Uniform Transfers to Minors Act (UTMA) accounts are a popular tool for gifting assets to minors. They can easily be set up without the services of an attorney or accountant. A contribution to an UTMA account is considered a completed gift for tax purposes, but the minor beneficiary is prohibited from accessing the funds in the account until their 18th (or even 21st) birthday.
The account is managed and controlled by a custodian, who can be the minor beneficiary’s parent, guardian, or some other responsible adult. Once an UTMA account is created, any funds or other property transferred to the account cannot be returned to the person making the gift. When the minor reaches age 18 or 21, depending upon the state in which the account was created, he is entitled to access the funds in the account.
However, UTMA accounts are not without their drawbacks. Like other planning tools, unforseen circumstances can arise that defeat the good intentions of the gift maker.
One such example is illustrated in a recent bankruptcy case out of Rhode Island, In re Marcus Soori-Arachi. In 1998, when Marcus was 15, his father purchased an UTMA annuity for him with Fidelity in Nebraska. Under Nebraska law, the UTMA annuity should have terminated when Marcus turned 19 and the proceeds distributed to him. However, Marcus’s 19th birthday came and went and the account went undisturbed for another 10 years.
In 2017 Marcus, then married and living in Rhode Island, filed a petition for bankruptcy under Chapter 7 of the bankruptcy code. As required by bankruptcy law, the trustee appointed to administer Marcus’s case began the process of gathering and liquidating all of Marcus’s non-exempt assets.
The case trustee notified Fidelity that the UTMA annuity (now worth $105,000) should be turned over to the trustee. Marcus objected in the bankruptcy court, arguing that the UTMA annuity was not part of his bankruptcy estate and could not be liquidated by the trustee. (Marcus did claim a basic exemption protecting about $6,500 from the trustee.)
The bankruptcy court disagreed, finding that the UTMA annuity belonged to Marcus when he turned 19. The court ruled that it did not matter that the annuity was still in the account as of the date Marcus filed bankruptcy. Under Nebraska’s UTMA law, the custodial nature of the account terminated on his 19th birthday. Marcus gained an immediate right of ownership, possession, and control of the annuity, regardless of whether he actually exercised that right. The UTMA annuity could not be sheltered from his creditors in bankruptcy.
While this case interpreted Nebraska law, a bankruptcy court interpreting Michigan law would reach the same conclusion. While Michigan law protects the proceeds of an annuity from the claims of the creditors of a beneficiary, it does not protect the annuity proceeds from the claims of the creditors of the annuity owner, which Marcus became at age 19.
The facts of this case are unusual in that the annuity remained untouched in the UTMA for so long after Marcus reached age 19. When Marcus turned 19, he more than likely didn’t have any debts. But as time went on, he acquired a debt burden that grew to the point that he had to seek bankruptcy court protection, losing about $99,000 in the process.
Still, the case serves as an important reminder for those of you planning your estates. How well do you really know your children or other beneficiaries? Do they have excessive debt? Have they filed bankruptcy in the past? Are they being sued, or is a lawsuit threatened? What about a divorce – is a child’s marriage on the rocks? Knowing the answers to questions like these can help you structure or revise your estate plan, including beneficiary designations, to protect an inheritance from being lost to a beneficiary’s creditors.
The bankruptcy court’s opinion can be accessed here.