Which Distribution Method Is Best? Showing Your Children, the Love

Recently, I had an appointment with three siblings over their parents’ distribution wishes in the will. I thought this blog would explain parents’ choices when preparing for their estate planning. As parents, we generally want to do good things for our children while we are alive, and when we are gone and leaving them an inheritance is one of the most tangible ways to show your love. You may not know there are various ways to leave money and property to your children, and you can choose the best method to take your goals, including their well-being, into account.

The Outright Gift

The first option for leaving an inheritance is to make an outright gift using a will to all children over the age of majority in your state (usually 18, 19, or 21). Age of Majority is the State’s law that children assume all the rights and responsibilities of adulthood.  This often comes to mind when people think about planning for their children’s inheritance. This may be a fine solution for parents with financially responsible adult children who ​will leave ​a little property and money to them. However, leaving an outright gift using a will is not the best option for most people. If your children are minors, they cannot legally take control over an inheritance, so it will likely be held in a particular account or managed by a court-supervised conservator until adulthood. But even if your children are young adults, they may not be mature enough to make sound financial decisions. Further, it is impossible to foresee the future, even for grown children who usually exercise good financial judgment. They could, for example, experience a divorce or be sued and have a judgment entered against them, and their inherited money could satisfy those claims. Certain types of trusts can prevent the money you have worked hard to save from going to your children’s creditors or a divorcing spouse while enabling the trustee to distribute for your children’s benefit under your wishes. 

In Trust with Child as Trustee

If you make your adult child the trustee of a trust to be established when you pass away, and he or she is also the beneficiary, the trust terms will specify the discretion your child will have in distributing to him or herself. Like an outright gift, this is often not the best choice for parents concerned about immature children or children who may have present or future money problems. If your child can exercise control over the trust money and property in the role of trustee, then his or her creditors may reach those assets to satisfy their claims. There is also the possibility of conflict, especially if the siblings don’t get along, if multiple siblings act as co-trustees or if one sibling is the trustee and the other siblings are beneficiaries.

A beneficiary-controlled trust can address some of these concerns. This trust enables a beneficiary to be a trustee, but the trustee/beneficiary can only distribute for his or her health, maintenance, education, and support (HEMS, see previous blog). An independent co-trustee may be empowered to distribute for the beneficiary’s benefit for reasons beyond health, maintenance, education, or support. Typically, the terms enable the beneficiary to remove and replace his or her co-trustee if the beneficiary is unsatisfied with the co-trustee’s performance. Although the trustee/beneficiary has some control over his or her inheritance, this trust prevents the money and property intended for your child from being used to satisfy the claims of creditors, divorcing spouses, and lawsuits.

Distribute percentage at certain ages

One of the most common–though not necessarily the best–choices parents make regarding how to distribute money and property held by a trust is to include terms requiring mandatory distributions at a certain age or several ages. For example, a trust could require one-fourth of the trust’s principal to be distributed at age 25, one-fourth at age 30, and the balance at age 35. This distribution scheme may discuss parents’ concerns about their children receiving a large sum of money before they have the maturity to handle it responsibly. Still, it does not provide as much protection against creditors as many parents would prefer.  If a beneficiary can require a distribution to be made from the trust, his or her creditors or divorcing spouses can also look to it to satisfy their claims. In addition, once a distribution is made to one of your children, it is vulnerable to present or future creditors’ claims.

Incentive trust distributions

Many parents want to pass on their values to their children, and an incentive trust is sometimes used as a mechanism for encouraging children to achieve essential goals by allowing trust distributions based upon the beneficiaries’ achievement of certain conditions, e.g., graduating from college, or denying distributions to beneficiaries who use drugs. Although this trust protects the money and property held in the trust from the beneficiaries’ creditors until the funds are distributed, there are possible downsides. This trust has the potential to trigger resentment in the beneficiaries whose behavior you wish to influence, especially if they believe the trust’s conditions are unfair: For example, a trust that rewards high income by increasing distributions as income increases may be perceived as unfair by a beneficiary who has chosen a laudable but low-paying career such as teaching or social work. In addition, this type of trust may not give trustees much flexibility in making distributions. Trustees may find it difficult and expensive to administer, as substantial investigation or proof may be necessary to establish whether the beneficiary has met the trust conditions. 

Distributions for specific purposes

A trust providing distributions for the beneficiaries’ health, maintenance, education, or support is standard. It is also possible to set up a trust that gives the trustee the discretion to distribute to beneficiaries for other specific purposes, for example, starting a business or buying a house. In those circumstances, the trustee may need to evaluate, for instance, whether the beneficiary can afford the monthly payments, home maintenance, and taxes before making a distribution to be used as a down payment on a house. Like other types of discretionary trusts, the money and property held by the trust will be protected from claims by creditors, divorcing spouses, or lawsuits.

Complete discretion by the trustee

A discretionary trust authorizes a trustee to make distributions to beneficiaries but does not require distributions to be made. Although this trust protects the money and property held in the trust from being used to satisfy claims made by the beneficiary’s creditors, some parents may be concerned that this type of trust gives the trustee too much control. Because the trustee need not make distributions, your children cannot depend upon receiving money at specific intervals or occasions, which may make financial planning more difficult. There is also the risk that unequal distributions among multiple beneficiaries could lead to family conflicts and resentment when the trustee is the only one to decide who gets money and when.

Each type of trust has its pros and cons. The right strategy–or combination of strategies–for your family depends upon your unique circumstances and goals. Call our office today, 301-468-3229, to set up a consultation or fill out our contact form so we can ensure your will or trust will provide for your children in the way you intend after you pass away.

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