Chapter 3
IN THIS CHAPTER
Choosing somebody to care for your minor children
Safeguarding your child’s inheritance
Providing for your child’s continuing financial needs
Providing for children is often the first concern of somebody creating an estate plan. Young children will need somebody to care for them and to manage their assets. An estate plan can also help adult children by providing for college or for supporting children with disabilities.
As the parent of minor children, you are undoubtedly concerned about who will take care of your children in the event of your death. In most cases, a surviving parent can provide care, but these issues can be particularly pressing for single parents.
If a surviving parent can’t provide care for your children, a court will appoint somebody to care for them. Although your choice of custodian, or personal guardian, for your minor children is subject to court approval, in most cases, a court will defer to your wishes. To best protect your children, you should select a primary custodian and an alternate custodian, somebody who will care for your children if the primary custodian becomes unable or unwilling to serve.
In some cases, you and your spouse may disagree on who should be the children’s custodian. You should strive to reach agreement, even if your choice is less than perfect, because otherwise a court will make the decision for you.
Most of the time, parents want to keep their children together and will choose a custodian who is willing to care for all their children. In some situations, such as where your children have a large difference in age, you may want to designate more than one custodian based on the individual needs of your children. For example, you may provide for a teenager to remain with a nearby family through the end of high school, while a grandparent cares for your younger children.
Questions to consider in choosing a custodian include
You should discuss these issues with possible custodians and interview them prior to making your choice. This is a major decision, and it should be an informed decision. You may also choose to draft a letter to the custodian, to be kept with your will, which will remind them of your wishes for your children’s care. Although the letter will not likely have any legal effect, it will remind the custodian of your wishes and may help ensure that they’re followed.
In the case of divorce, if the noncustodial parent still has custody rights, the law will presume that custody should go to that parent upon your death. You may be concerned that the noncustodial parent is not a suitable custodian. Although you may not be able to prevent that from happening, you can take steps to help protect your child:
If the noncustodial parent has abandoned the child or has a history of mental illness, abusive conduct toward the child, or substance abuse, you may be able to initiate guardianship proceedings shortly before or after your death, in which a court can consider appointing your preferred custodian as the child’s guardian. Please remember that custody and guardianship laws are different in each state, and this will not always be possible.
If you’re married, you may choose to leave your estate to your spouse and trust that your spouse will take care of your children’s needs. If you’re separated or divorced, or simply wish to do so, you can make bequests to your minor children. However, from both practical and legal standpoints, children have very limited authority to manage their own assets.
When a child has assets beyond a few thousand dollars, an adult must help manage those assets. If you don’t designate a custodian for your child’s estate and the other parent is not available to care for your child, the funds will fall under court supervision and may be managed by a stranger, who will charge fees for services provided. Even if the court appoints a relative who does not charge fees, legal and accounting expenses may be incurred when they prepare annual reports for the court.
You will probably choose the same person to be your child’s custodian and to manage their assets. Most of the time, that person will be a surviving parent. Yet some people are wonderful with children but terrible with money. If the person you select as caregiver for your children has poor financial skills, you can choose a different person to be custodian of their estate. Similarly, if you’re divorced and prefer that your ex-spouse not control your children’s inheritance, you may designate a different person or financial institution to serve as custodian.
The same considerations apply when choosing a custodian to care for your child or your child’s estate (see preceding section), but the emphasis shifts to the financial. Your choice should be a legal adult who is responsible with money, trustworthy, and has the time to handle your child’s assets. You will want to designate the primary custodian and also identify an alternate.
Conflict may arise between the person who oversees your child’s assets and the child’s custodian. You can minimize conflicts by
Depending on your wishes and the size of your estate, you may create a trust to hold some or all of your children’s assets. The trust can include detailed provisions about when money should and should not be paid out and can even provide a mechanism for resolving conflicts between the caregiver and the trustee. For more on trusts, see Book 5, Chapter 4.
You’ve taken care of your child’s physical care and financial well-being through adulthood. But what about providing for your child’s higher education? What if your child has special needs, and an inheritance may jeopardize needed government benefits? What if you want to be sure that your child doesn’t fritter away the inheritance you worked so hard to provide?
The principal tool for managing your child’s inheritance is the trust fund, through which you designate a responsible person to hold and manage your children’s inheritance. A trust also gives you greater control over when your children will receive an inheritance, even after adulthood. Although a few states let you postpone a child’s inheritance by a few years if you express that intent in your will, a trust is a much more powerful tool for controlling when and how your child will receive an inheritance. (For more on trusts, see Book 5, Chapter 4.)
You may already have a savings account for your children’s future education. However, more formal savings tools, such as qualified tuition plans, Coverdell Accounts, and accounts under the Uniform Transfers to Minors Act, may provide tax advantages as you save toward your child’s college. Even diligent savings will not be sufficient to cover college expenses, and you may also want to provide for college through an inheritance, insurance, or trust.
You can use any form of trust to help fund your child’s college education, but using a trust for college savings does have some drawbacks. The trust will have to file an annual tax return and is taxed on its income, and the balance of the fund may affect your child’s eligibility for financial aid.
