Other posts in this 3-part series: Part 1, Part 3
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.
