couple reviewing finances

Although leaving your hard-earned assets outright to your adult children, grandchildren, or other beneficiaries after you die may seem like the easiest and most desired form of distribution for the beneficiaries, this scheme will make their inheritance easier prey for creditors, predators (e.g. lawsuits), and divorcing spouses.  Instead, consider using discretionary trusts (aka continuing trusts) for the benefit of each of your beneficiaries.  I have done so in my own estate plan and the estate plan for my parents.  That’s important for you to understand because it means that I’m making things a bit more protective/structured for myself someday –I think it’s worth the extra structure in exchange for the protective benefits!

What is a Discretionary Trust?

A discretionary trust is an irrevocable trust set up to protect the assets funded into it for the benefit of the trust’s beneficiary. This can mean protection from the beneficiary’s poor money-management skills, extravagant spending habits, personal or professional judgment creditors, or divorcing spouse.  The language to create the trust is built into your own trust but it doesn’t get actually created/activated until you pass away.

Under the terms of a typical discretionary trust, the trustee is limited regarding how much can be distributed to the beneficiary and when the distributions can be made, according to your wishes.  You can make the terms and time frames as limited or as broad as you want. For example, you can provide that distributions of income can only be made for health care needs after the beneficiary reaches the age of 21, or you can provide that distributions of income and principal can be made for health care needs and educational expenses at any age.

The most protective type of discretionary trust would involve a third-party trustee (e.g. a bank, friend or family member) that has full discretion over distributions.  With this structure, a creditor, predator or divorcing spouse would have less ability to get to the trust assets because the beneficiary doesn’t have control over the assets.  A less-protective option that provides more autonomy to the beneficiary would allow the beneficiary to be their own trustee (e.g. a beneficiary-controlled trust).  This is preferable to an outright distribution to the beneficiary because it is substantially more protective against divorce (I sometimes explain it a parental pre-nuptial agreement) and would allow the beneficiary to step down as trustee and appoint a third-party trustee if additional protection is needed.

An added bonus of incorporating discretionary trusts into your estate plan is that they can be designed to minimize estate taxes (and avoid estate taxes being paid at your generation and the next generation), as the trust assets pass down from your children to your grandchildren (this is referred to as “generation-skipping planning”).  In addition, you can dictate who will inherit what is left in each beneficiary’s trust when the beneficiary dies, which will allow you to keep the trust assets in the family.

The bottom line is that a properly drafted discretionary trust will protect a beneficiary’s inheritance from creditors, predators, and divorcing spouses, avoid estate taxes when the beneficiary dies, and ensure that it ultimately passes to the beneficiaries of your choice.

What Should You Do?

If you are concerned that your children, grandchildren, or other beneficiaries will not have the skills required to manage and invest their inheritance or you want to help protect them from losing their inheritance in a lawsuit or divorce, then give us a call to discuss  how to incorporate discretionary trusts into your estate plan.

Curtis Kaiser, Board Certified Specialist in Estate Planning, Trust & Probate Law