Estate Planning Essentials Part 2: Are Trusts Needed for Minor Beneficiaries? - Rodgers & Associates
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Estate Planning Essentials Part 2: Are Trusts Needed for Minor Beneficiaries?

Willing assets to a child who is still a minor can be compli­cated.

One option is to leave assets outright in a trust until the child reaches the age of majority (or a later age if chosen). A trustee is named to control, invest, and distribute the assets to the benefi­ciary according to the terms of the trust. For example, 1/3 of the trust might be released when the child reaches age 25, 1/2 of the remaining assets in the trust at age 30, and the remainder at age 35. Income from the trust can be distributed each year from the trust after age 21, or the decision may be left up to the trustee to distribute funds for the child’s benefit.

Alter­na­tively, assets can be left in a continuing trust for a child’s lifetime. The terms for these trusts can be written directly into the estate plan; they do not have to be created separately. The benefits of continuing trusts include:

  • Providing financial stability for young benefi­ciaries
  • Protecting spend­thrift or finan­cially unskilled benefi­ciaries from going through the inher­i­tance too quickly
  • Protecting kind, generous, or gullible benefi­ciaries from being taken advantage of by others
  • Protecting benefi­ciaries from losing their inher­i­tance in a divorce
  • Continuing control over the dispo­sition of the assets

There are two require­ments to protect the assets in a continuing trust. The first is a demand right by the benefi­ciary. The second is the selection of the trustee.

Demand Right

Does the trust have language that allows the benefi­ciary to “demand” money from the trustee? This is commonly referred to as withdrawal rights.

A trust may be permitted to distribute principal when the child reaches age 25. At the same time, the child has the option to leave that principal in the trust. Either way, those funds are no longer protected, since the child has the right to withdraw them. Creditors, a plaintiff in a lawsuit, or a future divorcing spouse would have access to those funds.

Selection of the Trustee

There are two types of trustees:

Interested trustee: The Internal Revenue Code (IRC) Section 672© defines an inter­ested trustee as a related or subor­dinate party to the benefi­ciary or grantor. A sibling, parent, or relative of the benefi­ciary is a first-degree relative. A subor­dinate would be someone working directly for the benefi­ciary. The IRC does not consider the benefi­ciary’s CPA or attorney as a subor­dinate under this defin­ition.

Discre­tionary trustee: This would be a profes­sional trustee who is a disin­ter­ested party. They have the power to make distri­b­u­tions for any purpose and may refuse to make distri­b­u­tions to the benefi­ciary for any reason. A discre­tionary trustee could decide not to make a distri­b­ution to pay a judgment against the benefi­ciary. They could also use their discre­tionary status to negotiate the settlement of a claim for a lesser amount on behalf of the benefi­ciary.

Some asset protection is provided with an inter­ested trustee who is limited by the terms of the trust to distribute funds only for specific reasons. Standard language states for the beneficiary’s health, education, mainte­nance, or support. This does not always protect the assets from a divorcing spouse. A divorcing spouse could argue that alimony or child support meets this defin­ition and force an inter­ested trustee to make distri­b­u­tions.

A discre­tionary trustee listed as successor to an inter­ested trustee also provides some level of asset protection. The inter­ested trustee serves until a creditor claim or divorce situation develops. If the situation warrants, the inter­ested trustee resigns, and the discre­tionary trustee accepts trusteeship. If nothing bad ever happens, then the inter­ested trustee simply continues to serve.

Assets inside the continuing trust can be passed on to the next gener­ation with the same provi­sions. The trust can also be set up to terminate when the child reaches a certain age. Some of the downsides to estab­lishing a continuing trust are:

  • Set up costs
  • Trust admin­is­tration expenses
  • Potential tax conse­quences

There is no one-size-fits-all solution when planning your estate. Trusts can be an essential part of your plan—but they are often complex and time-consuming to set up. Only you can determine how much protection you want to provide to your children after you are gone. Be sure to work with an attorney that specializes in estate planning to ensure all your documents are correctly drafted after you’ve decided the direction you want to take.

Insights

  • Assets can be held in trust for minor children through outright trusts or a continuing trust.
  • There are two require­ments to protect the assets in a continuing trust: demand rights and a trustee.
  • A discre­tionary trustee should be a profes­sional without a connection to the benefi­ciary.