Many people scrimp and save in the hopes of having something left over for their children at their death. But as an estate planning attorney, I know that often times that hard-earned-by-mom-and-dad inheritance turns into a squandered opportunity for the kids. The money (much like lottery winnings) is quickly used on a new flat screen TV, that motorcycle they always wanted, a two-week cruise to the Caribbean, or the worst possibility: to fuel an addiction to drugs, alcohol, or gambling.
This article is intended to highlight various techniques you can use to pass your hard-earned assets on to the next generation, and to highlight some pros and cons of each. As discussed below, your choices are primarily either to leave the money outright as a gift or to place the money in one of a variety of trusts:
- Outright gift. Simply leaving the inheritance as an outright gift to your children gives them the maximum flexibility and control over the assets, and is the default outcome if you don’t do anything else. The cons are that the gift is subject to your children’s creditors (like major medical bills) and to your children’s mismanagement (poor financial habits and decisions), and the gift is easily comingled with other money and thus subject to division in the event of divorce. Moreover, if you have substantial assets, leaving money as an outright gift exposes a portion of those assets to taxation.
- Divorce protection or “access” trust. The least restrictive type of trust is one where your children act as their own trustees and can withdraw the money for essentially any purpose. Such a trust is an “access” trust, because the children have ready access to the funds in the trust. As the name might suggest, the biggest gain to this sort of trust over an outright gift is that, because the assets are accounted for separate from your children’s other assets until withdrawn from the trust, it is more likely that your children will not comingle the assets with their other property. Thus, in the event of divorce, your children’s inheritance will remain their property and will not be subject to division. The other cons remain, however, including that the gift is still subject to being squandered by poor decision making or circumstances of your children.
- Restricted access trust. A more restrictive sort of trust is one where your children can only receive money from the trust to pay for certain items, typically health and education, and sometimes living expenses depending on the circumstance. In such a trust, you can either allow your children to act as their own trustees, appoint a third-party to do the job (bank, family friend, relative), or allow your children to serve as co-trustees with a third-party. This arrangement gives the same divorce protection, but increases protection against creditors of your children and, so long as your children are not sole trustees, protects against mismanagement by your children. Further, depending on the structure of this sort of trust, it is possible to render such funds not subject to estate tax. This sort of trust, with a third-party trustee, is most appropriate for parents with young or young-adult children, who need the extra protection of such a trust.
- Lifetime trust with discretionary standard. Perhaps the most restrictive sort of trust is one where your children do not act as trustee and the third-party trustee is given complete discretion as to whether and when to provide benefits to your children. Such a trust provides total protection against creditors and your children’s mismanagement, as well as divorce and tax protection. In such a trust, you can give specific instructions to the trustee about when and under what circumstances you want distributions to be made, such as financial incentives for remaining drug and alcohol free or for graduating college.
Choosing the appropriate method for passing on your assets can get very complicated quite quickly. And the short list above does not scratch the surface of all the specialty trust options (supplemental needs trusts, pet trusts, DAPTs, SRTs, CRUTs, GRATs, GST dynasty trusts, etc.). The point is that you have many different options and the default option (that of the outright gift) is almost never the best approach. You should explore your various options for passing on your wealth with a qualified estate planning attorney.