Estate Planning to Ensure Wealth, Heirs Are Secure

You worked hard to build your estate, and you’re working harder than ever to keep it. One of your Estate Planning goals is for your estate eventually to make life easier for younger loved ones. Yet, you want to ensure the wealth isn’t wasted and also that it doesn’t make your heirs too comfortable. You don’t want them to become wastrels and stop living useful lives. You also don’t want to risk having your money end up with ex-spouses, creditors, gambling houses, or drug dealers. That is where proper estate planning comes in.

Proper estate planning can balance these interests. Leave your wealth in a trust or trusts with the right provisions. Your loved ones have the security of the wealth. You’ll be reasonably assured the wealth won’t spoil them and they won’t spoil it.

Don’t be put off by the idea of creating a trust. Trusts once were the province primarily of the very wealthy, but now many upper middle class and middle class estates include one or more trusts. They’re cost effective and can be drafted to fit many estate planning situations.

I’m going to give you some key provisions to consider for your trust. These generally are considered control or incentive provisions, and the trusts often are known as incentive trusts.

You want to be careful using these trust clauses. You don’t want to exercise too much control or micromanage things. You can’t foresee all circumstances, so there should be some flexibility and discretion in the trusts. Some of the worst estate planning results occurred because a trust was too tightly written. The trustee could not adjust distributions or investments to fit changing circumstances.

You also don’t want to create anger or bitterness in a beneficiary by making it clear you don’t trust their judgment and plan to control them even from the grave. That could lead to the decline in personal behavior you were hoping to avoid. Some estate planning attorneys won’t draft incentive trusts or at least some incentive trusts because of these control issues.

Here are the incentive terms to consider in your estate planning trusts.

? Spendthrift clause: This is the standard clause for most trusts. It generally provides that creditors of the beneficiary can’t force payouts from the trust or be paid directly from the trust. Even if the beneficiary is bankrupt, creditors can’t invade the trust. The creditors can lay claim to any money or property only after it’s paid to the beneficiary from the trust.

Some states don’t allow the spendthrift clause while others limit it to the first $500,000 or so of the trust value. So, while you should have the spendthrift clause, it isn’t always sufficient.

? Discretionary clause: Under this clause, the trustee has discretion when to pay or not pay income and principal to the beneficiary, and can decide how much to pay. This provision can work well when the trustee knows your wishes and you provided written guidelines.

The clause can set up the trustee and beneficiary as adversaries, so you might not want to pick a family member as trustee. Also, a corporate trustee who is not familiar with your family may not be willing or able to learn all facts and use the discretion effectively. The effectiveness of the clause depends on the trustee and the guidance you are able to provide.

? Milestone trust: This provision provides protection against giving money to an heir before he or she can handle it. Instead of leaving money outright, you leave it in a trust that at first pays only the income or will pay only for specified expenses, such as education and medical care.

The beneficiary receives principal payments in stages when certain milestones are met. The milestones can be whatever you want. Commonly used milestones are reaching certain ages, graduating from college, and being employed for a certain number of years. For example, a trust could provide that one third of the principal is paid when the beneficiary reaches age 25, one third at age 30, and the rest at age 35. This also is known as a stepping stone trust.

This is where excess control becomes an issue. Some people try to dictate their heirs’ choice of careers or other matters by allowing some payouts only when a beneficiary takes certain actions (graduating from law school, getting married) or refrains from some actions for a period of time (smoking, taking drugs). This trust is best used when the milestones are likely to establish that the beneficiary is mature enough to handle the wealth responsibly (such as reaching a certain age) or is not going to be a wastrel (has been employed for a minimum period of time).

? Matching trust: This is another clause designed to pay out trust principal only when the beneficiary has some maturity and responsibility. The trustee makes payments only to match income earned by the beneficiary. The payments can be for exactly the beneficiary’s salary or a multiple of it, such as two or three times the salary.

The matching trust must be used with care. It can be a bit unfair if there are several heirs with different incomes, or it might give the beneficiary the wrong values. An heir who is attracted to a relatively low-paying occupation, such as teaching, will receive less than a sibling who is drawn to a higher-paying profession. The trust might cause the heir to seek employment based on potential income rather than his skills, aptitude, and enjoyment.

? Escape clause: This clause is called by a number of different names, but the content is the same. No matter how carefully you choose from and draft the provisions already mentioned, the beneficiary still might not be ready to handle a large sum of money at the time it is scheduled to be distributed. Perhaps the person drifted into substance abuse, gambling, or high-risk business ventures or is going through a nasty divorce. Or the beneficiary simply hasn’t developed the skills and maturity to handle the responsibility.

If you don’t want your wealth distributed under those circumstances, say so in the escape clause. This allows the trustee to withhold payments when it is in the best interests of the beneficiary. Some people spell out the circumstances under which payments should be withheld. Others realize that they cannot anticipate everything and give the trustee a broad, general power to determine a distribution is not in the beneficiary’s best interests. Payments to the beneficiary resume when the situation that caused suspension of the payments is resolved. The potential downside of the provision is it depends entirely on the trustee’s knowledge and judgment.

? Emergency clause: Some of the saddest estate planning stories are those in which the trust creator wanted to be specific about trust distributions and focused on situations he knew about and anticipated. He also focused on saying money was not to be distributed in those situations. Ignored was the possibility of other circumstances arising and that distributions should be increased in those circumstances. For example, you probably would want the trust money to be used if your child or grandchild developed special medical needs or wanted extended education. But if you didn’t allow for extra payments in such circumstances, the trustee can’t do much. It is a good idea to give the trustee the power to increase payments in special situations. You can leave the trustee a broad power or try to define the circumstances.

There are two other keys to make these trust provisions work well.

The first is marital agreements between your beneficiaries and their spouses. You probably don’t want a big part of your estate to end up in the hands of someone you never knew or you knew and didn’t care for. Yet, without the right protection the money could end up with an ex-in-law or even the second spouse or the children of a second marriage of one of your current in-laws. You can avoid this situation by telling your children and stating in the trust that there won’t be principal distributions unless they have valid premarital or postmarital agreements.  These agreements are very flexible. The basic clause you want is that any gifts or inheritances received by a spouse are not marital property to be divided in the case of a divorce. They are non-marital property of the receiving spouse.

For a marital agreement to be valid, each party should have separate legal counsel, there must be full disclosure from each party, and there must be enough time taken to contemplate the agreement.

The other key is your choice of trustee. When the trustee has some discretion, you don’t want a trustee who will be easily pressured or influenced by the beneficiary you’re trying to protect. You also don’t want the choice of trustee to divide family members. On the other hand, you don’t want a corporate trustee who’s managing a few dozen (or hundred) trusts and doesn’t know anything about your family members. We’ll discuss trustee selection in more detail in another visit, but it is key to making a trust work. You can’t plan for all contingencies. But you can plan for the ones that have caused problems for people in the past. By inserting a few carefully-chosen words into a will or trust you can ensure that your loved ones are cared for and reduce the probability that your estate will be squandered or wasted.

RW October 2010.