ESTATE PLANNING TO PROTECT YOUR CHILD’S INHERITANCE

Gabriel Katzner - November 17, 2022 - Trust Administration
Parents sitting together covering their child with a wooden roof

The divorce rate is declining in the United States but remains between 31% and 42%. Your children enter their marriages sure that their marriage is strong and would never be subject to divorce, but it happens.

In addition to concerns about your child’s happiness and your grandchildren’s welfare, you also need to ensure that your child’s inheritance stays in their hands and out of the hands of their former spouse.

Careful estate planning is necessary to ensure your accounts and property go to the intended beneficiaries.

Separate Inheritance Money and Property from Marital Money and Property

As couples get married and the years go by, what’s yours, mine, and ours becomes blurred. Generally, accounts and property acquired while married becomes marital property regardless of which partner acquired it.

Marital property is subject to division in the event of a divorce, but exceptions exist.

Some people keep the money they receive from family or inheritance in a separate bank account to keep it out of the marital property.

However, it is difficult for spouses to avoid commingling funds in daily life. Depositing marital money into a separate account or paying a bill from its funds can make the account marital property.

One way to ensure that inheritance money and property are kept separate from marital money and property is to hold it in a trust account. Many people think trusts are for the wealthy, but anyone can use a trust to protect their child’s inheritance.

A trust is a flexible and powerful estate planning tool that gives you greater control over your money and property to help ensure it reaches the intended beneficiaries.

Steps for Establishing a Trust

Holding your child’s inheritance in a trust involves the following steps:

  1. Fund your trust with money and property
  2. Name your child or children as the beneficiaries
  3. Name a trustee to manage the trust distributions
  4. Write specific instructions on how the money and property are to be used

You may want to name your child as the trustee and the beneficiary of the trust, but this presents the same problems as using a separate bank account.

If your child uses trust money or property to pay for marital expenses and gets divorced, the court may consider the trust funds to be marital property.

To avoid commingling, it is best to name a third-party trustee to manage the trust on behalf of your child. The trustee will use their discretion in interpreting the trust instructions.

This takes control of the trust out of your child’s hands. The trustee can pay third parties on behalf of your child instead of distributing the money directly to your child to pay their expenses. This will help avoid commingling.

For example, if your child needs a new car, the trustee can pay the car dealership directly. If your child is buying a home, the trust can loan the money to your child using the home as collateral to secure the debt and protect it from asset division.

Trustee Options

A third-party trustee is the best option for protecting your child’s inheritance against commingling, but it also limits your child’s flexibility in how they can use their inheritance. Another option is to name your child and a third party as co-trustees.

Your child may handle investments with the authority to invest money held in the trust. Your child would be acting on behalf of the trust, so trust money is not commingled with personal or marital money.

The co-trustee can handle distributions for your child’s benefits. However, it is important to discuss all your options with your estate attorney, as there are likely other options that would be appropriate for creditor protection and tax purposes.

Your child can act as a co-trustee as long as the marriage is intact and then choose to resign in the event of a divorce. This option leaves the co-trustee with sole discretion and helps protect the trust’s money and property from their divorcing spouse, but it does not provide optimal creditor protection. It is also important to consider your child’s ability to remove and replace a co-trustee.

You can set up the trust so the independent trustee can make distributions for any purpose, but your child is limited to making distributions for health, education, maintenance, or support (HEMS).

A HEMS provision or ascertainable standard is a safe harbor under federal law.

This option may not provide maximum creditor protection because the distributions made to your child could be susceptible to creditors, but it does help protect trust funds.

The Many Possibilities and Threats

Though it is difficult to even imagine all possible scenarios that would result in your child’s inheritance ending up in their ex-spouse’s hands, it is important to take a wide view, even the unimaginable, including the possibility of your child’s death.

If your child should die before using all the trust assets and properties, the trust, by default, may be inherited by their spouse unless you have planned for this potential scenario.

One way to mitigate this possibility is to name a backup beneficiary for your child. This contingent beneficiary can be your grandchildren, your child’s siblings, a charity, or any other party.

If you give testamentary power of appointment to your child, this power will allow your child to direct their share of the trust property to another individual upon their death.

They may choose their spouse, which defeats the purpose of your trust. As the trust creator, you can specify who the trust property can go to and limit it to your child’s children or other descendants only.

Take Control of Your Child’s Inheritance

You can take steps now to protect your child’s inheritance, especially if they are newly married or in a marriage that is headed in the wrong direction. You can take steps to keep your hard-earned money out of your child’s spouse’s hands.

Creating a trust may be the answer you are looking for.

A trust provides a lot of flexibility, making it a powerful estate planning tool. There are many types of trusts to choose from and many ways each can be customized to ensure your final wishes are fulfilled.

As life happens, it is important to revisit your estate plan. You can make new restrictions on your trust and remove them as circumstances change. You may even decide that a trust is no longer needed. Whatever plans you have for your money and property, our team can help.

You can schedule a call with us or reach us directly at 855.631.3457 to learn more about how best to plan today to protect those most important to you.

 



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