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How newly rich minors can preserve their finances

With planning, your kid's windfall can last

Grace VanderWaal arrives at at the "America's Got Talent" Season 11 Live Show at Dolby Theatre on August 30, 2016, in Hollywood, California.
Steve Granitz | WireImage | Getty Images
Grace VanderWaal arrives at at the "America's Got Talent" Season 11 Live Show at Dolby Theatre on August 30, 2016, in Hollywood, California.

Your typical 12-year-old isn't snaring a $1 million windfall, but that's exactly what happened to "America's Got Talent" winner Grace VanderWaal.

The young singer-songwriter and her ukulele beat 35 other contestants for the coveted prize. She will also headline a series of live shows in Las Vegas.

Ownership of a $1 million prize is a massive undertaking, especially for a minor, but with proper financial planning, newly wealthy children can protect their assets while meeting their long-term savings and gifting goals.

Naturally, protecting the child and his or her earnings from undue influence is also a priority — even beyond age 18.

Here are some suggestions in case your child becomes an overnight sensation.

Lump sum vs. annuity

Much of your planning will be based on how he or she receives the money.

For most people, it's tempting to take $1 million in prize money as a lump sum. If you do, your family will launch right into the top federal income tax bracket of 39.6 percent. Syco Entertainment, the production company that represents VanderWaal, could not say whether the youngster took a lump sum or an annuity.

With an annuity, your child could receive a stream of income over time.

Over a 40-year period, for instance, $1 million becomes $25,000 in annual income. The immediate tax burden isn't as large.

And from a cashflow perspective, receiving income over time also leaves you with fewer opportunities to splurge irresponsibly.


Both choices have their pros and cons.

"You increase your tax burden by taking the lump [sum], but you have access to real wealth," said Jeffrey Wolken, national director of wealth and fiduciary planning at Wilmington Trust. "On the other hand, you have less overall taxes on an annuity, but 40 years from now $25,000 won't buy a lot."

Protect the cash — even from family

Four states require certain trust accounts, sometimes known as "Coogan Accounts," for entertainers under the age of 18: California, New York, Louisiana and New Mexico.

At least 15 percent of the child's wages must be deposited into a Coogan Account within 15 days of employment. In these states, parents must provide proof of opening the account before the child receives a work permit.

The parent acts as the trustee of the account and is responsible for providing an annual accounting of the funds, said Andrew Katzenstein, partner in the private client services department at Proskauer Rose in Los Angeles.

Jackie Coogan, the late child actor, is the namesake of these accounts. He earned millions of dollars in movie gigs after Charlie Chaplin discovered him in 1919. At age 21, Coogan had to sue his mother in order to recover his earnings.

"Squandering is the biggest concern when the kid earned the money," said Katzenstein. "With the Coogan account, at least 15 percent of it is still there."

These protections aren't available everywhere.

"In some states, it's still the case that the child's earnings are basically the property of the parent," said Wolken of Wilmington Trust.

Keep creditors at bay

Keep your child's stash protected from creditors.

Establish a limited liability company, contribute the child's assets to the LLC and place that entity in a trust, said David Pratt, chair of the private client services department at Proskauer Rose in Boca Raton, Fla.

Consider using an asset protection trust, an irrevocable trust that protects the money from creditors. Note: Only 17 states permit these kinds of trusts.

Some jurisdictions are more favorable than others for these strategies, due to nuances in creditor protection laws and state income taxes. Pratt said Delaware, Nevada, Alaska and South Dakota are some of the better locations for asset protection trusts.

The responsibility for creating the trust would fall to the parent or to whomever has guardianship over the child's estate, said Wolken of Wilmington Trust.

At the legal age of majority, the young star will have to establish a will, as well as power of attorney and health-care directives, said Charlie Mueller, executive vice president of trust and advisory services at Northern Trust.

In the future, a pre-nuptial agreement will be a "must."

Bread-and-butter financial planning

An education in the basics of financial planning, including investments and taxes, is in order for a budding child star and his or her family.

"The biggest threat to sudden wealth is spending without a plan," said Wolken.

There should be three tiers of spending. Assets in the trust can contain long-term investments to support lifetime goals. Another bucket of cash can cover the current cost of living and address any debts. Finally, leave some room to pay for short-term wants.

Here's a new element to consider in light of social media: etiquette. "Talk to your child about the importance of not discussing or displaying the fact that they're wealthy," said Mueller of Northern Trust.

He said that clients have been requesting guidance on how newly wealthy young people ought to handle social situations — including delicately refusing to pay for everyone's meals on nights out.

"Wealth attracts people in need, and the closer the relationship, the more difficult it is to say no," Mueller said.