Impact of a Gift Trust Account on Eligibility for Need-Based Financial Aid

<b>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.K.C. 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 future interest. 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 30 days. 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.