Estate Planning Strategies to Help Heirs While Protecting Wealth

Incentive trusts and protective trusts are all the rage. Many people want to be generous in their estate planning with succeeding generations – now or in their wills – but they want some assurance the wealth won’t be wasted.

People are concerned that inheriting wealth might reduce an heir’s work ethic. They don’t want the money to disappear in a spending spree. They also would like to know that the wealth won’t end up with ex-spouses, creditors, or worse.

There are a number of tools that can help reach these goals. Wealth can benefit the next generation while the chances are minimized that it will be squandered or wasted. There’s no reason for fears of “affluenza” to keep you from making gifts or using other estate planning strategies. You won’t have complete control, but you will have a strong influence on what happens to the property.

Most wealth control strategies begin with an irrevocable trust. The trust secures gift and estate tax breaks. The trust also is needed to protect the assets from the things you fear, such as a young beneficiary getting control of the property and wasting it.

The next step for most estate planners is to determine the terms of the trust. It is more important, however, to select the trustee or trustees. The trustee is the one who will follow the guidelines you set for distributing the money. You want someone who knows something about your family and will be able to stay informed. The trustee also should be someone who is able to resist entreaties to violate your guidelines.

Often the best choice for trustee is a responsible family member, close friend of the family, or a trusted professional, such as your accountant or lawyer. There’s no point in setting up a trust if you cannot find a trustee who will implement your strategy.

A trustee’s duties also include managing the trust assets, plus administrative work such as filing tax returns. You can split the trustee’s duties. For example, a money management firm might invest the assets. An accountant or attorney can do the tax returns. If it is a large trust, a corporate bank or trust company might be a better choice for the administrative work.

After selecting the trustee or trustees, also consider replacement trustees or a procedure for selecting them in case the original is unable to continue.

Now, your attention can be directed to the trust itself. Consider the things you are trying to avoid or achieve. Then, consider which provisions mentioned below will help achieve your goals. Many of these provisions are very flexible, and the provisions often can be combined. That’s why it is important to set your goals first, then work with an estate planner to design the trust.

• Spendthrift clause. This is the classic trust clause and is allowed in many states. Under the clause, creditors cannot step into the shoes of a beneficiary. They also cannot force distributions or require that distributions be paid directly to them. They have to wait until distributions are made to the beneficiary, then take action to get the cash from the beneficiary.Some states allow an unlimited spendthrift clause. Others limit it to the first $500,000 of the trust or some other amount. That means creditors could seize all but $500,000 of the trust. Other states don’t recognize the spendthrift clause at all.  Spendthrift clauses routinely are put in trusts by most attorneys, but they usually aren’t enough to meet all the trust creator’s goals.
• Discretionary clause. This is the ultimate in protective trusts. The trustee has complete discretion over when distributions are made and how much they are. The key for this arrangement to work is that the trustee understands your goals. Naturally, that is more likely if the trustee is someone close to you. An important step in making the discretionary clause work is to leave the trustee written guidelines about your concerns and goals. You won’t be able to consider every contingency, but it is a good idea to give the trustee some general principles and an idea how you would like certain situations handled.

For example, you might say that the beneficiary should receive enough to pay for education and necessary living expenses until age 21. You also might want money distributed for some extras and certainly for any emergencies. After that, you might want some principal distributed to help buy a house or start a business. But you might want most of the principal retained until the beneficiary is older, say 30 or 35. You also might tell the trustee to withhold payments if the beneficiary has substance abuse or gambling problems or is unable to maintain grades or keep a job.

These guidelines are not legally enforceable. Ultimately, the trustee has wide discretion. That’s why the choice of trustee is so important.

One shortcoming of the discretionary trust is that the trustee and beneficiary might become adversaries. Your trustee should realize that before accepting. Multiple beneficiaries also could create problems. For example, an adult child might be the primary beneficiary with your grandchildren eventually to receive the remainder. The grandchildren might argue that the trustee is paying out too much, or your child might argue that too much is being saved for the grandchildren. You can help avoid these problems by making preferences clear in your guidelines.

You can see that for a discretionary trust to work, drafting the trust agreement is the easiest task. Selecting the trustee and writing the guidelines are more difficult.

If you don’t want to give the trustee discretion, there still are other trusts that can be tailored for specific estate planning situations.

