian needs to be on the account until the child reaches the age of “financial majority,” often age 21.
- A potential disadvantage is that the child is legally entitled to the account assets at a relatively young age, generally 21 years – no ifs, ands, or buts. However, custodial accounts can serve as teaching opportunities and training ground to prepare the child for managing assets wisely.
| TRUSTS | UTMA ACCOUNTS | 529 PLANS | |
|---|---|---|---|
| Setup | Requires a legal trust document and account opening. | Simple application and account opening at a financial institution or investment firm. | Simple application and account opening. Plans are sponsored by individual states. |
| Costs | Setup costs and ongoing trustee / administration and investment costs, including annual tax return filing. | Little to no setup costs, but ongoing maintenance/ investment costs depending on financial institution. | Typically maintenance, administration and investment costs (can find lower cost options in certain states). |
| Control | “Trustee” has control (parent should not be trustee) and corporate trustee is recommended. | “Custodian” could be parent, although that would include the accounts in your estate. | “Owner” can be parent and account would not be included in estate in most cases. |
| Investment Choices | Flexible | Flexible | Limited to options in particular state plan. |
| Age of Distribution | Flexible as you designate age of distribution in trust document. | 18 or 21 in depending on the state (there is an “age 25 UTMA” option but annual exclusion gifting ability is lost). | Varies, depending on the state sponsor of he plan. |
| Income Tax Benefits | No, accounts are taxed at trust tax rates. | No | Yes, grows tax-free and distributions are tax-free if used for qualified expenses.* |
| Distribution Terms | Determined by trust document, can provide a flexible definition for education. | Limited: Only the Custodian can withdraw funds for the child’s costs, but once the child is over 21 (or 25 if elected) the account is controlled by the child. | Qualified higher education expenses including college tuition, room, board, fees, books. Up to $10,000 per beneficiary per year can be distributed for K-12 enrollment or tuition. |
*Beginning in 2024, certain rollovers from the plan to a Roth IRA for the beneficiary are considered qualified distributions under federal tax law.
529 Savings Plans for Education
- There are many advantages to 529 Plans, including tax savings. Established for college costs and recently expanded to include $10,000 annually for K-12, 529s grow tax-deferred AND receive tax-free treatment on withdrawal if you use them for qualified education expenses. Pretty cool! And you can “front-load” 529 Plans by transferring in one year up to five years’ worth of the annual gift tax exclusion ($19,000 in 2025), so a total of $95,000 per person (or $190,000 per couple).
- A potential disadvantage is if the child doesn’t attend college and wants to use the money for something else. However, the child does not control the funds; the account owner does. And you as account owner can switch beneficiaries at any time. You can even name yourself as beneficiary. If the 529 account has been open for at least 15 years, up to $35,000 (lifetime max) can be transferred to a Roth IRA for the beneficiary (if they have earned income), subject to the annual Roth contribution limits. Note that if 529 funds are withdrawn for non-education or education that does not qualify, there will be a 10% penalty on any income and capital gains as well as the regular taxes due on those.
Each of the above account types can financially enable children or grandchildren, while also serving to educate them on how to be good stewards of assets as they age. Whether your goals for your younger generation(s) are purely about college funding or more broadly about funding business endeavors or a house purchase, getting the young person involved proactively is paramount. Be sure to prepare them so they are also invested in their education, future career, or any other family value you want to pass on. Engage them early about the family history that led to funding these accounts as well as the nature of ongoing decisions relating to these accounts.
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