Should Beneficiary Receive Inheritance Outright or In Trust?
I Don’t Want Them To Blow Their Inheritance
Outright or In Trust
Welcome to my blog, I’m Estate Planning attorney Paul Rabalais and in this post I am going to analyze the decision whether to leave an inheritance to someone outright or in a trust. So let’s run through seven scenarios where it may be important to leave one or more beneficiaries’ inheritance in a trust instead of leaving it to them outright.
Okay to Leave Outright
But before we do that, let’s address quickly when you would likely feel it is ok to leave an inheritance to your heirs outright. Outright means probably what you think it means - an heir gets $1m, it goes directly into their name, they do whatever they want to with it; they have complete control over it from day one. People who leave an inheritance to one or more people outright often have heirs who are adults, they are responsible, they manage their money well, and you have confidence that by leaving it outright to them and allowing them to control it from the get-go is better than having it put into a trust for them with certain restrictions. So here’s seven reasons, however, why you may want to consider that one or more beneficiaries’ inheritance be placed in a trust after you pass away (note that after I go through these seven reasons, I’ll address the trustee selection and the distribution options that are customarily selected;
Beneficiaries are Minors
(1) Your beneficiary or beneficiaries are minors. It almost never makes sense for a minor to inherit in their own name. Since a minor cannot own property in their name, a judge would be required to name a legal guardian for the minor, and then the judge would have to oversee how those assets would be managed for the minor until the minor reached the age of majority (let’s call that age 18) and then upon the minor’s 18th birthday, the 18 year old can have 100% control over their inheritance. Most people don’t like all of that government bureaucracy, and most people don’t like the idea of dumping a chunk of money into a child’s lap on their 18th birthday, so people with minor heirs or beneficiaries should, and often do, provide that the inheritance of the minors would be held in trust by someone you choose as the trustee, and the trust would likely last beyond the 18th birthday of the minor.
Beneficiaries are Young Adults
(2) Young adult - you can go either way with this one. Some people who have heirs who are in that 18 to 23 age range often feel that the young adult is still too young to inherit a lump sum outright. So some people with young adult heirs or beneficiaries will make that selection that the portion for the young adult, perhaps if the young adult is, let’s say younger than 25 when you pass away, their inheritance will be managed in a trust until that age is met.
Heirs are Financially Immature
(3) An immature heir. As you might imagine, there are many potential heirs out there that are in their 20’s, 30’s and 40’s who simply make bad financial decisions. And you just know that if you leave $500,000 to this particular 37 year old, you know that it will be gone in six months due to their financial immaturity and poor spending habits. So leaving the inheritance of that 37 year old in a trust, while taking into consideration the trustee selection and distribution provisions that I reveal later in this video, would be not only appropriate, but would truly be in the long term best interest of that 37 year old.
Beneficiary with Addiction Problems
(4) Obvious drugs. You could really harm someone who has an alcohol or drug addiction problem by leaving them a lump sum of money. This is pretty much a no-brainer that a trust should be considered for the inheritance of that beneficiary with an addiction problem.
Beneficiary Controlled by Spouse
(5) A beneficiary is inappropriately controlled or influenced by their spouse. I’ve heard many times something like, “Mr. Rabalais, if I leave an inheritance to my daughter, then before she can blink, her husband, who exerts too much control over her, will get his hands on that money, and go by a new truck, a new boat and a new 4-wheeler within minutes of my daughter inheriting from me. It’s sad that that would happen Mr. Rabalais but that is the reality of their relationship and I need to see what I can do to prevent my daughter’s husband from getting his hands on my daughter’s inheritance.” Now it is unfortunate that a parent may have to restrict their child’s access to their inheritance for a period of time, but this is the world we live in and parents need to do what parents feel that they need to do.
Heir has Creditor Problems
(6) Your child or beneficiary has, or could potentially have, creditor problems, debt problems, or bankruptcy problems. So why leave an inheritance outright to someone when their creditor could come in and take it from them. You can leave a beneficiary’s inheritance to them in what is commonly referred to as a trust that has spendthrift protections, and an heir or beneficiary’s creditors will not be able to seize their interest in the trust.
Protect Inheritance From Child’s Future Divorces
(7) Protect the inheritance of a beneficiary from their potential future divorces. When you leave an inheritance outright to a child, it belongs to the child, but your child might mix up those inherited funds with other funds your child has with their spouse. And then, if your child later divorces, your child may have to split those inherited assets with their spouse. By leaving your child’s inheritance to a trust, even if your child controls that trust as the trustee, it may be the extra added layer of protection that your child may need so that if your child divorces in the future, your child will keep their trust, and your child and their spouse may divide other assets they acquired together during the marriage.
Trustee Selection
Now, when you leave an inheritance in trust for someone, you must select a trustee to oversee that inheritance. Trustees are typically individuals that you know and trust, or if you feel it is appropriate and the inheritance would meet the minimum asset requirements of a corporate trustee, you could designate a corporate trustee (like a large bank or financial institution that has a trust company or trust department), could be selected. And note that you could have two or more co-trustees that would be required to act together pursuant to the terms of the trust instrument. If you choose to leave the inheritance of a beneficiary in a trust or any of the first six reasons above, you will name someone other than the beneficiary to be the trustee. However, if you are setting up a trust for a beneficiary with the only objective of protecting their inheritance from their future potential divorces, you might select the beneficiary to be the trustee of that trust.
Trust Term
Now, anytime you set up a trust for any of the reasons previously expressed in this video, you must state a trust term, or rather, when can the beneficiary control the inheritance.
Distributions for HEMS
Note, however, that in many trusts, it is provided that even if the beneficiary can’t have control over the trust assets until they are, let’s say, 30 years old, many trusts give the trustee the discretion to use or distribute the trust assets, prior to that beneficiary reaching the age of 30, for the beneficiary’s HEMS. Thus, if the beneficiary is in college and the trustee determines that it is in the best interest of the beneficiary to use trust assets to pay for those educational expenses, then the trustee can exercise that discretion they are given in the trust instrument to pay for the educational expenses of the beneficiary prior to termination date of the trust.
Trust Termination Options
A few options for when trusts terminate include a certain age (like 25 or 30); certain ages (like ⅓ at 25…); a certain number of years after your death (like ⅓ as soon as practical…); you can provide that a beneficiary can get a certain dollar amount each month (for example, $3,000 monthly) until the trust assets are depleted; you can give the trustee discretion to determine when the beneficiary is ready to receive the inheritance. For example, if you have young children and you do not know how they are going to turn out, you could leave your estate in trust for your children, name your super-responsible younger brother, for example, as the trustee and you would not set a date at which your children would automatically control their inheritance, but rather your brother could use his discretion to determine when your brother feels it is appropriate to turn over the inheritance to your child or children.
And in the alternative, if divorce protection is in mind, perhaps you could provide that the trust stays in effect for the lifetime of your beneficiary, but the beneficiary becomes the trustee upon attaining a certain age or upon a certain date.
That about sums it up for this decision whether to leave an inheritance outright or in trust, and if you leave it in a trust, what goes into that trustee selection as well as the trust distribution options.
See you next time.