OPTIONS FOR LEAVING AN INHERITANCE TO YOUR CHILDREN

For most of our estate planning clients, their general desire is to leave their estate (eventually) to their children.  That’s usually an easy decision, but it is only a starting point for what needs to be an extensive discussion.

One of the biggest decisions our clients need to make is how the child will receive his or her inheritance.

Essentially, there are only two ways to leave assets to a person – either outright or in trust.

That being said, there are many varieties of trusts that can be designed to provide different levels of control and flexibility.  Let’s look at these options in further depth.

OUTRIGHT BEQUESTS

The simplest and easiest way to leave an inheritance is an outright bequest.

If property is left to your child, they will own it completely, with no strings attached.  That means that they (not you) will determine where those assets (and the proceeds and profits thereof) will go when they die.  It also means that those inherited assets will be subject to the child’s creditors, bankruptcies and lawsuits.  If the child is later divorced, unless the child has been careful to keep the inherited assets separate from marital assets, they will be at risk.

Clients should also keep in mind what often happens when a married child receives their inheritance outright – they put it into a joint account with their spouse.  So, if your married daughter, the mother of your grandchild, dies after receiving her inheritance and placing it in a joint account with her spouse, the spouse will own the property outright.  That means there is no guarantee that the inheritance will be used for the benefit of your grandchild.  Your son-in-law might re-marry, in which event those assets you intended to be passed on to your grandchildren will instead pass to someone you don’t even know.

The bottom line is that with an outright bequest, your planning stops at your death, and what ultimately happens after that is beyond your control.

BEQUESTS IN TRUST

The alternative to leaving an inheritance outright to a person is to leave it in trust for the benefit of that person.

I like to think of a trust as a box with assets in it along with a set of instructions.  That box is handed to a person (or, in some rare instances a bank or corporate entity) you designate as Trustee.  The Trustee is the person who controls the assets subject to the instructions you have written.  Those instructions will depend on the particular situation, including the age of the beneficiary and other characteristics, such as disabilities, irresponsibility, substance abuse, etc.

Your instructions will typically include directing the Trustee to make distributions for the health, education, maintenance and support of the beneficiary.  If the beneficiary is a minor, it might provide that the trust only lasts until the child reaches a certain age, at which time any remaining assets are distributed to the child outright.  Given the risks outlined above attendant to outright bequests, a common alternative is to provide that when the child reaches sufficient maturity, the child can take over as Trustee, and thereby be in control of his trust.

Now let’s consider some common types of trusts.

TRUSTS FOR MINORS

For clients with minor children, a trust is essential.  Without a trust, assets passing outright to a minor will require a Court-appointed guardian to hold, manage and distribute the inheritance.  Furthermore, when the child reaches the age of 18 the guardian must hand over, with no strings attached, whatever portion of the inheritance remaining.

Generally, the child’s trust will be drafted to give the Trustee broad discretion to make distributions from the trust for whatever the Trustee considers appropriate for the child’s health, education, maintenance and support.

Clients with more than one minor child often choose to provide for a “pot trust” as opposed to separate trusts for each child.  This variation, which we call a “Children’s Education and Support Trust”, holds the inheritance in a common fund to be accessed by the Trustee to provide for all the children, without having to maintain equality among the beneficiaries.  This provides added flexibility to enable the Trustee to provide support where needed when one of the children requires the expenditure of more than his or her share of the estate.  Typically, when the youngest beneficiary reaches age 23 (or graduates from college) the Education and Support Trust is then divided into separate equal shares for all the children and distributed outright or held in continuing separate trusts for each beneficiary.

TRUSTS FOR ADULT CHILDREN WHO NEED HELP

Some beneficiaries would be better served if their inheritance was managed by someone else.  These include beneficiaries who have gambling or substance abuse issues or are just irresponsible with money.  These trusts can be specifically tailored to fit the given circumstances. The Trustee may be directed to distribute a certain specified amount each month or simply be given full discretion to distribute (or withhold) income to the beneficiary for only what the Trustee deems necessary for the beneficiary’s health, education or support.  In some circumstances it may be appropriate to have the beneficiary serve as a Co-Trustee, with some powers over the trust, but require another Trustee to approve of all decisions.  Or the trust document may allow the beneficiary to take full control upon the happening of certain events or conditions.

TRUSTS FOR BENEFICIARIES WITH SPECIAL NEEDS

Special Needs Trusts or Supplemental Needs Trusts are specifically designed for beneficiaries with disabilities which entitle them to “needs based” government benefits, including Medicaid.  Leaving an inheritance outright to such a beneficiary would disqualify the beneficiary from receiving those benefits and require the inheritance to be spent instead.  A properly designed Supplemental Needs Trust will enable the Trustee to provide needed supplemental support distributions to improve the life of the beneficiary without causing the assets in the trust to disqualify the beneficiary from the government benefits he or she is already receiving.

THE “BENEFICIARY-CONTROLLED LIFETIME TRUST”

Many clients come to us with absolutely no intention or desire to restrict how their children spend their inheritance.  There may be no reason to require the approval of any other person for what the beneficiary does with the inherited assets.  So why would such a client want to leave the inheritance in trust instead of outright?

A beneficiary who has received his inheritance outright now has that money “in his pocket.”  As we tell our clients: “money in a trust is worth more than money in your pocket.”  Why?  Because if you are sued or go bankrupt, or your spouse leaves you, the money in your pocket is at risk.  On the other hand, money in a trust can be protected from those dangers, while still giving the beneficiary control over his own trust.

It is possible to leave your estate to your child in trust, while also naming such child as the Trustee of that trust.  As Trustee, the child can control all assets in the trust, including how the money is invested and spent.

This is where we really get down to fine-tuning the trust provisions to accomplish the client’s goals.  If the beneficiary is already wealthy, the trust can be designed to be kept out of the beneficiary’s taxable estate, thus saving estate tax.  If the beneficiary is in a profession that poses a heightened risk of being sued, added creditor protection can be provided, while at the same time ensuring that the beneficiary maintains virtual control.  If asset protection is not a big concern, the trust can give the beneficiary complete control, including the power to withdraw the assets from the trust and terminate the trust.

Considering the advantages of having an inheritance passed down in the “protective wrapper” of a properly designed trust, outright bequests are rarely advised.  By utilizing a trust properly designed to fit the beneficiary you can make that inheritance more valuable, and otherwise achieve your objectives.