A qualified tuition plan, commonly called a 529 plan, comes in two forms:
Anybody can contribute to a 529 plan, so they provide an easy way for members of your extended family to help contribute to your child’s future education costs. Most states offer full or partial tax deductions for contributions to the plan. The assets are exempt from federal income taxes and are often also exempt from state and local taxes, and earnings accumulate on a tax-deferred basis. If your child dies or decides not to go to college, you can transfer the plan to another member of your family. For financial aid purposes, the plan is valued at an amount equal to the refund value of the plan.
A Coverdell Account (previously known as an education IRA) is funded with post-tax dollars and is maintained for the benefit of one beneficiary. You can contribute to a Coverdell Account for any child below the age of 18. As long as the money is used for education-related expenses, no tax is incurred on either the principal or interest earned when you make a withdrawal. Unlike other savings options, you can use the fund for K–12 education costs as well as for college costs. You have much greater flexibility with the investment of the funds than with a 529 savings plan. As the funds are considered to be an asset of the parents, there is no financial aid consequence to Coverdell Account savings.
Despite their advantages, Coverdell Accounts also have serious disadvantages. Total annual contributions are limited to $2,000 per year, and high-income parents may be subject to even lower limits. Also, your child must use the money from the account by the age of 30, or the account balance will be disbursed to your child subject to a 10 percent penalty and will be subject to taxes on its earnings. It may be possible at that time to change the beneficiary or roll over the account to another beneficiary, so another child or qualifying relative can benefit from the money without incurring those penalties, but the rollover process is very complex. You can find information on transfers and rollovers on the IRS website (presently at www.irs.gov/publications/p970). Due to the low limits on contribution, the account’s management costs can consume or exceed its earnings.
You can also use trusts and similar vehicles to save toward your children’s college expenses during your lifetime. One popular option is an account created under the Uniform Transfers to Minors Act (UTMA). Unlike other trusts, the terms of an UTMA trust are defined by statute. Gifts made into an UTMA account are irrevocable. The money you place into the minor’s UTMA account will fall under his control when he reaches the age of majority, which in most states is the age of 18. Most states permit you to set a turnover age of 21.
If you’re concerned that your child is more likely to buy a car than budget for college, then the UTMA trust is unlikely to be your tool of choice.
An option very similar to an UTMA is the Section 2503(c) trust, which is also created for the benefit of a person under the age of 21. You can make annual contributions to the trust up to the amount of the annual gift tax exclusion, presently $14,000. You can apply the principal and interest earned to college expenses. You can provide the child with the option to continue the trust past the age of 21, if he chooses not to withdraw his money at that time.
A popular form of trust that also takes advantage of the annual gift tax exclusion is called a Crummey trust. That name is not a judgment on its merits — it was named after its creator.
A Crummey trust can continue past the age of majority, but there is still a catch. The beneficiary is allowed to withdraw the gift only during a window of 30 to 60 days after each contribution. While most children understand that such a choice will probably result in that gift being the last you make, the money can still present a temptation.
Few choose this type of trust for college savings, because administrative costs of Crummey trusts tend to be high, and their entire balance will be treated as an asset when your child seeks financial aid.
One approach is to purchase a life insurance policy to pay college expenses. The best approach is to create a life insurance trust, to be funded by the policy upon your death. Because your estate is not the beneficiary of the life insurance benefit, the money is not subject to estate taxes. The trust can provide for the payment of tuition and living expenses during college and for how any balance is to be distributed to your child after graduation.
If your child has a physical or mental disability that may require a lifetime of care, you may be torn between how to provide for your child and concern about how an inheritance would affect your child’s government benefits. Parents sometimes feel that their choices are limited to the following:
These approaches are all far from perfect, and each can frustrate your goal of providing for your child. Fortunately, you have another option — the special needs trust. This type of trust can hold your child’s inheritance without putting government benefits at risk or causing them to be discontinued.
Creating a special needs trust is complex, as is the interplay of Medicaid, SSI, and other government benefits. For special needs planning and the creation of a special needs trust, you should get help from a qualified lawyer.
Although your child is not likely to object to inheriting a large sum of money as a young adult, you may be frightened by the idea. No matter how mature and responsible your child may be, he may not be wise with his inheritance.
A few states provide you with a limited ability to delay inheritance, but if you state that wish in your will, most will allow your child to take control of an inheritance at the age of 18. None will delay inheritance past the age of 25.
If you do not want your child to inherit as a young adult or want to provide for inheritance of only a portion of your bequest at that time, your best solution is to create a trust. A trust will not only give you that flexibility but will also allow you to provide for special disbursements in the event of special events, achievements, or emergencies.
If your child has a history of substance abuse, irresponsible gambling, or wild spending, you can utilize a form of asset protection trust called a spendthrift trust to help ensure that your child can’t squander his inheritance. The trust disburses money on a schedule or under circumstances you define. Your child can’t borrow against the balance of the trust fund, nor can creditors attach it as security for loans. A valid spendthrift trust will even survive your child’s bankruptcy.
An asset protection trust can also help protect your child’s inheritance in the event of divorce. Though most states will compel the trust to pay child support or spousal support from the trust, the funds within the trust will not be considered part of the marital estate and thus will not be subject to division in divorce.