Many clients want to give their children full access to their inheritance but then control where the money goes after the children die. Most people will use a trust as the estate planning tool to accomplish this objective. However, it can be tricky to get it right.
If the child has too much access to the money, you lose the protection of a trust. For instance, a court may rule that a creditor or divorcing spouses can reach the money just as the child could. If the child can take the money out for himself, he can certainly take the money and give it to his ex-spouse or creditor. On the other hand, if the trustee controls distributions, the child may be prevented from fully using the money whenever and however he wants to.
Here are six issues to consider as you navigate the balance of power in setting up your child’s trust.
· Determine if you really need a trust. If you give the child his inheritance outright, he can do what he wants with it. The money is then susceptible to his creditors as well as to a divorcing spouse. The child can also spend it, give it away, or leave it to anyone he wants when he dies. This may not align with your plans – especially if you have grandchildren you want to provide for.
· Name an independent trustee. This cannot be your child. Your child can be a co-trustee, but you will need to name another trustee to serve with her. This could be a bank, trust company, lawyer, or accountant. You can also name a friend or family member as a co-trustee, but if the child can exercise too much influence over the friend or family member then that may defeat the purpose of your trust. For instance, a court may determine that the family member did whatever the child asked and will therefore allow the trust assets to be reached in a lawsuit. If you are highly concerned with creditor protection, an independent trustee such a bank or trust company is the best option.
· Give your child “veto” power. You can give your child the ability to remove and replace the independent trustee. This allows the child a bit of control in the event that the relationship with the independent trustee breaks down. You can also put it safeguards such as the independent trustee can only be removed and replaced every five years, or the independent trustee needs to be replaced with a similarly sized bank or trust company. You can also give someone else the ability to remove and replace the trustee like a trust protector or a trusted advisor.
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· Create an income stream. This will ensure that the child receives a regular distribution of trust money while reserving principal for emergencies and future generations. Another option is to let the child withdraw a specific dollar amount every year. For instance, each year he can withdraw $250,000. However, be careful not to give him so much as to deplete the trust principal before he dies. And don’t forget that any monies the child receives from the trust are susceptible to a creditor or to a divorce (unless he has a prenuptial agreement).
· Develop a distribution “wish list.” Spell out in the trust document (or in a separate letter to the trustees) what you would like to see distributions made for. Some people will want the child to receive trust money to purchase a primary home or vacation house, to invest in a business, to buy a new car every three years, or to travel, etc.)
· Build in limited autonomy. You can give your child the ability to direct where the remaining assets go on her death. This is done by including a power of appointment in the trust. It allows you to limit who the child can give the remaining trust money to. The trust includes a list of people who he can benefit. For instance, you can allow her to leave the trust money to her spouse, children, any of your other children or grandchildren, or to charity.
Each trust is unique. You will need to work with your attorney to create a trust that meets your goals while still providing adequately for your child.