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 immediate outright distributions to them.
However, when you leave outright distributions to your beneficiaries, those bequests are available to satisfy claims against your beneficiaries from lawsuits, and other creditors. In addition, if any of your beneficiaries deposit the inheritance into a joint account with a spouse or co-mingle it with marital property, the inheritance may be considered marital property in the case of a divorce property settlement.
If any beneficiary is a minor at the time of distribution, what you leave that beneficiary would have to be held in a probate court-supervised conservatorship until the age 18. At age 18, your beneficiary miraculously gains all the wisdom and insight of adulthood when the law says that a person is an adult and shall have the entire inheritance being held in the conservatorship. Oftentimes, when a youth receives a large sum of money at age 18, he ends up going to college, the University of Corvette.
In order to avoid these outright distributions, you may have 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 beneficiaries from making inappropriate decisions during their youth, there is no protection for the distributions after they are made. A beneficiary’s inheritance could still be available to satisfy claims against a beneficiary from lawsuits and 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 a beneficiary for his or her lifetime. For younger beneficiaries, you could appoint a third party trustee who would manage your trust assets until such time that a beneficiary is able to handle his or her own financial affairs. After a certain age, a beneficiary child could be named a trustee of his or her separate lifetime trust with someone he or she chooses.
Also if your beneficiaries are younger, you may want to place all of your assets in a common trust for the benefit of all your beneficiaries until the youngest one reaches a certain age or receives a college degree.
For example, in my own family, my wife Emily and I have two children; Luke is 25 and Elizabeth is 21. Luke is out of college, has a job and is off our payroll. Elizabeth still has a year and a half to go. 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 have no college expenses coming out of his share, but Elizabeth would have a year and a half of college expenses coming out of her share. After college, Elizabeth’s share of our estate would be 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 after both of our deaths, our entire marital estate would go into one bucket. The trust funds would be used for either Luke or Elizabeth as needed. 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 death 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 25, they each become a co-trustee of their separate trust with our death trustee. Luke or Elizabeth cannot act alone as trustee, but our death trustee can. The children will then get up to five years of financial tutoring from our death trustee before they take over their own trusts. Once Luke or Elizabeth reach age 30, they can act alone and can choose their own co-trustee.
With separate lifetime trusts, your beneficiaries would have access to what you left them at any time for any of their needs. They could also use those trust assets to buy a home, start a business or professional practice or fund a wedding.
Lifetime trusts have three key protections, among others. First, there is creditor protection. Any of the assets which you leave to your beneficiaries in lifetime trusts are generally protected from claims against your beneficiaries from lawsuits and other creditors. If a beneficiary gets sued, the creditors cannot touch the assets you left that beneficiary in the separate lifetime trust. Although the creditors do not have access to these funds, the funds are still available to the beneficiary for his or her needs.
Second, there is divorce protection. So long as a beneficiary keeps the assets in the separate lifetime trust and never co-mingles trust assets with marital assets, what you left that beneficiary will be protected from a divorcing predator spouse. These trust assets would generally be considered the beneficiary’s separate property and not part of a marital property settlement in a divorce proceeding.
Thirdly, these protections can continue for succeeding generations. You can give a beneficiary the power to leave anything left in his or her separate trust at the time of that beneficiary’s death to protective lifetime trusts he or she has set up for his or her own beneficiaries. If each generation does this, any unspent amounts of the inheritance you leave can have creditor and predator protection forever
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 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, CPA, JD
Published edited December 22, 2013 in The Times Herald newspaper, Port Huron, Michigan as: How to leave an inheritance to a child or other beneficiary