Estate Planning For An Irresponsible Child
Having an estate plan in place is one of the most important gifts you can give your children. You've worked hard to build up assets that will help them in the future.
But a difficult question that is on the mind of many investors we work with is, "How can I prevent one of my kids from wasting their inheritance?"
Your concern may come from your child's reckless overspending, or your worries could be rooted in your child's history of substance abuse or destructive relationships. This article will offer tips for estate planning for an irresponsible child.
The Living Trust: Your Bulwark Against Irresponsible Behavior
Although a will lays out how your assets will be distributed, a trust is often a better option for many families. A trust is a valuable estate planning tool that allows you to deposit assets, including cash, property, and other investments, into the trust account during your lifetime.
There are two main types of trusts – testamentary and living. A testamentary trust is created after your death by your will, while a living trust is established during your lifetime.
A living trust is usually revocable, meaning it may be changed during the trustor's lifetime, and it becomes operational at the trustor's death. Unlike a will, a living trust does not have to go through probate court. Your assets can be passed immediately and directly to your named beneficiaries.
How is a trust a solution for an irresponsible heir?
When you create a trust, you give another party (your trustee) the authority to handle your assets for your beneficiaries' benefit. You can select a trusted friend or family member to serve as your trustee. Your trustee could also be your attorney or a financial institution.
Understanding living trusts is an important way to protect your assets from misuse. While your assets are in the trust, they are safe from a beneficiary's irresponsible spending and any other relatives or in-laws who may want to misuse your assets.
Different Ways to Structure A Trust
Trust assets may be distributed to your children with regular installments giving you a level of control over their use. Depending on your financial and family situation, there are several different ways to structure a trust.
- Age-Based Trust. You can set up the distribution of the trust based on your child reaching a certain age.
- Annuities. With this type of trust, the inheritance is distributed over time based on a schedule that you establish.
- Incentive Trust. Also called a Pay for Performance Trust, this type allows you to set conditions your children must meet in order to obtain their inheritance. It could be earning a degree, achieving specific life goals, or whatever you deem appropriate.
- Income-Matching Trust. This type of trust matches annual distributions to all or part of your child's earned income.
You also can use a trust to provide non-monetary assets for your heirs. You could place a home in a trust, for example. However, since we're on the subject of irresponsible children, you might want to place the home in a trust that stipulates that any money from its sale must be reinvested in another house.
The Spendthrift Provision
Another answer to the problem of estate planning for an irresponsible child is to include a clause known as the "spendthrift provision" in your trust. A spendthrift clause limits the transfer of a beneficiary's interest in the trust assets.
A spendthrift trust directs the trustee on how to distribute the beneficiary's entitlement. Limitations might include paying only for a beneficiary's basic living needs or making only limited payments directly to the beneficiary.
A spendthrift trust might be useful if the beneficiary has a history of
- mismanaging money
- having addictive behavior
- being easily deceived or defrauded
- falling into debt with creditors
Each spendthrift clause is written according to the trustor's specific preferences. For example, the clause can include protection of the trust assets if your child goes through a divorce. In some cases, the trustee of a spendthrift trust can cut off benefits to a beneficiary. The benefits could be distributed to that child later or paid to another beneficiary instead.
The trust document can also spell out that the trustee only makes payments on the beneficiary's behalf and may withhold direct payments of cash from the beneficiary.
Individual states vary on the extent of the protection they allow under a spendthrift clause. For example, some states allow creditors access to a trust with these clauses. Some state laws also allow for alimony or child support payments under the provision.
For the strongest protection, aim to be as specific as possible on the conditions under which your assets are to be distributed. Here are two examples:
- Distributions will be made only if your child is gainfully employed or making steady progress toward becoming gainfully employed.
- Distributions are not to be used for certain items, such as a car, unless the beneficiary has the means to pay for the vehicle's upkeep.
The spendthrift provision must be worded very carefully to avoid placing the trustee in a difficult situation. An overly strict clause could prevent your child from obtaining money when there is a genuine need. On the other hand, a too lenient clause leaves a trustee having to deal with an angry heir demanding their assets.
How to Set Up a Spendthrift Trust
Your lawyer will help you create a spendthrift trust that fits your particular needs. Here are some questions you should be ready to answer:
- When and under what circumstances do you want the trust to end?
- If a beneficiary's circumstances change, what should happen to the trust principal?
- Do you want to allow for special payouts if the beneficiary faces large expenses, such as a prolonged illness or college tuition?
You've worked hard to provide for your family both now and in the future. No one wants to think about their money disappearing in a few years due to an heir's reckless spending or poor lifestyle decisions. A spendthrift trust can offer you a combination of protection and freedom.
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