You want to leave everything to your children or other beneficiaries after you are gone. If you are like many people whose estate plans I have reviewed, you may have just left outright distributions to them.
However, when you leave outright distributions to your children, those bequests are available to satisfy claims against your children from lawsuits, bankruptcies and other creditors. In addition, if your children deposit their inheritance into a joint account with their spouse or co-mingle it with marital property, their inheritance may be considered marital property in the case of a divorce property settlement.
If your children are minors at the time of distribution, what you leave them would have to be held in a probate court-supervised conservatorship until the children reach age 18. At age 18, your children miraculously gain all the wisdom and insight of adulthood when the law says that they are adults and shall have their inheritance. Often times, when children receive a large sum of money at age 18, they end up going to the University of Corvette.
In order to avoid these outright distributions, you may want to set up a trust which has staggered distributions. A portion of the inheritance is distributed at certain ages, such as one-half each at age 25 and 30 or one-third each at 30, 35 and 40. Although these staggered distributions do protect your children from making inappropriate decisions during their youth, there is no protection for the distributions after they are made. Your children’s inheritance could still be available to satisfy claims against your children from lawsuits, bankruptcies, other creditors and divorcing predator spouses.
Usually a better option you may want to consider is lifetime trusts for your children or other beneficiaries. With lifetime trusts, the assets are placed in trust for your children for their lifetimes. For younger children, you could appoint a third party trustee who would manage your trust assets until such time that your children are able to handle their own financial affairs. After a certain age, each child could be named a trustee of his or her separate lifetime trust with someone he or she chooses.
Also if your children are younger, you may want to place all of your assets in a common trust for the benefit of your children until they reach a certain age or after the youngest child receives a college degree.
For example, in my own family, my wife Emily and I have two children; Luke is 21 and Elizabeth is 18. Luke is just finishing his third year of college and Elizabeth does not start college until this fall. If Emily and I were to die this year and we just split our estate into two equal shares, our kids’ college expenses would come out of their half of our estate. In that case, Luke would only have one year of college expenses coming out of his share, but Elizabeth would have four years of college expenses coming out of her share. After college, Elizabeth’s share of our estate would be substantially smaller than her brother’s share. Can you hear the “It’s not fair!”?
In order to avoid this inequity, Emily and I have set up a common trust in which our entire marital estate would go into one pot. The trust funds would be used for either Luke’s or Elizabeth’s needs. Once Elizabeth reaches age 25 or gets a college degree, if earlier, the assets in the common trust are then split into two equal lifetime trust shares for Luke and Elizabeth.
Our named successor trustee would manage and distribute the assets in Luke’s and Elizabeth’s separate lifetime trusts until they reach age 30. When Luke or Elizabeth reach age 30, they become the successor trustee of their own separate lifetime trust and choose their own co-trustee.
With separate lifetime trusts, your children would have access to what you left them at any time for any of their needs for health, education, maintenance and support. They could also use those trust assets to buy a home, start a business or professional practice or fund a wedding.
Lifetime trusts have two primary protections, creditor protection and predator protection. First, any of the assets which you leave to your children in lifetime trusts are generally protected from claims against your children from lawsuits, bankruptcies and other creditors. If one of your children get sued, their creditors cannot touch the assets you left your children in the separate lifetime trusts. Although the creditors do not have access to these funds, the funds are still available to your children for their needs.
Second, so long as your children keep these assets in the separate lifetime trusts and never co-mingle trust assets with marital assets, what you left them will be protected from their divorcing predator spouses. These trust assets would generally be considered your children’s separate property and not part of a marital property settlement in a divorce proceeding.
Some of my clients have also named their children as co-trustees of their own separate trusts with the primary successor trustee for a period of time, such as from age 25 to age 30. In those cases, the children cannot act alone, but can only act with the primary successor trustee. The children will then get five years of financial tutoring from the primary successor trustee before the children take over their own trusts. I have been thinking of doing the same for Luke and Elizabeth.
In addition to the above, for very large estates, you can put generation skipping transfer tax provisions in these lifetime trusts to get additional tax exemptions to allow assets to be transferred down to your grandchildren without any estate tax assessments in 2011 and thereafter.
In a perfect world you would not need these protections and I would be out of a job. But, the job of your estate planning attorney is to prepare your estate for potential risks. Lifetime trusts are a valuable tool to address these risks and to leave what you have to whom you want when you want the way you want.
By: Matthew M. Wallace, CPS, JD
Published edited April 4, 2010 in The Times Herald newspaper, Port Huron, Michigan as: How to leave an inheritance to your beneficiaries