We all want what’s best for our children and the people we leave behind when we die. You’ve worked hard and managed your money wisely to provide a comfortable lifestyle and leave a legacy. You know careful estate planning is integral to solid financial planning, but you may not be aware that decisions you make now can affect your kids well into the future.
If your heirs are young, immature, or tend to make poor financial decisions, you probably already have some concerns about how they might handle their inheritance. But if you have adult children who are reasonably responsible with money, you may think naming them as beneficiaries and completing a will are the only necessary steps to take.
Effective estate planning requires thinking several steps ahead, no matter the heir or circumstances. With the transfer of assets after your death, your hard-earned estate is vulnerable to a number of factors and there is a lot at stake, regardless of its size.
Here’s how to protect your kids (or other beneficiaries) from themselves and safeguard their inheritance with trusts.
Assess Various Scenarios
Let’s say you want to leave everything to your children. There are a variety of reasons a sudden windfall could work against them. To assess the situation, consider the following questions:
- Are they old enough, mature enough, and equipped to handle a significant sum of money? Much like lottery winners who wind up broke, young adults who are unprepared to handle large windfalls can be susceptible to frivolous spending.
- Are they in deep financial trouble, such as facing bankruptcy, large medical bills, lawsuits, or tax levies? If so, the debt could quickly swallow up their inheritance without even bailing them out of trouble.
- Might they be in an abusive or unstable relationship? Their partner could pilfer the funds or a judge could award your money to their ex in a divorce settlement. Think about unsavory friends, too. Do you think they might be susceptible to being pressured into loaning money or investing in foolish schemes?
- Do they have addiction problems? Substance abuse, gambling, or shopping addictions have led to the squandering of many inheritances.
- Could they lose a needed form of state benefits, such as disability, Medicaid, or financial assistance? Be mindful of the fact that inheriting even a small amount of additional assets would likely render them ineligible and could put them in a bind.
It’s important to be careful about how you pass assets along to your kids. You’ll want to do so in a way that not only prevents them from blowing it, but also protects them from threats.
Remember That You’re in Charge
Deciding what to do with your estate does not always come with a straightforward or simple answer. Nobody is entitled to what you own—not even your adult children. While your spouse and your dependent children may have a legal claim to your estate or part of it, you are primarily in charge.
You get to choose who is deserving, equipped, and ready to be a beneficiary. You’re justified to attach strings to the inheritance, put measures in place to regulate the flow of money, or even disinherit your children or loved ones as you see fit. Make sure your wishes are clear in your will and that you have the proper estate documents in place.
Create a Spendthrift Trust
If you lack confidence that your child or other heir is responsible enough to handle the inheritance or there is another reason it needs to be protected, you can assign the responsibility to another party. This can be accomplished by setting up a trust and assigning a trustee to manage the funds.
A spendthrift trust gives the trustee authority to control funds and sets limitations on how your beneficiary is able to use the inherited funds.
For example, you may leave assets to your adult child in a trust and assign your sibling—their aunt or uncle—as the trustee, stating that they cannot access the funds without the trustee’s oversight until they reach the age of 30.
You can even put stipulations on the money, such as indicating that it must be used for tuition or that the beneficiary must present a clean drug test to access funds.
If not a family member, the trustee could be your attorney, accountant, or professional firm. Keep in mind, the trustee not only has the burden of dealing with the heir (and their possible resentment) but is also responsible for managing and investing the money. It’s a considerable responsibility, but the goal is to ensure a mature and responsible party holds the reins.
An added benefit is that a spendthrift trust can protect the funds from debtors, lawsuits, divorces, and bankruptcies because the assets are not directly owned by the beneficiary. However, it is important to note that the money can be treated as income or assets when it is actually paid out.
If a great deal of wealth is at stake, you may want to establish what’s called a dynasty trust, which would keep the inheritance in a trust indefinitely, protecting it from squandering, lawsuits, creditors, and poor decisions over a lifetime or as long as the money lasts.
Set up Installments or an Incentive Trust
Rather than putting a trustee in charge of doling out the funds at their sole discretion, you could also put measures in place to automatically limit how the funds are distributed.
Some people set up an incentive-based trust. The trustee maintains the burden as gatekeeper, but specific rules are put in place. For example, the inventive trust may only allow access to the funds based on certain behavior—payouts triggered by graduating from college, completing a drug rehab program, having children, reaching a certain income, qualifying for a home loan, or whatever milestone you’d like to set.
Here’s another option. Maybe you don’t want your heirs to receive one lump sum but would prefer the funds trickle out over time. For example, you can state that the heir gets an annual allowance, or break up the full amount—a third at age 25, another third at age 30, and the final payment at age 35. You could achieve a similar payout structure by buying an annuity for your heir, which would save the fees associated with managing a trust.
Your estate planning should take careful consideration of how your assets will be passed on to your heirs. Whether the goal is to shield them from themselves, creditors, predatory behavior, taxation, or all of the above, an experienced estate planning attorney can help you establish a trust that ensures your wishes are met and provides adequate protection.
Robert "Fenn" Giles, Jr., MBA, CIMA® is a founding partner of Wealth Advisors of Tampa Bay (WATB) and acts as the firm’s President and Chief Investment Officer. WATB is an independent Registered Investment Advisor (RIA) located in Tampa, Florida. Learn more about them at wealthadvtb.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific tax or legal issues with a qualified tax advisor or legal professional.
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.