There’s an important gap in many estate plans. The oversight can cause a large portion of your estate to end up with people other than your loved ones.
The Estate Planning goal many people overlook is to ensure that a large portion of the estate doesn’t end up in the hands of people you never intended. That can happen, and in fact, it happens regularly. Fortunately, you can keep the wrong people from getting their hands on your estate.
A lot of people want a part of your estate and know how to grab it. Gifts and bequests for your children or grandchildren could end up with their spouses as part of a divorce settlement. Creditors of your loved ones are waiting in line for some of the property. When one of your loved ones is in a business or profession that’s susceptible to liability lawsuits, part of your estate could be awarded to a lawsuit plaintiff.
Of course, there always are con artists, hustlers and others looking to talk your heirs into spending or investing in certain ways.
Even charities and fake charities could make pitches to your family. You can save your hard-earned wealth from these risks, and you don’t need elaborate and expensive strategies, such as multiple foreign trusts and corporations, recommended by many asset protection specialists.
Those methods could deter a few lawsuits. But they also cost a lot of money, and some could make you a target of the IRS.
They’re also becoming less effective. Courts have little patience with people who use these strategies to shield their assets and are more and more amenable to arguments that see through them. You need a strategy that is effective, costs less and has a lower profile.
The preeminent way to protect your estate and legacy from being grabbed by others remains the trust, especially the irrevocable trust.
You can create an irrevocable trust either during your lifetime or through your will. When the trust is created during your lifetime, you don’t have to put a lot of assets into it now. Instead, you start it. Then, in your will have more of your wealth transferred to the trust.
For the trust to be effective, it should be irrevocable, meaning you generally can’t change it. Assets you transfer to the trust no longer are legally your property and aren’t owned by your children or grandchildren. To ensure the trust is respected by the courts, an independent person should be the trustee.
Your children or grandchildren or both are the beneficiaries. You can set up one trust that benefits the group, or there can be separate trusts for each beneficiary or group of beneficiaries. The children or grandchildren benefit from the trust’s wealth over time. Since your loved ones don’t own the wealth outright, it generally is safe from their creditors, potential ex-spouses and others. It also is safe from their bad decisions about investments and spending.
The trust agreement spells out when income and principal are distributed to the beneficiaries. Most commonly, in-come to maintain a certain standard of living is distributed in the early years. Principal is distributed in installments as the beneficiary reaches certain ages, such as 25, 30, 45 and so forth until it is fully distributed and the trust ends.
There’s no requirement that assets be distributed during the beneficiaries’ lifetimes. To fully protect the as-sets for life, give the trustee discretion over the distributions, which we’ll discuss shortly.
Some key features can be added to the trust to further protect your legacy.
A spendthrift clause is a mainstay of trusts. Not every state respects spendthrift clauses, and some states only partially respect them. The clause protects trust assets from creditors. In-deed, creditors have no claim on trust assets until they are distributed to the beneficiary, and then they have to deal with the beneficiary.
A trust protector also is a good idea. This idea originated in foreign trusts but is being used more and more in the United States. Some states now specifically define the roles of trust protectors.
A trust protector oversees the trustee. The protector reviews transactions and has access to the records and reports. The protector often is allowed to change trustees and the state in which the trust is located, and even can move the assets to a different trust. Other powers also might be allowed, depending on state law and your trust agreement.
The trust should allow what’s known as decanting. That’s when the trustee or the trust protector (and sometimes the trust grantor) essentially closes the trust and moves the assets to a new trust. There are limits to the power defined in state law. The new trust must be irrevocable and have other provisions in common with the original trust. Decanting can be a valuable tool when there’s been a major change in the law so that the original trust no longer is ideal. A change in the beneficiary’s circumstances and dissatisfaction with the trustee also are frequent reasons for a decanting. The trustee also can be given some level of discretion over distributions, including total discretion.
With discretion, the trustee monitors the beneficiary’s situation and decides on the appropriate amount to distribute each year. If the beneficiary is doing well financially, especially if a higher tax bracket is likely, income might remain in the trust to be reinvested and wait for a more strategic time to distribute it.
More importantly, the trustee can consider non-financial factors. For example, if the beneficiary is or might be the defendant in a lawsuit or a divorce is in the offing, only money the beneficiary needs for support might be distributed. In lieu of giving the trustee discretion over every distribution, the trust can contain what’s sometimes called an emergency clause.
The emergency clause allows the trustee to withhold some or all of the scheduled distributions when it is deemed in the beneficiary’s best interest. The clause often is used to withhold distributions when the trustee believes there is substance abuse, a gambling problem, creditor problems, a possible divorce, or similar occurrences. The trustee restores distributions when the emergency is over.
The trustee can make payments directly to providers of services for the beneficiary. The trustee might make payments for rent, medical care, food and other essentials. You also should work with your estate planner to carefully choose the state where the trust is located. A trust is located wherever the trustee is a resident. So, look at the laws of different states to determine which has the features you prefer.
Some states have structured their laws to make them more attractive locations for trusts. They allow many of the protections available through foreign trusts but at a lower cost and without triggering attention from the IRS. The most aggressive states are South Dakota, Alaska and Delaware, but others also have attractive trust provisions.
A potential disadvantage is the laws are fairly new and haven’t been tested in the courts. Also, the laws tend to have waiting periods. For example, a state might require a trust to be located in the state and the assets in the trust to be there for at least four years before some of the provisions kick in. If you choose a state other than the one where you are a resident, that probably means choosing a bank or trust company in that state to be the trustee. A final strategy when you’re wealthy and want to discourage others from seeking a portion of your wealth is to use layers with your trust.
For example, the trust might be one partner in a family limited partnership that owns the assets. Or the trust might own a family limited partner-ship that owns the assets. Some estate planners will create several layers of trusts, partnerships and corporations. The layers can be expensive to set up and maintain, so a lot of wealth needs to be involved.
Consider the risks to your assets, both during your lifetime and after the assets are passed to your loved ones. Then, work with your estate planner for the right way to protect the assets while benefiting your loved ones.