- Why trusts 25 years ago are not the same as trusts today.
- Set up trusts for your kids, and specify exactly how they can use the money.
- Use trusts to protect your kid’s inheritance from creditors and the estate tax in the long run.
The idea of creating a trust for a child leaves many parents conflicted. On the one hand, trusts are a powerful estate planning tool. On the other, trusts make most folks picture spoiled trust fund babies.
Personally, I want my kids to feel the financial security of a future inheritance, but I don’t want that security to make them less productive today. So, how do you tackle the use of lifetime trusts for your children or other beneficiaries?
The History Of Trusts
I have two sons, and there are a variety of ways I can craft the inheritances they will receive. 50 years ago, the standard was pretty simple. Each would get a 50% interest in my assets, and if he was over the age of 21, he would get it all immediately. Only the ultra-high net worth considered using trusts to protect inheritances, probably because of three main factors. First, trust planning wasn’t common, and it was hard to find an attorney who was well versed in it. Second, most families didn’t consider themselves affluent enough to need a rarified trust and estate attorney. And third, a 21-year-old was considered an adult.
25 years ago, the standard approach to inheritance was very different. It was much more likely that I’d use a trust as my primary estate planning document, which meant it was much easier to build some layers of protection around my sons’ inheritances. The most common was age-based. Instead of allowing my son full access at age 21 (which no longer seemed a responsible age), I might delay distribution so that he got access to smaller amounts over a determined period of time. “A third at age 25, a third at age 30, and a third at age 35” became pretty common.
Today, estate planners routinely suggest leaving a child’s inheritance in trust for a lifetime, with no specified date of distribution. Instead, the trust allows the child to use the assets for certain purposes and sets ages at which the child can start to make decisions about use on his or her own.
Why this shift?
If I direct my sons’ inheritances through a trust, I can give specific instructions about who can use the assets and how they can use them. If I limit use to what the IRS calls “ascertainable standards,” then I can make my sons the only people who should benefit from my assets. If I still want each of my sons to benefit from half of my assets, employing these standards is easy. In my trust, I simply say that my oldest son’s share of the assets can be used only “to provide for his health, education, maintenance and support.” These standards effectively mean the assets can be used to provide for his normal living expenses.
How Trusts Work
What is a trust? Trust standards are adaptive to different life stages. The normal living expenses of a 25-year old, for example, should be much lower than those of a 45-year old. As my son’s life gets more complicated (think mortgages, car payments, or child care), he’ll naturally need more money. The standards adapt to this, which means I do not really limit his access to his inheritance by keeping it in trust. But my instruction that the assets be used for HIS health, education, maintenance and support is a powerful limitation.
Let’s assume my son goes through a reckless period, during which he causes an auto accident. We can really pile on the costs and say that an attorney was driving one of the cars involved in the crash, and he sues my son for $1 million. Every dollar my son has received of his inheritance will be subject to that creditor’s claim. But the attorney can’t get to the assets still inside my trust because my trust says those assets are only to be used for my son’s normal living expenses.
People go through tremendous efforts to achieve this kind of creditor protection for themselves, but it is hard to wrap around your own assets. By using the ascertainable standards in my trust, I can give my sons an incredible advantage.
And it gets better.
Not too many people actually get sued over auto accidents. The much more likely trip is to divorce court. The same language in my trust reduces the risk of a divorce court divvying up my son’s inheritance to an ex-spouse. Divorce proceedings are never predictable, and judges are the least predictable part of the process. Fortunately for my son were this scenario to occur, protective language in my trust will give him an advantage in the event of a divorce.
Finally, the ascertainable standards will reduce my family’s exposure to the federal estate tax. That’s because the estate tax applies at my death to assets over which I have control that amount to outright ownership. Assets that I acquire on my own are definitely subject to the estate tax at my death, but assets that someone leaves to me in a trust are not subject to the tax if I can only use assets for the ascertainable standards. So, if I leave assets to my son and he’s successful on his own (and creates a taxable estate), then his inheritance from me is subject to the estate tax at his death unless that inheritance is subject to the ascertainable standards.
Trusts And Your Family
Let’s recap. If you leave assets to your children in a trust, the assets are available for normal living expenses any protected from potential creditors, less likely to end up going to future ex-spouses, and subject to less estate tax.
If you’re considering setting up a trust for your children, it’s a great topic to chat with a financial advisor about. To learn more, set up a consultation with a Personal Capital advisor today.