Estate Planning Options for Parents of Minor Children

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Estate Planning Options for Parents of Minor Children

Parents of minor children face the question of what to do with their assets through their will. Assets can be left outright in a trust until the child reaches the age of majority or a later age if they choose. A common example would be for 1/3 of the trust to be released at age 25, 1/2 the trust at age 30 and the balance at age 35. Income from the trust may 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 benefit of the child.

Assets can also be left in a continuing trust for that child’s lifetime. This may be desirable if the objective is to protect the assets from a spendthrift child or from a future spouse. There are two requirements to be able to protect the assets in a continuing trust. The first is no demand right by the beneficiary and the second is the selection of the trustee.

Demand Right – Simply put, does the trust have language that allows the beneficiary to “demand” money from the trustee? This is also commonly referred to as withdrawal rights. In the earlier example, the trust may be permitted to distribute principal from the trust when the child reaches age 25. The child could decide to leave the money in the trust. However, because she has the right to withdraw principal, those funds are not protected. Creditors, a plaintiff in a lawsuit or a future divorcing spouse would have access to those funds even if they remained in the trust.

The Trustee – There are two types of trustees:

  1. Interested trustee: IRC 672(c) defines an interested trustee as a related or subordinate party to the beneficiary or grantor. A sibling, parent or anyone related to 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.
  2. 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 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. Common language states for the beneficiaries health, education, maintenance or support. This does not always protect the assets from a divorcing spouse. A divorcing spouse could argue 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. There is no one size fits all solution when planning your estate. Each situation is unique. Trusts can be an important part of your estate plan when leaving assets to beneficiaries is involved. However, they are often complex and time consuming to set up properly. Only you can determine how much protection you want to provide your children after you are gone. Be sure to work with an attorney that specializes in estate planning to make sure all your documents are properly drafted after you’ve decided the direction you want to take.

Rick’s Insights

  • Assets can be held in trust for minor children through outright trusts or through a continuing trust.
  • There are two requirements to be able to protect the assets in a continuing trust – no demand rights and a discretionary trustee.
  • A discretionary trustee should be a professional without a connection to the beneficiary.

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