Protecting Assets for Spendthrift Children
Enter what has been termed the greatest invention of English common law: the trust. Trusts are legal entities that may hold and use assets for a beneficiary (your son or daughter) but have them managed by a trustee (one of more responsible adults, including a professional trustee).
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.
Today, however, adolescence lasts much longer than it used to. Some say that “30 is the new 20” and, anecdotally, we see much evidence of this. Another recent phenomenon is children coming back home to live with their parents, for many reasons, but often having to do with their inability to deal with the problems of life.
In light of the foregoing, and the fact that trusts, which have become as common as wills today, may continue for many years after the death of the parent, new planning options are available to clients.
For example, one popular plan of distribution is 20% at age thirty, one-half of the remaining balance at thirty-five and the remainder at forty. The theory here is that the child can get the 20% and spend it all, but they have to wait five years before they get one-half of what's left and then, finally, ten years later, when they have hopefully made their mistakes and matured somewhat, they still have about one-half of the inheritance left. A twist on this plan is 20% on the death of the parent, one-half of the remaining balance five years after the parent's death and the remainder ten years after the parent's death. This latter formula is often accompanied by a “cap”. For example, upon attaining the age of fifty, any undistributed amounts shall then be distributed outright to the adult child beneficiary.
What if the parent wishes to “rule from the grave” and keep the assets in trust for the child's lifetime?
Let's say your son Richard is the problem. Your estate plan using a living trust would provide that upon your death or, if you have a spouse, upon the second death, Richard's share would go into the Richard Trust with perhaps a family member and your attorney as co-trustees. The Richard Trust would continue for his lifetime, and the trustees may use the money for Richard's health, education, maintenance and support. The trust can help him start a business or buy a house or, alternatively, purchase a house for him. Then, upon his death, the trust would go to his children (at a stated age).
The sprinkling, or spray trust is also often used in this context. Let's say Richard has two children and you are very concerned about them as well. You may set up a trust for Richard and his children and direct the trustee to “sprinkle” the income and principal amongst the beneficiaries, in equal or unequal amounts, whenever it is needed or will do the most good. So if one of Richard's children is accepted to Harvard, while the other goes to the local community college, the trust may help both. An added bonus with these trusts is that they keep the assets out of the hands of Richard's spouse who, in some cases, may be a large part of the financial problem.
For children in dire financial straits or perhaps headed in that general direction, the effects of a potential bankruptcy on the inheritance and estate administration must be addressed. What happens if your son or daughter files for bankruptcy within six months of the date of your death? The inherited assets are then available for their creditors. Nevertheless, by leaving assets to your son or daughter in a trust, giving the trustee discretion to distribute income and principal as the trustee sees fit, you may protect those assets from being lost in a subsequent bankruptcy proceeding.
There is much to consider concerning setting up a trust for an adult child, such as the pros and cons of naming siblings, other relatives, friends and professionals as trustees. Other factors are how long the trust should go on, what payments the trust should allow or disallow, and who the back-up trustees might be. All your choices have their pluses and minuses which need to be fleshed out, with the help of an experienced attorney, so as to provide the plan that best suits your family's needs.