“Protecting” Your Children’s Inheritance

by Justin Dituri

 

 

How important is it to you that the estate that you leave to your children, also be available for your grandchildren (after your children are gone)?

 

Another question to ask yourself is, “How old should my children be before it is OK for them to lose half their inheritance to an ex-spouse in a divorce?”  Looking at the same question another way you could ask yourself, “How old must my children be before it is OK for them to lose their inheritance in a lawsuit?”

 

If your answer to the first question is, “I would like my grandchildren to benefit from my estate,” or if your answer to the second question is, “This would never be OK,” you should address these issues in your estate plan.

 

The answer of how to protect your children’s inheritance from any potential creditors, or predators (the ex son-in-law or daughter-in-law), or to preserve it for future generations is trusts.

 

In talking about trusts, I do not mean the revocable living trusts that many people set up as an alternative to a will.  (Some people say you should set one of these up so that your estate will avoid the probate process).  A revocable trust is a trust that you set up for your benefit during your life, and that you are the trustee of.  Any property you place in a trust that benefits you, and over which you are the trustee, can be reached by your creditors.

 

What I am talking about here is having a trust set up after your death that your spouse or your children will be beneficiaries of, a trust that will continue for the rest of the trust beneficiary’s life.

 

You should understand that this can be done with either a revocable living trust or a will.  The revocable living trust would simply become a trust for your spouse or children after your death, in a will you can direct that property be left to a beneficiary in a trust.

 

Now, you may be asking yourself, “If I leave my property to my spouse or children in a trust, doesn’t that mean they will have a hard time getting to it?  Won’t they be at the mercy of a cold-hearted institutional trust company and not have any say as to how the money is invested or when they get to spend it?  And won’t that trust company collect a big fee for preventing my spouse from enjoying what is rightfully hers, or our children from enjoying their inheritance?”

 

The answer to this is “no”, this is not only way to accomplish leaving the property in a “protective,” lifetime, trust for your spouse or children.

 

 

 

Control vs. Protection

 

You may be asking why someone would want to limit their children’s control over their inheritance.  There are some obvious family situations, such as minor children or children  with disabilities, where there is a need to have a third party protect and manage your children’s inheritance.  But the natural concern when the children are normal, successful, adults is that leaving property in trust would mean severely limiting their control and treating them as if they were children, disabled, or incompetent.

 

Traditionally, to take care of the situation where there are minor children, people will have their will or revocable living trust create a trust for their children to hold any property until the children become adults.  This would be a trust that ends when each beneficiary (each child) turns 18 or 21, or completes their education.  Another approach is to create a trust for children that will give them one-third of the trust when the child is 30, another third at 35, and the final third at 40.  In these situations, the trust ends at some point during the trust beneficiary’s life, the trust property is given to the beneficiary, and the beneficiary has total control over the property. 

 

But, once the beneficiary has total control over the property, it is exposed to the potential claims of creditors or division in a divorce. 

 

There is the possibility of leaving property in a trust, with a trust company (such as a bank) as trustee where the trustee gets to decide when a beneficiary receives distributions.  The trust could also include what is known as a “spendthrift” provision, prohibiting the trustee from making distributions to a beneficiary’s creditors and not allowing a beneficiary to pledge or encumber any of the trust property.  In this situation it would be very difficult for a creditor to have any access to the trust property.  And, the beneficiary never has any control.

 

In the last few years some “hybrid” approaches to trusts have developed.  The goal has been to create lifetime protective trusts that have flexibility to meet changing circumstances and changing laws.  Some of the solutions include allowing the beneficiaries to remove a trustee and appoint a different trustee, or allowing the beneficiary to be co-trustees with a trust company or CPA that the beneficiary can choose.  

 

Recently, a trend has developed to draft trusts that distinguish three trustee functions, administration, distribution, and investment.  The administrative trustee performs administrative tasks, such as keeping the checkbook, and preparing and filing income tax returns.  The distributive trustee decides when, to whom, and how much, to distribute from the trust.  The investment trustee decides how to invest the trust assets. 

 

In the above scenario you could have a trust where the beneficiaries could be the investment trustee (the beneficiaries have control over how the trust is invested), a trust company could be the distributive trustee, with the beneficiaries having authority to fire the trustee and hire a new one if the trustee is too restrictive in making distributions (the beneficiaries have some control), and a beneficiary could be the administrative trustee (the beneficiary has control over record keeping and tax filings).  In this example, if the beneficiary has an issue with a creditor, a judge will have to order the trust company (not the beneficiary) to make a distribution, and the trust company can argue that it cannot make the distribution to the creditor.

 

So, you can see that trusts are not “one size fits all”.  These tools can be used to create unique trust arrangements for your family, and your family’s unique situation.  The article is meant to help you better understand your estate planning options with trusts, and is not meant to be specific legal advice for any ones situation.  Each family should work together with their own attorney, who is familiar with these options and who can counsel the family, to design and put into effect a estate plan that best reflects the family’s own personal hopes, desires, and wisdom.

 

Mr. Dituri is Colorado attorney who has limited his practice to estate planning issues for the last ten years.  You may contact Mr. Dituri at 303-774-1976. 

 

© 2005 Justin Dituri