Most clients view estate planning as a way to address how their often-unprepared children and grandchildren will handle a large inheritance and whether the inheritance will stay within the family’s bloodline. Specifically, most clients worry about the exposure of the family’s wealth in the event of a child’s divorce or other creditor claims against a child, or in the event a child predeceases his spouse. This article will discuss the benefits of using trusts as part of an estate plan to address these and other concerns.
Because inherited trust assets are generally not treated as the assets of the trust beneficiary, inherited assets held in trust for the benefit of a child are not only protected from creditor claims against the beneficiary, but also generally are not subject to subsequent death taxes in the deceased child’s estate, thereby allowing assets to pass from generation to generation death tax-free as a family legacy.
It is reported that 40 percent to 50 percent of first marriages and 60 percent of second marriages end in divorce. Without appropriate planning, a child’s soon-to-be ex-spouse will likely be entitled to a material share of the couple’s marital assets, which could include inherited assets held by the child before the marriage and even assets inherited during the marriage. If the client fails to plan adequately, the decision regarding the division of assets owned by a child involved in a divorce may be left to a sometimes unpredictable judge. Moreover, putting these assets into play may increase the probability that the divorce will be a more expensive contested proceeding. Most young engaged children with little personal wealth are not concerned about entering into a premarital agreement and not concerned about creditors or premature death. The subject of a prenuptial or premarital agreement is also often difficult for a child to raise with a prospective spouse. A recent survey found that only 3 percent of all married or engaged couples (regardless of age) have a premarital agreement in place. It is most often the parents who are concerned because it is their assets that will eventually be inherited by the child that are often at risk. However, broaching the subject of a premarital agreement can be sensitive and emotional for a child and the child’s fiancé and because of this it can also be damaging to familial relationships.
Even if your child has a premarital agreement in place, there are numerous ways in which such an agreement can be challenged, which means there is no assurance that it will not be invalidated, in whole or in part, by a judge. Therefore, a trust, formed as an Asset Protection Trust (also known as a spendthrift trust under state law), is often an excellent option for protecting and preserving family wealth.
Leaving an inheritance in trust for the benefit of a child who is to be or who is married can mitigate the risks of the child not having a premarital agreement and can more securely preserve your assets for the child and grandchildren by allowing you to dictate where the trust assets pass at your child’s death (i.e., to the child’s children, rather than the child’s spouse). Setting aside the issue of divorce, a child could predecease his spouse, which may result in the spouse inheriting the assets that the deceased child inherited from his parents. Under those circumstances, there is no way to control who might later inherit the assets that originally belonged to the parents when the child’s spouse passes—it could be the son-in-law or daughter-in-law’s next spouse.
Typically, a trust for a child will be set up as part of a parent’s estate plan and will be funded when the parent passes away. However, lifetime gifts for children can and should be made through trusts as well.
Also consider what happens if a child or a child’s spouse defaults on a bank loan, has a failing business or is involved in an accident the liability for which is not fully covered by insurance. An inheritance that is not held in trust for the child could be exposed to these liabilities. To protect an inheritance from a child’s creditor claims, parents should consider an Asset Protection Trust for their children. Asset Protection Trusts are easy to establish, and a properly prepared trust will allow a client’s heirs full access to these trust assets, while also assuring that access is not available to their creditors.
A parental trust in which the individual’s children or grandchildren (but not the descendants’ spouses) are the beneficiaries are sometimes called Bloodline Preservation Trusts. For estate tax savings and asset preservation purposes, Bloodline Preservation Trusts are typically multi-generational trusts or Dynasty Trusts. Bloodline Preservation Trusts for the benefit of descendants can be formed in every state as an asset protection vehicle for the trust beneficiaries under standard state spendthrift trust rules.
Moreover, even though clients as parents may not be concerned about their child getting divorced, there is a real possibility that the client will remarry after his spouse dies. In such a case, the client may also find it difficult to raise the topic of a premarital agreement to protect his own assets. A properly prepared trust for the benefit of a surviving spouse can protect the assets in the event of the surviving spouse predeceases or divorces his or her next spouse or has financial issues.
Trusts set up as Asset Protection Trusts along with bloodline beneficiary and multi-generational dynasty trust features will generally address all of a client’s estate planning needs. Like corporations and limited liability companies, trusts can provide excellent protection for clients and their assets and should be freely used for this purpose. For these reasons a trust is a very useful legal vehicle. For example, it is common for the trust to purchase a new home for the child beneficiary rather than have the child own the home in his own name. When a trust holds title to a child’s home, the home is generally protected from bankruptcy and creditor claims of the child. To further illustrate this point, imagine if a child or the child’s spouse files for divorce, the trust would secure the residence and the child beneficiary’s home is instantly available to the child without court intervention. Thus, the trust is a fabulous vehicle for protecting your inheritance and providing comprehensive legal protections for a client’s children and grandchildren.
Although trusts may be the most overlooked or ignored entities in our legal system, a trust is a very useful legal entity that all lawyers should integrate into their everyday considerations when advising clients about estate planning, asset protection planning and providing limited liability.
This article was published in the Legal Intelligencer Wealth Management/Trusts & Estates Supplement, February 14, 2017. To read the article on the Legal Intelligencer website click here.