What They Say About Us
It’s an estate planning epidemic. So many successful parents we meet have children who are poor at handling money or lack financial management experience. What’s a parent to do when leaving assets for such spendthrift children?
Enter what has been termed the greatest invention of English common law: the trust. While trusts date back to ancient Rome and Greece, the trusts we’re familiar with today originated in medieval England, chiefly to avoid feudal inheritance tax.
Learn more about what trusts are and how they can help your children spend your assets responsibly.
Trusts are legal entities that may hold and use assets for a beneficiary, such as your children, but have them managed by a trustee. The grantor creates and funds the trust and chooses the beneficiaries and the trustee. The trustee can be one or more responsible adults, including a professional trustee. It is the trustee’s responsibility to distribute the trust’s assets as the grantor directs.
It’s important to distinguish the relationships that the trustee and beneficiaries have with the assets. While the trust has legal ownership over the assets, the trustee controls the assets to the extent laid out in the trust agreement. The trustee has a fiduciary duty to act in the best interest of the beneficiaries. The beneficiaries have no control or access to the assets beyond what the trustee allows, but do benefit from the assets. In some cases, such as a grantor trust, a trustee can also be a beneficiary.
A trust can either be a testamentary trust, which is created in a will and becomes effective after the grantor’s death, or a living trust, which becomes effective during the grantor’s lifetime. Typically, a living trust benefits the grantor during their lifetime, but benefits the designated beneficiaries after the grantor’s passing. The grantor often fills the role of both trustee and beneficiary before their passing.
One of the main goals of a trust is to provide you, the grantor, with the power to say exactly how and when your assets are distributed, and to whom. This can give you peace of mind that your assets are being put to the best possible use. It also reduces the risk of your beneficiaries squandering what you give them, whether by distributing your assets gradually or by setting conditions for when they’re responsible enough to manage the assets.
A trust can also provide tax benefits for your beneficiary and can create an additional level of protection. For example, certain types of trust can protect your assets if your beneficiary declares bankruptcy or gets divorced.
Finally, revocable trusts are designed so the grantor can easily amend them, allowing them to change the terms of the trust and even cancel it as needed.
A trust can either be defined as a grantor trust or a non-grantor trust. A grantor trust is where the grantor retains control of the trust and the power to:
The grantor is also responsible for paying tax on any trust income.
A non-grantor trust is one in which the grantor has given up control of the assets in the trust. The most common reason for a grantor to do this during their lifetime is to lessen their tax burden since a non-grantor trust is taxed as its own entity, with the trustee filing tax returns for the trust.
Historically, estate planning consisted of setting up a will and leaving everything to one’s children in equal shares, “per stirpes.” The “per stirpes” is Latin for “by the roots,” meaning that if any of the children predecease their parents, then their share goes to their children, if any.
However, parents today often look to alternative methods of leaving behind assets for their children. This could be for many reasons, such as children displaying varying levels of fiscal responsibility. Compared to a generation or two ago, young people are more likely to live with their parents in their 20s and 30s. As a result, many parents believe that their children aren’t learning the financial skills they learned themselves at a similar age.
By leaving assets in a trust rather than a will, grantors can control how their assets are distributed to their children. For example, the trust’s terms could state that the beneficiaries can’t inherit any assets until they reach a certain age, or that the distribution be spread out over a period of time. This can give the beneficiaries time to learn how to manage finances at a safer pace without squandering their inherited assets.
The main difference between wills and trusts is that wills require probate, a court process to carry out the terms. Legal time frames must be adhered to, and a certain amount of time has to pass before assets can be distributed. The terms of the will also become public record. All these factors can be unappealing, leading many people to choose a trust rather than a will.
The grantor can decide exactly how and when the assets are distributed, which is the distribution plan. The grantor can direct the frequency and quantity of asset distribution, plus how long the trust should last. They can also dictate which conditions, if any, must be met before the beneficiaries receive any assets.
It is important to note here that assets left in the trust for delayed distribution are still available for the beneficiary’s health, education, maintenance and support. The more experienced and mature trustee simply manages those assets, making decisions as to the distribution of income and principal, based on the needs of the beneficiary.
A trust with consistent distribution amounts, also called annuity distributions, has simpler and generally more consistent payout plans. This distribution plan directs the trustee to distribute a certain amount at set intervals as prescribed in the trust instrument. This interval could be every week, month, year or something else.
For example, your beneficiaries receive $3,000 every month.
Distributing assets as percentages over time is another option. This involves distributing assets in lump sums as a percentage of the total inheritance, rather than a set amount. In some percentage-style distribution plans, grantors start with smaller distributions and increase them over time.
The theory behind such a plan is that the beneficiary can receive a smaller amount and spend it all, but they have to wait a period before receiving the next lump sum. The hope is that during that time, the beneficiary will have made mistakes and gained some financial management experience before being trusted with a larger sum.
Like any other distribution plan, percentage plans can be accompanied by a “cap,” which limits how old the beneficiary is before receiving the full amount. For example, a cap of 50 years old would mean they’ll receive the rest of the assets then.
For example, your beneficiary receives 20% when you pass away, one-half of the remaining balance five years later and the remainder seven years after this, with a cap of 50 years old.
A landmark distribution plan can work several ways, but the idea is to encourage your beneficiaries to strive for certain goals. The grantor chooses these goals, but common options are:
It can also be an ongoing goal, such as matching the beneficiary’s income dollar for dollar.
For example, your beneficiary receives 25% upon graduation, then distributions matching their earnings.
As the grantor, you have complete freedom to decide how your assets are distributed, which means you can combine the different strategies as you please. Here are some examples:
If you want to allow for some flexibility in how your assets are distributed, you can give your trustee discretion. This lets them decide when your beneficiaries receive their assets, and how much they receive. While many grantors prefer to decide this for themselves, providing discretion to the trustee does allow for changing circumstances.
For example, imagine you set college graduation as a condition for receiving assets, since you believe this would put the beneficiary on the path to success. If they drop out of college and start their own highly successful business, they would normally be unable to receive the assets that come with graduation, despite their success.
By giving your trustee discretion, they could distribute the assets anyway, since the beneficiary has met your wishes for them to be successful.
When creating a trust, there are several common mistakes that people make, including:
There is much to consider concerning setting up a trust for adult children, such as the pros and cons of naming siblings, other relatives, friends and professional advisors as trustees. Other factors are how long the trust should go on, what payments it should allow or disallow, and who the backup trustees might be.
All your choices have pros and cons, and with the help of the experienced attorneys at Ettinger Law Firm, you can gain peace of mind and create the plan that best suits your family’s needs.
Get in touch today to schedule a no-cost consultation.
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At Ettinger Law Firm, our elder law lawyers focus on the needs of older adults in New York when protecting their families, assets and future. We recognize that many of our clients have minimal or no experience working with attorneys — our low-pressure approach enables you to make these crucial life decisions at your own pace. Trust our team to educate you and make the information you need accessible throughout the process.
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