-written by Attorney Maureen Renehan
When a married couple has a child, often times that couple opens a financial account for the benefit of the child. Some parents open savings accounts or trust funds when the child is a baby. Other parents may wait and open a college savings account once the child is school-aged. And, some parents choose to open a checking account for the child when the child becomes a teenager to teach him or her how to track and manage funds and spending. Regardless of when a child’s account is opened, if the account was opened during the parents’ marriage and that marriage ends in divorce, the question arises: how are these accounts treated?
Types of Children’s Accounts
The five most common types of accounts that can be opened for the benefit of a child are: education savings accounts (or “529 plans”), custodial accounts, joint checking accounts, interest-earning savings accounts, and trust funds. A brief description of each follows.
Education Savings Accounts / 529 Plans
Education savings accounts, also known as 529 plans, are established to help pay the future education expenses of a child. 529 plans are named after Section 529 of the Internal Revenue Code, which purpose is to provide tax-free status for qualified tuition programs. These education savings accounts are often established for children under the age of 18, and may be set up by a parent, grandparent or other interested person if he or she meets specific income requirements stipulated by the financial institution. The funds from education savings accounts are to be used solely for qualified educational expenses including tuition and fees, books and materials, room and board (for students enrolled at least half-time), computers and related equipment, internet access and special needs equipment for students attending a college, university or other eligible post-secondary educational institutions.
There are two types of education savings accounts: college savings plans and prepaid tuition plans. Almost every state has at least one 529 plan. Maryland has both a college savings plan (“the Maryland College Investment Plan”) and a prepaid tuition plan (“the Maryland Prepaid College Trust”).
- College savings plans operate much like a Roth IRA by investing after-tax contributions in mutual funds or similar investments. A college savings plan offers several investment options from which to choose, and the account will go up or down in value based on the performance of the investment options.
- Prepaid tuition plans allow the account owner to pre-pay all or part of the costs of an in-state public college education. They may also be converted to be used at private and out-of-state colleges.
The account holder of the college savings plan and prepaid tuition plans is the person who sets up the account for the benefit of the child (i.e. the parent, grandparent or other interested person) and the child is beneficiary of the account. The funds contained in an education savings plan belong to the account holder, who has the option to withdraw them for any purpose. However, the earnings portion of a non-qualified distribution will generally be subject to ordinary income taxes and a 10% tax penalty. The advantage of college savings accounts is that the earnings from the investment, as well as any withdrawals from the account if used for educational purposes, are not taxable for federal income tax purposes.
The two most common types of custodial accounts are Uniform Gifts to Minors Act accounts (“UGMA accounts”) and Uniform Transfers to Minors Act accounts (“UTMA accounts”). Since children under the age of 18 are not allowed to open savings accounts under federal law, custodial accounts were created. These accounts are the property of the child but are managed by the parent until the child reaches the age of maturity. The parent may use the funds to provide for the child’s needs. Custodians are not allowed to make withdrawals from these types of accounts for their own benefit since the account is considered the child’s property. Once the child reaches the age of 18, the account is usually converted into a regular savings account.
UGMA accounts provide a simple way for a parent to transfer financial assets, including but not limited to securities and money, to their child without having to set up a formal trust fund. Once granted, the property becomes the child’s asset and receives certain preferential tax benefits. The parent may use the assets to purchase securities on behalf of the child. And, as long as the transaction benefits the minor, the parent can make withdrawals from the account. UGMA accounts are managed by the parent until the child turn 18 (or 21 or 25 depending on the state), at which point the child assumes control of the account.
UTMA accounts are similar to UGMA accounts in that they satisfy Internal Revenue Service gift tax rules for granting up to $14,000 per year to another person tax-free. However, UGMA and UTMA accounts differ in the type of property they permit a person to transfer. UGMA accounts are usually restricted to cash, securities and life insurance, while UTMA accounts allow a wider variety of investments, including but not limited to mutual funds, stocks, bonds, and even real estate.
Joint Checking Accounts
Some parent opt to simply open a jointly-titled checking account for their child in the names of the parent and the child. Both the parent and the child have access to the funds in the account, and the money is owned jointly until otherwise specified. With many of these accounts, banks allow parents to put withdrawal limits on the account and track their child’s spending habits to teach them responsible money habits.
Interest Earning Savings Accounts
Interest earning savings accounts allow children to learn financial responsibility and the importance of saving money. Many of these accounts do not have minimum opening deposits or monthly maintenance fees. Parents may also connect their accounts to their children’s accounts and make electronic deposits to the accounts.
Contrary to popular belief, trust funds are not just for the ultra-wealthy. Trust funds are a way for families to ensure their children make wise financial decisions after they have grown. There are many different types of trust funds. Typically, trust funds are set up by a grantor, the parent, who decides what assets go into the trust, such as stocks, bonds, cash and property. The grantor also decides when and how the beneficiary, the child, gets to use the money. When the grantor dies, the appointed trustee makes sure the trust is managed according to grantor’s plan. Then, when the beneficiary reaches a certain age or milestone, the trustee gives them the money.
Treatment of Children’s Accounts In Divorce
The Marital Property Act in Maryland sets forth a three-step process for dividing divorcing parties’ assets. First, the Court must make a determination whether the property is marital or non-marital. Second, the Court must determine the value of all marital property. And third, the Court must decide if the division of marital property according to title would be inequitable, and if so, the Court may make a monetary award to resolve such inequity. Until recently, trial courts in Maryland typically have treated children’s accounts as belonging to the spouse whose name is on said accounts with the child. Thus, if the parties established a 529 plan or a savings account during their marriage for the benefit of one of their children, but only the father’s name is on the account with the child, then at the time of divorce that account would be deemed to be the father’s property.
The recent Maryland Court of Special Appeals case of Abdullahi v. Zanini has clarified the law in Maryland regarding treatment of children’s accounts during the parents’ divorce. In that case, the parties had established two 529 plans for their son (one college savings plan and one prepaid tuition plan), and the mother was the account holder for both plans. The trial Court, in calculating a monetary award, included the two 529 plans as the mother’s assets. The Court of Special Appeals overturned this decision, holding that “[w]here there is nothing to suggest that the custodian of 529 college savings account, which are held for the benefit of a child’s college education, will use the funds for another purpose, it is improper to consider the funds as assets of that parent in determining a monetary award.”
While the Abdullahi v. Zanini decision only addressed the treatment of 529 plans, one may suspect that going forward, there may be future cases which address the treatment of custodial accounts, joint checking accounts, interest earning savings accounts, and trust funds in calculating appropriate monetary awards incident to divorce.
If you and your spouse have children’s financial accounts you should carefully discuss with your lawyer how to address what happens with those funds in the event of a divorce.