When families come in to do planning with me, we discuss at length how they want their children (or other beneficiaries) to inherit their wealth. In fact, whether they want their wealth inherited 1) outright, or in 2) Lifetime Asset Protection Trusts, is one of the critical questions we dwell on. Things to considers are how much control they want to have of their money from the grave and each beneficiary’s spending habits, spouse (and potential for divorce), maturity, etc.
Trusts can be drafted in such creative ways to achieve very specific goals; so let’s review:
Beneficiaries can inherit in one of two ways. The first way, and most common, is to inherit assets outright, where the assets are distributed free and clear from all oversight and directly to the beneficiary. In reality, this means a check is made payable to the beneficiary or assets are titled in the beneficiary’s name, and the beneficiary does as he or she wants with the inheritance.
Alternatively, a beneficiary can inherit “in trust.” This can mean a lot of different things, but most often, it means the assets that are inherited are titled in the name of a trust, rather than the beneficiary’s name. The structures of these inherited trusts vary widely.
Some trusts are designed so that the assets in the trust are protected for the beneficiary from things such as a potential divorce, creditors, lawsuits, bankruptcy, etc. These assets do not become marital property with the beneficiary’s spouse, and they are protected from any personal liabilities of the beneficiary.
The assets are for the beneficial use of the beneficiary, and distributions can often be made to the beneficiary for health, education, maintenance, and support (the IRS HEMS Standard), or otherwise, as determined by the trustmaker. Often times they are set up so that when the beneficiary reaches a certain age, they can become their own trustee, having full control over the assets and making distributions to themselves whenever they choose. Prior to reaching that certain age, another person acts as trustee, either a trusted person or a professional trustee.
Sometimes a trust will prohibit distributions for certain things, or allow distributions only for specific purposes, such as education. If a beneficiary is (or likely will be) on any state or federal benefits, a special needs trust may be created, prohibiting distributions for anything that the beneficiary’s benefits would otherwise pay for. These trusts also prohibit the beneficiary from ever being his or her own trustee, which is usually required in order to maintain any benefits.
Trusts can be structured so that when the beneficiary reaches certain ages, the trustee makes distributions from the trust outright. For example, the trust may say that the beneficiary receives 1/3 of the trust assets at age 25, 1/3 at age 30, and the remaining balance at age 35. The purpose of a trust like this may be to protect the beneficiary from receiving a large sum at once and preserving the trust assets over a period of time. However, once a distribution is made to the beneficiary, it’s no longer protected from the beneficiary’s personal liabilities. Also, if the beneficiary has reached the age for the final distribution when the assets are inherited, (e.g. has reached the age of 35) the trustee must distribute all the assets to the beneficiary, and none are inherited in trust.
A trust can also be created by the court if a person passes away, leaving assets to a minor. This trust would then hold the assets until the beneficiary reaches the age of majority. Until then, a trustee, appointed by the court, controls the assets and has the responsibility of making distributions to the beneficiary.
Inheriting in trust can mean a lot of different things, but usually comes with benefits that are not available otherwise.