If you are a parent, you love to help your children and leaving them an inheritance is a tangible way to show your love after you are gone. There are a variety of ways that you can do this, and you should choose the method that best takes your goals, including their wellbeing, into account.
The Outright Gift
Your first option is to make an outright gift. Your will or trust can transfer money to any children over the age of majority in your state. This is often what comes to mind first when people start planning an inheritance. This may be a fine solution for parents who have financially responsible adult children and a small amount of property and money to leave for them. For most people, however, an outright gift is not the best or easiest option. If your children are minors, they cannot legally take control of the inheritance, which may need to be held in a special account or managed by a court-supervised conservator until they reach adulthood. But even if your children are adults, they may not yet have the maturity to make good financial decisions. Even mature children who normally exercise good financial judgment can still make mistakes or experience mishaps—more so when a material amount of money falls into their lap. They could experience a divorce or be sued, and their inherited money could be used to satisfy those claims. Certain types of trusts can be used to prevent the money from going to your children’s creditors or a divorcing spouse. A trust can also allow the trustee to make distributions for your children’s benefit in a way that aligns with your wishes.
In Trust with Child as Trustee
If you make your adult child the trustee of a trust to be established when you pass away, and he or she is also the beneficiary, the trust terms will specify your child’s ability to make distributions to him or herself. Like an outright gift, this is often not the best choice for parents concerned about children who may have money problems. If your child can exercise control over the trust money and property in the role of trustee, then his or her creditors may reach those assets to satisfy their claims. Also, conflict may arise, especially if the siblings don’t get along, multiple siblings act as co-trustees, or one sibling is the trustee and the others are beneficiaries.
A beneficiary-controlled trust can address some of these concerns. This tool allows a beneficiary to be a trustee, but the trustee/beneficiary can only make distributions for his or her health, maintenance, education, or support. For reasons outside of this article, an independent co-trustee may be allowed to make distributions for the beneficiary’s benefit. Typically, the terms of this type of trust let the beneficiary remove and replace the co-trustee if the beneficiary is not satisfied with the co-trustee’s performance. Although the trustee/beneficiary has some control over his or her inheritance, this type of trust prevents the money and property intended for your child from being drained by creditors, lawsuits, and divorcing spouses.
Distribute percentage at certain ages
Parents often include terms requiring mandatory distributions at a certain age or at various ages. For example, a trust could require one-fourth of the principal to be distributed at age 25, one-fourth at 30, and the balance at 35. This distribution can address issues of maturity, but it won’t provide as much protection from creditors—which is a concern regardless of age. If a beneficiary can require a distribution to be made from the trust, creditors or divorcing spouses can also look to it to satisfy their claims. Once a distribution is made to one of your children, it is also vulnerable to future creditors’ claims.
Incentive trust distributions
Many parents want to pass on their values to their children, and an incentive trust is sometimes used to encourage children to achieve goals by basing distributions on the beneficiaries’ achievement of certain conditions, like graduating from college. This method can also be used to deny distributions to beneficiaries who use drugs or engage in discouraged behaviors. Although this trust protects the money from the beneficiaries’ creditors until the funds are distributed, there are some downsides, including the potential to trigger resentment if beneficiaries believe the conditions are unfair: For example, a trust that rewards high income by increasing distributions as income increases may not work for a beneficiary who has chosen a laudable but low-paying career such as teaching or social work. In addition, this trust may not give trustees much flexibility in making distributions and may be expensive for trustees to administer, as investigation or proof may be required to establish whether the trust conditions have been met.
Distributions for specific purposes
A trust providing for distributions for the beneficiaries’ health, maintenance, education, or support is quite common. You can also set up a trust that lets the trustee make distributions for other specific purposes, for example, starting a business or buying a house. In those circumstances, the trustee may need to evaluate whether the beneficiary can afford the monthly payments, home maintenance, and taxes before making a distribution to be used as a down payment on a house. Like other discretionary trusts, the property held by the trust will be protected from claims by creditors.
Complete discretion by the trustee
A fully discretionary trust authorizes a trustee to make distributions to beneficiaries but does not require distributions to be made. Although this type of trust protects the money from the beneficiary’s creditors, some parents may be concerned that this trust gives the trustee too much control. Because the trustee does not have to make distributions, your children will not be able to depend upon receiving money when you expect, which may make financial planning more difficult. Unequal distributions among multiple beneficiaries could also lead to family conflicts and resentment when the trustee decides who gets money when.
Let’s meet to discuss your options
Each type of trust has its pros and cons. There are other things to consider such as a right of first refusal. The right strategy depends upon your unique circumstances and goals. Contact our office today to set up a consultation. We can make sure your estate plan provides for your children as you intend.