WHILE CHILDREN can own property, they can’t legally enter into contracts. That makes it difficult for them to manage an investment portfolio, because they can’t buy or sell. This is the reason a child’s investment account needs an adult custodian—and the reason substantial sums bequeathed to children who are under age 18 or 21 are often placed in a trust, with a trustee overseeing the assets involved. Trusts for children are typically testamentary trusts, meaning they’re set up according to the instructions in your will, rather than being established before your death.
While your children could receive their trust assets once they reach the age of majority, which is typically 18 or 21 depending on the state, all the money doesn’t necessarily need to be disbursed at that point. Instead, you might specify that the trustee should use the trust’s assets to pay living expenses and education costs, with the remaining balance distributed when your children reach age 25 or even age 35. That will give them a chance to mature and, you hope, become a little more sensible about managing money.
While you may not want the trust to hand over great chunks of money to your children in their early 20s, you probably want the trust to disburse a little money every year for tax reasons. If a trust disburses its investment income, that income is taxable to the beneficiaries. But if the trust retains dividends, interest and realized capital gains, it can quickly find itself paying taxes at a steep rate. In 2020, a single individual needs taxable income of $518,400 before he or she is in the top 37% federal tax bracket, but a trust will be in that tax bracket if it retains more than $12,950 in taxable income.
You might be able to sidestep this problem by focusing the trust’s investments on tax-efficient stock funds and tax-free municipal bonds. If you establish the trust while you are alive, you could also set it up as a grantor trust, which means that during your lifetime the trust’s retained income would be taxable on your return.
Next: Special Needs Trusts
Previous: Living Trusts