My daughter turned 18 recently, and received a $25,000 mutual fund
statement with her name on it. Her aunt had put $10,000 away in 1995
in a gift trust account for a minor. This was a mutual fund account in
which the interest was reinvested each year and therefore no IRS
interest statements were generated. We were unaware that her aunt had
opened this account and let the money grow for 17 years. My daughter
will be applying for financial aid for her sophomore year in college
and must fill out the FAFSA and CSS Financial Aid PROFILE forms. How
will this $25,000 mutual fund affect her financial aid for next year?
She does not have any assets and works a part time job for income.
What is the smart thing to do in reducing the affect of this asset for
financial aid? Can she put the mutual fund in my name? I do not not
own a home due to a recent foreclosure and do not have much assets.
A gift trust account is an irrevocable trust fund. It is structured so
that the amount contributed to the trust by the trust's creator is
not subject to gift or estate taxes. To qualify, the gift must be
irrevocable, meaning that the creator cannot change his or her mind
about the gift or change the beneficiaries. The amount contributed
must fall under the annual gift tax exclusion at the time of
contribution. The trust terminates at a future date or when conditions
specified in the trust document are satisfied, such as when the
beneficiary reaches the age of majority, at which time the beneficiary
will receive the gift trust account.
In addition, the contributions to the gift trust account must
represent a present interest
to the beneficiary, not a
. This means that the beneficiary must have
been able to withdraw the funds from the account. As with a Crummey
trust, the beneficiary should have been informed about the
contribution to the trust at the time of the gift and then had the
opportunity to withdraw funds for a limited period of time, typically
But since the beneficiary was a minor at the time, the minor's
interest in the gift trust account would have been structured as a
custodial account. The notice of the gift would have been provided to
a custodian on behalf of the minor. It is likely that the creator of
the trust also served as the custodian.
This is a clever way of giving money to a minor in a tax-advantaged
manner that precludes the child's parents from having access to the
funds. It also protects the money from the parent's creditors.
If the student and parents are unaware of the existence of a gift
trust account, they have no obligation to report it as an asset on the
Free Application for Federal Student Aid (FAFSA) or other financial
aid forms. So the failure to report the gift trust account as an asset
during the student's freshman year, before she reached the age of
majority, does not present a problem.
But even if the creator of a gift trust account for a minor serves as
custodian for a minor beneficiary, it is unclear how the creator would
have been able to hide the existence of the trust from the child and
the child's parents. Although trusts can have a separate taxpayer
identification number and file their own annual tax returns, in most
cases the benficiary must pay income tax on the trust's annual
income. (A major exception occurs when the creator of the trust has a
legal obligation to support the beneficiary, in which case the creator
of the trust would pay income tax on the trust's income.) The
automatic reinvestment of the interest in the account is irrelevant,
as the interest must still be reported as income to the beneficiary.
The most likely scenario is one in which the gift trust account was
invested in US savings bonds. US savings bonds are exempt from state
and local income tax and the federal income tax obligation may be
deferred until the bonds are redeemed or reach maturity. The average
annual return for a $10,000 investment worth $25,000 after 17 years is
5.5%, consistent with the rates for savings bonds issued in 1995.
Another scenario could involve having the trust invest in stocks or
other securities that do not pay dividends. So long as the investments
do not pay dividends, there is no taxable income from the
investments. So long as the investments are not sold, there would be
no taxable capital gains either.
But once the family becomes aware of the existence of the gift trust
account, they must report it as an asset on the FAFSA and other
financial aid forms. Since the account is owned by the student, it
must be reported as a student asset, reducing need-based aid
eligibility by 20% of the asset value. Thus a $25,000 student asset will
reduce aid eligibility by $5,000. (The annual income from the account
must also be reported as student income, reducing need-based aid
eligibility by as much as 50% of the amount of income.)
The simplest solution is for the student to contribute the money to a
529 college savings plan with the student as the account owner and
beneficiary. Even though the student is the account owner, a 529
college savings plan owned by a dependent student is reported as a
parent asset on the FAFSA. Parent assets have a much more favorable
treatment on the FAFSA, reducing aid eligibility by up to 5.64% of the
asset value. A portion of parent assets, typically $40,000 to $50,000,
are also sheltered by the financial aid formula. Thus a $25,000 parent
asset will reduce aid eligibility by at most $1,410, and in many cases
by a lower figure.
Another solution is for the student to spend the money on her
education or other expenses. This can reduce or eliminate the negative
impact of the account on her eligibility for need-based financial
aid. Assets are reported based on the account value on the most recent
statement received before the FAFSA is filed.
It is unclear whether the student can gift the money to her
parents. Legally the account is owned by the student. Before she
reaches the age of majority in her state, she lacks the capacity to
make such a gift and it would be a breach of the custodian's fiduciary
responsibility to transfer the money. It may also be illegal for the
custodian to transfer the money, since the creator of an irrevocable
gift trust cannot change the beneficiary. After the student reaches
the age of majority, she may still lack the maturity to rationally
gift the money to a parent, given her likely lack of financial
sophistication and the dependent nature of the relationship between
child and parent.