Estate Planning Trust#1

Milestone trust. Instead of a protective trust, this is an incentive trust. This type of trust is popular when the beneficiary is young. The trust creator wants to be sure that the wealth helps the beneficiary but doesn’t prevent the beneficiary from maturing and becoming a productive member of society. The creator also wants the beneficiary to have some experience handling money before getting access to a large amount of it.

A typical milestone trust will distribute income up to a maximum amount each year. It might distribute additional amounts for specific items, such as education and medical expenses. This ensures the beneficiary has the essentials paid for.

The beneficiary then receives the principal when one or more named milestones are met. The milestone can be almost whatever you want. Some trusts use age to determine when principal is distributed. Others have a milestone that is achievement oriented. Distributions might be made when the beneficiary graduates from college or is employed full time for a specified number of years.

Estate Planning Strategy #2

Stepping stone trust. This is similar to the milestone trust, but the principal distributions are made in stages. For example, a trust that uses age as the stepping stones might provide that principal is distributed equally when the beneficiary reaches ages 25, 30, and 35. An achievement-oriented trust would distribute portions of principal as a series of education and job goals are met. The details are up to the imagination and goals of the trust creator.

Estate Planning Strategy #3

Matching trust. This is another achievement-oriented trust. Those who favor the trust believe it keeps the beneficiary’s drive and ambition alive. The trust, for example, might make distributions matching the beneficiary’s earned income or a multiple of that income.

Some observers believe that many stepping stone and matching trusts provide the wrong incentives, so you must be careful when constructing a trust. You don’t want to give the beneficiary an incentive to do something that is not his or her true interest or calling. For example, a trust that matches the beneficiary’s income might steer the beneficiary away from a relatively low earning career, such as teaching. Consider all the implications and incentives before using a stepping stone or matching trust.

Estate Planning Strategy #4

Escape clause. This clause converts any trust into a discretionary trust when things go wrong. The clause allows the trustee to withhold payments whenever the trustee decides that is in the best interests of the beneficiary. You would leave the trustee written guidelines explaining when you think the clause should be invoked.

For example, you probably don’t want trust money being distributed when the beneficiary develops a problem with substance abuse or gambling. Protecting against such things was a goal in using the trust in the first place. You also might want money kept in the trust when the beneficiary is having or might have creditor problems, such as at the start of a high-risk business venture. The possibility of a divorce also might make it desirable to withhold payments, though any premarital agreement and local divorce law would determine if the trust assets would be part of the marital estate.

You can provide a specific emergency clause or a general clause with written instructions for the trustee. Unless you are clairvoyant or have limited concerns, the general clause probably is better. You can leave guidelines, but you cannot anticipate every eventuality. Your best move is careful selection of a trustee.

The clause also should state that payments to the beneficiary will resume when the trustee determines that is in the beneficiary’s best interest.

Estate Planning Strategy #5

Emergency clause. Trust creators often are concerned about the situations in which they do not want distributions made, and they overlook the opposite situation. That’s why many trust horror stories involve situations when distributions weren’t made. Often, widows and children are struggling on limited income after losing jobs or suffering medical problems. Emergency distributions from the trust, especially to pay for medical expenses, would help these beneficiaries more than knowing they or their children might get the trust principal some day. It also might be a good idea to allow unplanned distributions to pay for additional education later in life.

Since you cannot anticipate everything life will throw at your beneficiary, it is a good idea to give the trustee the power to make payments in an emergency or any other situation when it would be compassionate or in the best interests of the beneficiary

Estate Planning Strategy #6

Marital agreements. A marital agreement is not a trust, but it can be an essential wealth protection strategy. Do you want a big part of your estate to end up with a former in-law or with someone you never knew, such as the next spouse or children from another marriage of your in-laws? That can happen without a marital agreement that spells out what will and will not be considered marital property. Ideally, you do not want any gifts or inheritance from you to be considered part of anyone else’s marital estate.

Marital agreements are flexible and can be made either premarital or postmarital. For the agreement to be valid, each spouse must have separate legal counsel and there should be a reasonable time between when an agreement is drafted and when it is signed.

If your adult children do not have marital agreements and don’t want them, you can provide that they will receive only income payments and emergency principal distributions from the trust. The principal eventually will go to their children or some other beneficiary. That’s the only other way to keep your trust property from leaving the family in a divorce.

Many people are hesitant to give their hard-earned property, because they are afraid the next owner won’t care for it as well. A well-crafted trust, however, can set your mind at ease while letting you share the wealth.