Following on my last newsletter column, I will continue to look at how BWFA can help you implement the goals of your estate plan. For some clients, trusts are an important part of handling their assets today and cost-effectively transferring them to heirs in the future.
Advantages of Trusts
A trust is often used to manage an inheritance. Trusts offer tax benefits to the people who fund the trust, and they can be structured to encourage certain actions on the parts of heirs, as well as to limit an heir’s negative impulses.
For many parents, the attraction of a trust begins with helping to protect a child from himself or herself. Many people cannot manage money or control their spending. They, as Ronald Reagan used to say, “Spend money like a drunken sailor.” The creator of the trust can define the amount of money to be disbursed from the trust each month or other time period, thus limiting the ability of the beneficiary to overspend. The trustee of the trust will make sure the beneficiary does not fritter away the inheritance through bad decisions or poor investment management.
Dean Bouland, Managing Partner at Bouland and Brush, LLC, a Baltimore law firm, notes that there are two other principal reasons to use a trust when leaving an inheritance to children. The first is to protect the inheritance from creditors, and the second is to protect the inheritance if a child gets divorced.
Creditor Protection. When assets are placed in trust, the trust owns the assets; the child does not own the assets. The person who funds the trust selects a trustee, who has a fiduciary duty to manage and distribute the trust assets as the trust stipulates. The child (or some other heir) is the beneficiary of the trust and receives distributions from it. Since the beneficiary does not own the trust, creditors cannot make claims against the assets of the trust. The trust also protects an inheritance if the beneficiary gets sued or declares bankruptcy. This is particularly helpful to a beneficiary who is a business owner or is in a profession, such as medicine, where lawsuits are common.
Divorce. It is very rare indeed for parents to want their assets to wind up in the hands of an ex-son-in-law or ex-daughter-in-law. Technically, the assets a child inherits are not considered marital property and cannot be split in a divorce. However, this is only true if the inheritance is traceable-that is, if the assets can be specifically accounted for. Over a 20-year marriage, separating which assets were inherited can be difficult because assets get commingled and jointly owned. By placing the assets in a trust, they stay segregated, and the question of ownership vanishes.
Spendthrift Provision. Many trusts contain language showing that the parent intends for the trust to qualify as “spendthrift.” This means that the trust must go to the beneficiary only. The heir cannot pledge trust assets to a third party such as a creditor or ex-spouse.
Downsides to a Trust
As with other financial instruments, trusts do have some downsides.
Cost. Attorney fees to establish a trust can be significant, and the trust will have to file annual tax returns and incur other fees. If a professional trustee is hired, he or she must be paid, too.
Lack of control. While parents find trusts attractive because they can control a child’s spending, it’s possible that children will be frustrated by those same provisions.
Conflict. Lack of control is one of the causes of conflict in management of a trust. It’s not uncommon for conflicts to arise between a trustee and an heir. A trust managed by an inexperienced family member is perhaps even more prone to conflicts than a trust managed by a professional.
Trusts are not for everyone, but they can make sense for people with very substantial assets, especially if they have strong desires about how they wish their heirs to receive their inheritances. At BWFA we have successfully worked with our clients to decide if a trust should be part of their estate plan, and we have coordinated discussions with estate attorneys to make sure that our clients’ desires are reflected in trust documents. If you think a trust should be part of your estate plan, give us a call.