How a trust can help ensure the longevity of your gift to a beneficiary
One component of an estate planner’s role is to become familiar with your family dynamics. This includes learning about your relationship with immediate family members as well as extended family members — and anyone else you identify as an important person in your life. Estate planners often ask questions that may come across as uncomfortable, or might be perceived as rude, but this is a critical component of our job: understanding you, who you care about, and what you value.
One such potential sticky question that presents itself in the discussion of beneficiaries: how does this person (or how do you anticipate this person will) manage their inheritance? Answers range from: “they’re fantastic with their money!” to “I think they’re at risk of giving away everything to an organization I don’t agree with” – and everything in between.
It is the latter response that we want to focus on today: if you have someone you care about leaving a gift to, but you are worried they will squander, mismanage, or be untrustworthy with it, how can you protect the beneficiary from their own bad decision-making habits?
The Least Restrictive Trust Provision: Staggered Distributions
The first option available to you is creating a trust that utilizes a staggered distribution format; this entails periodic mandatory distributions with discretionary distributions available throughout the existence of the trust. What does that mean? Take this example:
Alfred has a total of $500,000 set aside as a gift to him. These funds are going to be held in a high interest account to create the opportunity for these funds to grow. From the principal (not interest) Alfred will receive 5% or $25,000 on his: 25th, 30th, and 35th birthdays. Upon turning 40, Alfred will receive the remaining funds outright.
However, Alfred will have the option to request the Trustee give other distributions to him if he can show how the distribution is necessary for his maintenance, education, or support.
This means that Alfred has the possibility of benefiting from this gift in other clearly defined ways before the final distribution upon his 40th birthday. That means Alfred can use the gift to obtain higher education or buy a home, or other valid and necessary expenses, but not take a month long trip to Las Vegas or squander the money with other frivolous spending.
This is often very important to individuals setting up a trust: they want their beneficiary to have the benefit of the gift without the risk of squandering the gift.
A More Restrictive Trust Provision: Staggered Distributions With Incentives or Mandatory Provisions
In this example, Batman has similar restrictions to Alfred; however, here the creators of the trust will impose additional restrictions.
Batman has a total of $500,000 set aside as a gift to him. Batman may have the benefit of these funds for his health, education, and support so long as Batman is in a period of sobriety for at least 6 months at the time the request for distribution is made. Upon turning 40, if Batman has maintained his sobriety for the preceding 5 years and has obtained a minimum of a Bachelor’s Degree from an accredited United States University, then Batman shall be entitled to receive an outright distribution of all remaining funds.
The restrictions on discretionary distributions can be more restrictive as well such as only for educational purposes at an accredited college or university. Restrictions can also be related to substance use or dangerous behavior: Batman must maintain sobriety for a minimum of 90 days before any distribution and must provide an observed negative drug test weekly prior to receipt of the distribution.
The Most Restrictive Trust Provision: Lifetime Spendthrift Trust
The most restrictive option available to individuals with serious concern about their beneficiaries is a lifetime spendthrift trust.
With a lifetime spendthrift trust, a beneficiary will never receive a full distribution of the gift set aside for them; however, throughout their lifetime they will have a right to distributions for their benefit based on ascertainable standards like the two other options above. Just like with the options above, you have the option to place specific restrictions on the distributions or make them broad and simple: health, education, maintenance and support.
Here, Cat Woman would be the beneficiary of the trust, for the duration of her life, but will never have the right to have the funds in their name and she will never be entitled, under any conditions, to receive the funds outright. Cat Woman will have the benefit of the funds for her lifetime if they meet the right conditions but their right to the funds ends there.
- Until a staggered or final distribution is required, your beneficiaries have no entitlement to the funds.
- Distributions are discretionary, unless there is a specific distribution that is mandatory.
- These provisions provide some protection from creditors. There are always legal exceptions to the creditor protections, but in the broad sense, the funds will be protected from bankruptcy, judgment creditors, and possibly even child or spousal support. The funds will also be protected in the event of divorce.
- For these trusts, the beneficiaries cannot be the trustees as they cannot be responsible for the management of the funds and be in charge of their own distributions; there must be a third party in charge of the funds.
- With discretionary distributions, the distributions do not go to the beneficiary; instead, the funds are paid directly to the service provider, whether that’s a medical provider, the car dealership, the landlord, or educational institution. This ensures that the funds do not ever legally qualify as belonging to the beneficiary.
- Restrictive trusts can be created in your personal revocable trust, or they can be created in a separately created and funded irrevocable trust if more extensive tax planning is required.
- If the restrictions are created in a revocable trust, then during the creator’s lifetime, the terms can be amended if needed.
Creating any limiting provisions in a trust is a detailed process that must be thoroughly thought out and discussed with your attorney. These are important decisions and all possible contingencies must be discussed in detail. If you have concerns about a beneficiary’s ability to manage funds or abstain from substances, or concerns about their creditors, a limiting trust or discretionary distributions might be the best decision for you. We invite you to give us a call to discuss your options and how you can protect your legacy for the benefit of your loved ones.
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