Why should I make a trust? This is a common question. In this series of posts, here’s twenty great reasons to have a trust!
Part C: Trusts Allow You to Better Protect Your Loved Ones.
9. A trust can protect young heirs from themselves and others. If you die without a trust, a child will be entitled to receive his or her inheritance – no strings attached – the moment the child turns 18. It is a rare 18 year old whom would be able to handle a significant inheritance at that age. And it’s not just the young heir you have to worry about, it’s all the charlatans around him, too. Don’t forget about the time before 18. Who will be in charge of the child’s money then?
With a trust, the world is your oyster! A trust leaves someone else – the trustee – in charge of the child’s inheritance until you say otherwise. You can instruct the trustee to hold everything and use it for specific purposes, such as education. You can provide for staggered distributions at various ages, so the child doesn’t get everything at once and has time to learn to manage money. You can keep it in trust for the child’s lifetime, or give it earlier as a reward or gift for major life events.
Other alternatives exist, but they make poor substitutes. For example, you can make a trust within your Will, known as a “testamentary trust,” but that’s a foolhardy remedy because it does not avoid the probate process (see #5 through 8) and may subject your trust to long term court supervision. Sometimes you can delay the inheritance to age 21 or 25 under the Uniform Transfers to Minors Act, but that usually doesn’t happen because people forget to write that into their Wills, it’s more complicated, you have little planning control, and you can’t control the future custodians of the funds.
10. A trust can be used to encourage behavior and instill values you cherish, even in your absence. A trust can set aside funds to help cover the cost of major life events for your children or grandchildren. College education, a first home, starting a business, getting married — these are all worthy and expensive endeavors. A properly structured trust can go a long way toward making these dreams reality for your loved ones.
Of course, some children need motivation in addition to opportunity. A trust can help with this, too! Say you value education. Your trust can instruct the trustee to pay for education. It can specify the grades that must be attained. It can specify the college or the types of degrees for which you are willing to pay. It can also provide a reward when the goal is achieved. How about a nice cash gift on graduation day? Or a new car?
Want to encourage philanthropy? Community service? Religious observance? All of these, and many more, can be encouraged and assisted with a trust.
11. A trust offers protection from divorce and creditors. Your trust can be structured to help protect your loved ones from their creditors or divorcing spouses. Nothing can protect them once the money is distributed and “theirs” to do with as they please. The protection comes prior to distribution.
Your trust can prohibit beneficiaries from assigning their interest to creditors, such as taking out a loan secured by their trust interest or pledging their next distribution to a creditor. And as long as the beneficiary’s interest is still being held by the trustee, those assets are not being commingled with the beneficiary’s marital property, so there is no question that the trust assets are separate property if the beneficiary divorces.
Creditors can reach money or property that is actually distributed to the beneficiary, but would not be able to touch assets still held in trust that the beneficiary is merely being allowed to use, such as a house. Some obligations can be reached even in a trust, but those are limited. The most common examples are payments due for spousal support and child support. But even then, a court order is usually necessary and that places another hurdle before the creditor.
12. A trust can provide for your spouse while protecting your children. A trust is a wonderful tool for balancing your desires to provide for your spouse but leave something to your children as well. It can be structured to provide income to your spouse, and provide principal to your spouse if your spouse needs it for support, but to pass unused portions on to your children when your spouse dies.
This can be helpful if your spouse is not the parent of one or more of your children. By specifying these uses, you make clear to your children your intention that the spouse be supported; but by specifying where the remainder goes, you make clear to your spouse that you wish to benefit your children, if possible – it’s not up to your spouse where the remainder will pass.
This scenario also protects your spouse and your children from the spouse’s remarriage. Even if your spouse is the other parent of your children, he or she may fall prey to a second spouse’s influence. If you leave assets to your spouse outright, those assets may become part of the marital estate with the later spouse, or at least subject to the later spouse’s influence. A trust ensures that your children will receive something if your spouse did not need all of the assets. It also ensures that your assets remain segregated from the new marriage, thereby still available to your spouse in the event of need or later divorce.
13. A trust affords better management of life insurance proceeds. Many people forget about life insurance when thinking about their estate planning, even though the life insurance is often one of the biggest assets. If you name your minor child as beneficiary, that child will receive the proceeds at age 18 and a guardian will be in charge of it prior to that age. (This presents the same problem described in #9.)
In addition to the problem of young heirs is the problem of intended use. Did you intend for the insurance to be used to pay off the mortgage? Was the insurance a safety net to pay for education? Did you want the insurance used for long term support? Any of these intentions may be lost if the life insurance is paid to the heirs directly, rather than being paid through a trust. If the insurance is paid to the trustee, it will remain under the trustee’s control subject only to the instructions you gave in the trust. Divide it, hold it for education, pay a mortgage, etc. Your wishes get carried out.
The only drawback is potential exposure of the insurance amount to your own creditors. If your life insurance pays out to your probate estate, your own creditors can reach it. If it pays out directly to a beneficiary other than your estate or your trust, then your own creditors cannot reach it – but the beneficary’s creditors can. If it pays to your trust, rather than your probate estate, the law is not clear whether or not your own creditors could reach the proceeds, but it appears to be leaning in that direction. However, unless you have a great deal of debt at the time of your death, the concern that your life insurance may be used for your own creditors should be relatively small, especially compared with the dangers of leaving insurance outright to your heirs.
Another concern is the condition of your heirs. If you name a beneficiary other than your trust, and that beneficiary dies shortly after you do, the proceeds will pass through to the beneficiary’s heirs (spouse, children, etc.) whom may or may not be the persons you would have preferred to benefit. It will also probably require a probate administration, costing unnecessary expense.
14. A trust can benefit loved ones receiving government benefits for special needs. If you have a loved one receiving SSI, Regional Center Services, or other government benefits based on a developmental or related disability or special need, you know that income or property passing to that loved one risks loss of benefits (usually including medical coverage!) A trust can be structured to allow the trustee to provide assets and advantages to your loved one in a way that will not cancel those benefits. This must be done carefully and a trust is the only means for doing this safely.
You may be tempted to leave your assets to another child, feeling that child will “take care of” the sibling with special needs, but this is risky. The child’s creditors will be able to reach those funds to pay debts. The child’s spouse may be able to reach those funds in event of divorce. What if the non-needy child dies? Who then will provide for the child with special needs, and how will the assets pass from the non-needy child?