The Inheritor’s Trust is dramatically under used as an estate planning strategy, which is remarkable considering its significant benefits.
Estate planning usually is done one generation at a time.
The oldest members, for example, decide how they want to disburse their assets among their children and perhaps their grandchildren.
Their adult children do their own estate plans, and those plans are focused on their children.
Rarely do different generations talk about these plans or try to coordinate them.
The trust gives added protections and more control to those who inherit wealth.
It also can relieve the older generation of difficult decisions and the expense of having trusts drafted as part of their estate plans.
Most people want to leave their assets outright to their children, provided they are mature enough to manage the assets.
But using an Inheritor’s Trust instead can increase the benefits to the heirs. For example, an adult child might be financially well-off.
Leaving the assets outright to the child means the assets eventually would be included in the child’s estate and potentially be taxed or at least create estate planning issues for the child.
Plus, income and capital gains from the assets would be taxed to the adult child at his or her tax rate.
The family’s after-tax wealth might be higher if the income and gains weren’t taxed at the adult child’s rate.
In addition, leaving bequests outright to an adult child makes the wealth vulnerable to creditors of the child or to a spouse in a divorce.
The Inheritor’s Trust provides the adult child or grandchild with all the benefits, control and rights of outright inheritance.
Yet, the trust provides protection from taxes, creditors and divorce that wouldn’t be available if he or she owned the property outright.
The Inheritor’s Trust can be used for lifetime gifts of property in addition to bequests.
I’ll describe a standard Inheritor’s Trust, and then explain how it helps.
The trust is an irrevocable one created by the adult child working with his or her estate planner (though the parents certainly can have it drafted by their estate planner).
The adult child is the primary beneficiary of the Inheritor’s Trust. He or she also might be able to be either the sole trustee or a co-trustee, which I discuss further below.
The trustees have the power to distribute assets from the trust to the primary beneficiary at their discretion for the health, education, maintenance and support of the beneficiary.
While the trust has secondary and contingent beneficiaries, the adult child has a broad power of appointment that allows him or her to change beneficiaries.
This power effectively prohibits any secondary or contingent beneficiary from interfering with or objecting to the management of the trust, because the beneficiary could be eliminated as a beneficiary.
But the power of appointment can’t be used to benefit the primary beneficiary, his or her estate, beneficiaries of the estate or creditors.
It also is a good idea to have a trust provision that says the prudent-person investment standard doesn’t apply.
The result of these provisions is the beneficiary has all the benefits of outright ownership of the property and some protection from taxes, creditors and divorce that aren’t possible through outright ownership.
After the secondary beneficiary or beneficiaries succeed the primary beneficiary (usually due to the primary beneficiary’s death), they have the same rights and power the primary beneficiary had.
To maximize tax benefits and creditor protection, it often is best that the primary beneficiary not be the sole trustee.
A better approach in many states is to use at least two trustees with the primary beneficiary being one of the co-trustees. (In some states, the best results are when the primary beneficiary isn’t a trustee at all.)
The primary beneficiary as trustee has sole control over the investment decisions, though he or she can delegate the investment decisions to an investment manager.
The other co-trustee has the sole power to make distributions from the trust in his or her absolute discretion.
It usually is best to name either a close friend of the primary beneficiary or a corporate trustee as the co-trustee.
Under the trust agreement, the primary beneficiary has the power to remove and replace the other co-trustee. But any successor to the co-trustee must be an unrelated party and can’t be a subordinate employee of the beneficiary.
You don’t want to use the Inheritor’s Trust when the primary beneficiary is a minor or there are reasons to believe he or she is incapable of or unable to manage and spend the wealth responsibly.
The Inheritor’s Trust also shouldn’t be beneficiary to have the equivalent of full ownership of the property.
For example, you might have reasons to limit the beneficiary’s power to dispose of the property or you might want to limit the benefit he or she receives from the property and ensure others receive some benefit from it.
When you’re inclined to gift or leave property outright to your heirs, consider making gifts and bequests to the Inheritor’s Trust instead.
The beneficiary will receive the enjoyment of full ownership but have additional protection from taxes, creditors and divorce.
The assets in the trust also will avoid probate after the primary beneficiary passes away. The burden of creating the Inheritor’s Trust doesn’t have to fall on the parents or grandparents.
The beneficiary who will receive the assets should go to his or her estate planner and have a trust drafted based on the beneficiary’s needs and state law.
Then, the parents or grandparents simply must amend their estate planning documents so that anything bequeathed to the heir goes instead to the Inheritor’s Trust for the heir.
If you are likely to inherit wealth from your parents or grandparents, consider setting up your own Inheritor’s Trust – and asking that the estate planning documents of the parents or grandparents be amended – so the inheritance goes to the trust instead of outright to you.