Protecting Your Child’s Inheritance With a Trust

Protecting the Inheritance of a Child, Spouse and Those You Love With a Trust

Thoughtful financial planning after death includes more than just successfully passing wealth on to loved ones in a manner that protects that wealth for him and/or her and (perhaps) future generations.  In a litigious society where the “have nots” want what the “haves” own, asset protection has emerged as one of the greatest concerns of successful people.  Parents are not only concerned about threats to their own wealth while they are alive, they are concerned about protecting their wealth for their descendants.  With divorce, bankruptcy rates and lawsuits as high as they are, it is easy to understand why clients are concerned about the risk of lifetime assets passing to their children’s spouses, creditors, and predators.

Asset Protection trusts can be set up by parents and grandparents for their descendants. These Trusts can provide asset protection for the children because the children have not set up the trusts for themselves.

How to Protect Your Spouse and Children Through the Use of a Protective Trust

Here’s a Case Study:

At her death, mom had a trust in place in which she left her Estate outright to her son.  Mom expected that after her son, her estate would eventually pass to her son’s only child (mom’s grandson) from his first marriage.  At the time of mom’s death, her son had recently married his second wife. What could happen to mom’s Estate without proper planning?

If her son were to co-mingle his inheritance with his second wife and they divorce, half of the assets could go to the second spouse instead of to his son.  If her son dies without an estate plan, New Jersey’s intestate law on estate assets controls.  By operation of law, the inheritance could be split equally between his new wife and his son, with the son receiving his inheritance outright at age 18.  If son inherits mom’s estate outright and has creditor problems, the entire inheritance could be lost to creditors.  However, if mom had created and designed her trust estate to go to her descendants in a beneficiary-controlled trust, the assets could be protected from immature beneficiaries, predators, a second spouse, and creditors.

Trusts Offer Four Levels of Protection

Below are the most common distribution techniques parents and grandparents and can use to leave assets to their children or designated beneficiaries. Read from left to right to better understand the subject.

There Are Four Distribution Techniques You Can Select to Leave Assets in Trust to Children or Other Beneficiaries: 
Each option has its benefits and disadvantages which I summarize for you.

Distribution Alternatives For Descendants Sample Language Advantages Disadvantages
Outright Distribution “After my death, my trustee shall distribute the trust assets to the beneficiary outright.” -Descendants appreciate their parent’s confidence in them. They receive the Trust assets all at once with no limitations
-No trust fees, tax rates, and compliance.
-No asset protection here.
-Distributed assets from the trust are included in descendant’s estate.-In most states, once your children have inherited assets, it is too late for them to create their own protective trusts.
Income & Support Trusts “The income and principal of the trust is distributed to the named beneficiary as is necessary for his/her health, education, maintenance, and/or support.” -Creditor protection features can be included in the trust and the Assets in trust are not included in descendant’s estate -Beneficiary does not have complete freedom to access the trust during its term.
Staggered Distributions from a Trust “After my death, my trustee shall distribute one-third of the trust assets to my beneficiary at age 25, one-half of the balance at 30, and the remainder at 35.” -Descendant’s appreciate the safeguards while they are young.
-Assets are protected while in trust.
-No asset protection for distributed assets as child reaches 25, 30, & 35.
-Distributed assets are included in descendant’s estate.
Discretionary Distributions from a Trust “After my death, my trustee may distribute to the beneficiary as much of the principal of the trust as my trustee may determine is advisable for any purpose.” -Descendants have highest safeguards.
-Distributions to children are subject to complete trustee discretion.
-Asset protection of assets while in trust exists.
-Assets retained in trust not included in descendant’s estate.
-There is the potential for trustee refusal to distribute principal and interest to beneficiaries

Let’s take a look at the above summarized trusts in greater detail so you can understand how each trust works.

Mandatory Income and Support Trusts. With this type of trust, the trustee is required to make income distributions to the named beneficiaries according to the terms of the trust.  Support trusts direct the trustee to distribute the trust’s principal and/or income for the health, education, maintenance, or support (HEMS) of the beneficiaries.  With these types of trusts, descendants do not have mandatory distribution rights.  If they do and beneficiaries have a demand right, creditors can “step into the shoes” of the beneficiary and demand distributions from the trust.  A support trust usually contains spendthrift language (spendthrift means creditor protection)that does not permit the beneficiary to assign future income or principal from the trust.  This is a very effective safeguard to protect a trust from creditors and predators and ex-spouses.

A Staggered Distribution Trust hold assets in trust for a person (child, grandchild, and often niece, nephew, etc.) which trust assets are distributed in intervals or when the person attains a certain age (such as 25, 30, and 35).  Staggered distributions are used to prevent a child or beneficiary from squandering the inheritance all at once. Until the triggering ages are reached, a trustee (other than the child) typically makes distributions for the child’s health, education, maintenance, or support.  Similar to the mandatory income and support trust described above, if a child is able to demand a distribution a creditor may have the same demand rights.  Furthermore, once the child receives the distributions of income principal, the distributed assets lose their protection.

A Lifetime Beneficiary-Controlled Trust is the newest, preferred way to leave assets to a child, loved one or another person.  The child has access to the parent’s assets in the trust as if the parents had left them to the child outright, but the assets are protected from the child’s spouse, creditor’s and others not included in the child’s estate.

Lifetime support trusts are created by the parents when they create their own trusts.  The parents’ trust provides that, after the death of the second parent, the child serves as a co-trustee along with an “independent” distribution trustee.  In other words, the parents’ leave assets to the child’s trust, naming the child as co-trustee to handle the investment of the assets and naming a second, independent co-trustee who has complete discretion to make distributions to the child.  According to IRC section 672, an independent trustee is someone other than a spouse, parent, grandparent, sibling, issue, or employee of the beneficiary.  Possible candidates for independent trustee include  friends, more distant relatives, such as an aunt, uncle, or cousin; professional fiduciaries; or financial institutions.

In this type of trust, the child is the beneficiary of his or her own trust.  The trust assets are re-titled directly from the parents’ trust to the child’s trust.  If the child becomes a party to a lawsuit, such as a divorce or creditor action, the trust assets are protected because the child does not have the authority and cannot compel the distribution trustee to make distributions from the trust.

A variation on this type of beneficiary-controlled trust allows the child to serve as sole trustee of his or her separate trust.  However, if the child resigns as trustee, he or she must appoint an independent trustee who has complete discretion to make distributions.  The theory is that once the independent trustee is in place, the assets will not be vulnerable because the parent, not the child, established the trust, and the child who is no longer trustee does not have the discretion to distribute income or principal to himself or herself.

I’m a big advocate of protective trusts for many reasons. I’d like to explain these reasons to you if you think a Trust makes sense given your individual and family circumstance(s).

 For more information on protecting a loved one’s inheritance using a Trust,

Contact Fredrick P. Niemann, Esq. a NJ Trust Law Attorney at

(855) 376-5291 or email him at fniemann@hnlawfirm.com.

I welcome your call and look forward to helping you.

 

Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Trust Attorney