We are all human, we all make mistakes, and our children are no different. No matter their age, mistakes, or negative outside conditions, can occur that take a major financial toll. A marriage or business deal can go bad, the economy can take a bad turn, or a sudden illness could hit. That’s not to mention situations with children, usually younger children, who are just bad with money. If you gifted or willed assets directly to your child, any of these situations can lead to your assets going where you did not intend them to go.
You left those assets to your child to keep the family’s assets in the family, to make your child’s life a little easier, to help get them back on their feet should they fall, to help provide for your grandchildren, or for a myriad of other reasons. Safe to say though, you probably didn’t leave your assets to your child so that your child’s creditors or ex-spouse could have a better life.
Luckily, through estate planning, there are ways of protecting the assets that you leave to your child from the child’s creditors, ex-spouse, or their own poor spending habits.
As stated earlier, if your children receive your assets outright, then there is no asset protection. Your children receive assets from you outright when you give them assets by gift, make them the co-owners of property, leave them your assets by will, or die without a will, amongst other ways.
One solution to this issue is the use of a trust. A lifetime, inheritance or “dynasty” trust holds the assets that you left to your child, and distributes them based on the rules you create when you set up the trust. The trust protects the remaining trust assets from creditors, lawsuits, ex-spouses and current spouses. You also get to appoint a trustee to manage the trust. I recommend that you don’t choose the child who is the beneficiary of the trust to also be the trustee, as this may remove the asset protection component. You can choose an attorney, financial institution, trusted friend or family member, or a different child to act as trustee.
Additional benefits to this type of trust is that you can name who receives the assets after your children. This allows you to ensure that any of the assets that go unused by your child during their lifetime can go directly to your grandchildren or your other children. If you do not want to disinherit a son-in-law or daughter-in-law in this way, they can receive the remaining assets, or they could receive any income from the assets during their life, with the principal then going to a person or group of your choice. You can use these types of trusts to avoid estate taxes and generation skipping tax, depending on a number of factors.
If you are concerned about a child who may be unable to handle an inheritance, the terms that you put into a trust can be a very useful way of making sure your heirs use their inheritance in the right way. You can make it so that only a certain percentage of the assets are available at any particular time. For example, you can put in the terms of the trust that the beneficiary can only receive 20% of the principle before turning 30, 40% before 35, 60% before turning 40 and then 100% can become available on the beneficiary’s 40th birthday.
If you are worried that your child will not work after receiving an inheritance, you can put in a rule that the amount of trust assets that are available is some percentage of the child’s yearly income. You can also limit the types of things that the beneficiary can use the trust assets for. One of the most common limitations is that the trustee can only distribute trust assets for HEMS expenses (Health, Education, Maintenance and Support).
If you would like to make sure that assets that that you leave to your children actually stay in your family, a trust is a very valuable tool. However, trusts are quite technical and the creator of the trust needs to take state and federal law into account. Improperly drafted trust documents can, at best, defeat the purpose of the trust. They are an expense, but they provide control and protection that can be very valuable.