Asset Protect Your Child's Inheritance
There is a misconception that a revocable trust protects trust assets during the lifetime of the settlor. While revocable trusts serve several worthwhile purposes, protection of assets during your life is not one of them. Unfortunately, simply transferring certain assets to yourself as trustee of your revocable trust does not create a barrier from creditors because you are still the beneficial owner.
At your death or the death of your surviving spouse, however, your revocable trust does become irrevocable simply because you are no longer alive to make changes or revoke it. An irrevocable trust with specific language limiting how and when a beneficiary is permitted to receive assets provides a layer of protection not otherwise available to you during your life. You may include provisions that help to ensure money going to your children does not go to your child’s potential future ex-spouse or other unintended creditors.
Most revocable trusts are typically established to avoid probate and have the added feature of including a distribution plan for beneficiaries, typically children of the settlors. A common theme is to set up different ages at which time the children will inherit and as the child reaches certain specified milestones, he or she can simply “demand” that the specified asset value be distributed. For example, if a trust provides that the child has a right to one-half of the trust assets at age 30 with the remainder at 35, the child may demand up to that amount upon reaching those assigned ages.
This is a very common way of distributing funds to a child but what if your child takes no withdrawals and leaves those funds in the trust? Or what if your child got sued and thoughtfully decided against taking a distribution because it would make those funds available for seizure? Here is where it gets interesting. If the acting trustee is related or subordinate to the beneficiary then he or she must make distributions for “health, education, maintenance or support.” The term “related or subordinate” is a legal term used to describe a person who has a familial relationship or subject to the authority of the beneficiary (i.e., an employee) to either the person who established the trust or the person receiving its benefits. In a situation where your child is the named trustee and is the beneficiary it is apparent that those distributions must be made because both titles belong to the same person. In this situation, the danger exists that a creditor could step into the beneficiary’s shoes and demand that those distributions be made, arguing that the money being requested is for the health, education, maintenance or support that an “interested” trustee must make.
This problem can be averted by one of two ways; either by naming an independent “discretionary” trustee as successor directly in the trust document at the outset, or making sure that your child knows to resign immediately and name an independent discretionary trustee in the event of divorce, creditor issues or lawsuits. An independent trustee can make distributions based solely on their discretion without relying on the “health, education, maintenance or support” standard for those related or subordinate to the beneficiary. In this situation, the trust must be written with specific language for this to properly work permitting the independent trustee to make distributions for any reason or for no reason at all. This allows the trustee to simply deny any benefits to a creditor.
Creating estate planning documents can be a laborious process but the benefits of creating a continuing asset for your children are huge.