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23Dec2013

Rethinking Trust Distributions Based Upon the Beneficiary’s Age

Morningstar article by Helen Modly, CFP, ChFC

Why put an age limit on the ability to protect assets from creditors and predators?

Many trusts direct that young beneficiaries will receive distributions of trust principal (corpus) when they attain certain ages. The intent of this language is usually to protect the beneficiary from herself until she is sufficiently grown-up to manage the funds effectively. This language also protects the beneficiary from creditors–until they reach a distribution age.

But grown-ups need asset protection, too. Why put an age limit on the ability to protect assets from creditors and predators?

The young homebuilder was doing pretty well until a lawsuit involving negligence on the part of a subcontractor pulled him into litigation, ending in a judgment against him just a few days shy of his 30th birthday.

A teacher with very wealthy parents was shocked to learn that her husband of 10 years was suing her for divorce only months after she received her final trust distribution at age 35. She had used all the previous distributions to acquire jointly owned rental properties.

Both of these are real-world examples of beneficiaries losing control of trust assets because the grantor of the trusts tried to give them control over time.

Pick up almost any will or revocable trust document, and you will find language that directs the executor or trustee to hold assets in trust until the beneficiaries attain age 21, 30, 35 or even older. These distributions will usually be fairly large percentages of the trust assets, such as one-third or one-half. Grantors often use this staggered distribution strategy with the thought that their loved ones will achieve emotional and fiscal maturity by these ages, and they want them to have full control.

Beneficiary as Trustee

As the examples above show, this strategy is flawed. If one assumes that children or grandchildren will be able to handle wealth at these ages, consider giving them the ability to manage their wealth while providing some protection from creditors and predators. Consider letting the beneficiary become the successor trustee of an irrevocable subtrust at an acceptable age as determined by the testator or grantor.

A will, or even better, a revocable trust can create subtrusts upon the testator’s or grantor’s death. These could be trusts having multiple beneficiaries such as “all my grandchildren” where the trustee has discretion over how to spend money on each child, based on each child’s specific needs, also called a “family pot trust.” You could also establish separate sub-trusts for each beneficiary.

The initial trustee of the subtrusts could be given sprinkling rights to make distributions of income and/or principal as the trustee sees fit, or the trustee could be constrained to make distributions only to an ascertainable standard such as health, maintenance, and support. When each beneficiary reaches an age determined by the grantor, a separate trust can be created if not already in existence, and the beneficiary becomes the trustee.

This could be an automatic occurrence, it could be subject to the current trustee’s willingness to resign, or it could be subject to a trust protector’s acquiescence, according to the will of the grantor. The trust would allow the beneficiary/trustee to make distributions of income and principal subject to a strict ascertainable standard, but also have the ability to appoint and remove a noninterested party to serve as trustee with the right to make fully discretionary distributions to the beneficiary.

This structure allows the beneficiary to be fully in control of the trust assets with a high level of asset protection almost as strong as having only a noninterested party serving as trustee with full discretion as to making any distributions. Having other beneficiaries such as children would also increase the creditor protection. Providing that a clearly drafted ascertainable standard is used, most creditors will not be able to compel the trustee to make a distribution to the beneficiary, even if they are the same person.

‘Isn’t it expensive to have a trust?’

An irrevocable trust is a separate tax-paying entity with its own Tax ID number and must file its own tax return. The tax rate bands are highly compressed for trusts, so the top federal rate of 39.6% is reached when the trust reports income over $11,950. However, if the trust distributes the income to the beneficiary, it will be taxed at the beneficiary’s bracket rather than at the trust’s tax rate.

If an irrevocable trust is created under a will, rather than as a revocable trust becoming irrevocable at death or as a sub-trust of a now irrevocable trust, there are usually annual accountings required by the court. This accounting may require professional help, especially with the first couple of accountings filed.

‘But I want to buy a beach house’

The most common reason beneficiaries want to take money out of a trust is to buy something. Fine. Let the trust buy it for the use and enjoyment of the beneficiary. A trust-owned beach house is even better once you realize that it is protected from the creditors or the soon-to-be ex-wife of the beneficiary.

It will take a bit of educating to help clients and their children understand the advantages of this strategy. There are also implications should the trust document not be drafted carefully by an experienced estate planning attorney. I would not try this with a website at home on your own!

Note that I am not an attorney, and even if I were, I would warn you that this is not meant to be legal advice, rather a general discussion of estate planning strategies. As always, consult with an experienced estate planning attorney.

Initiating Conversations With New or Existing Clients

Talking with existing clients about the pros and cons of this strategy can help to open up overall estate planning conversations while demonstrating your knowledge. Many clients are still on the fence about the need for more sophisticated planning than the simplistic “I love you will,” and for those with young children, this could provide an impetus to move forward.

This discussion could also be an opportunity to open conversations with estate planning attorneys to develop additional centers of influence. Asking local estate planning attorneys for their opinion on this strategy will help to develop your credibility with them as a knowledgeable advisor.

Source: morningstar.com 

  • 23 Dec, 2013
  • Courtney Lawver
  • 0 Comments

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