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Whether it's a scandal or tendency to squander, a lifetime protective trust provides safeguards

by Amelia Burke | Contributor
November 2, 2021

Estate planning involves more than deciding who to leave your property to; it also involves deciding how and when these individuals will receive the property. If you choose to leave your inheritance directly, there is a risk that it will be quickly squandered or transferred to a creditor or other third party. A lifetime protective trust guards against these risks. Among other benefits, it provides asset protection and safeguards the inheritance from the beneficiary's poor financial decision making.

In October 2020, Seagram's heiress Clare Bronfman was sentenced to 81 months in prison for her role in Nxivm, a “cult-like” group involved in sex trafficking. Over 15 years, she funneled around $150 million from her inheritance into the criminal organization. You can be sure that her father, Edgar Bronfman Sr., did not intend for his daughter's inheritance to be misused in this way.

Although it is very improbable that your legacy will end up funding a sex cult, many parents planning to leave an inheritance to their children are concerned about what will happen to their assets after they die. They may be worried that their kids will quickly squander the inheritance or that it will be transferred to a creditor or other third party. This fear is not unfounded. Many families lose their wealth by the second generation, albeit often in much less extreme and scandalous ways than Clare Bronfman.

Luckily, there are ways to maintain some control over your property while your intended beneficiaries still benefit. In addition to deciding who to leave your property to, comprehensive estate planning allows you to control how and when they receive their inheritance. Three common options available for leaving an inheritance to your children include:

  1. You can give the inheritance directly
  2. You can give the inheritance in stages
  3. You can create a lifetime protective trust

Each of these three options is discussed in greater detail below.

What are the risks of leaving an inheritance directly?

Most parents initially assume that they will leave their property to their heirs directly, meaning they will receive the property outright with no strings attached. This choice is almost always the simplest option. However, there are two primary concerns with leaving your inheritance directly: you lose control and the risk of loss.Most parents initially assume that they will leave their property to their heirs directly, meaning they will receive the property outright with no strings attached. This choice is almost always the simplest option. However, there are two primary concerns with leaving your inheritance directly: you lose control and the risk of loss.

When you leave an inheritance outright, the funds are not subject to your control. Ownership of the property is fully transferred to the beneficiary, and you cannot control, redirect or pull back the inheritance. The inheritance is distributed directly to the beneficiaries after the decedent's final bills and taxes are paid. The beneficiary can spend the funds however they want, regardless of the decedent's wishes.

In addition to the loss of control, a direct inheritance carries a risk of loss. Once your child receives (or has the right to receive) the inheritance, the property is subject to their life events. There are various reasons why a direct inheritance may be quickly dissipated, including:

  • Poor spending habits
  • Poor financial management skills
  • Substance abuse
  • High-risk occupation
  • Divorce
  • Creditor's claims
  • Lawsuits
  • Bankruptcy

What are the risks of distributing assets at specific ages or stages?

The second option that parents have is to give the beneficiary their inheritance in stages. For example, you could have the beneficiary receive a third of the inheritance at age 25, half of the balance at age 30 and the remainder at age 35. The thought behind this strategy is that the child will become increasingly financially responsible as they age. They will receive the inheritance when they have acquired maturity and experience.

However, this strategy only provides limited protection and still leaves your inheritance vulnerable to loss. You risk the same drawbacks as leaving the entire inheritance directly. For example, since the beneficiary has the right to those amounts at those ages, creditors can force the trustee to make the distributions. Additionally, reaching a particular age or stage in life does not automatically translate into greater financial responsibility. Some people are spendthrifts, no matter their age.

Distributing your assets at specific ages or stages is more costly than leaving your inheritance directly because there are added legal and accounting costs. Additionally, the trustee will probably require a fee for services rendered.

What is a lifetime protective trust?

A lifetime protection trust is a type of trust designed to protect your property from creditors and your beneficiaries' bad decision making. The trust holds the property during the beneficiaries' lifetimes, and the assets are managed by the trustee that you designate. All distributions from the trust are made at the trustee's discretion based on the beneficiary's ascertainable standard of health, education and welfare.

A lifetime protection trust allows individuals to leave property to their beneficiaries in a continued trust rather than in an outright lump sum or staged gifts.

Distributing your assets at specific ages or stages is more costly than leaving your inheritance directly because there are added legal and accounting costs. Additionally, the trustee will probably require a fee for services rendered.

What are the benefits of leaving your inheritance in a lifetime protective trust?

Lifetime protection trusts provide solutions to many of the problems created by direct inheritances. The benefits of these trusts are valuable not only for the wealthy, but also for those with modest estates. In fact, there is arguably a greater benefit to modest estates where there is a better chance that one unfortunate accident could wipe out the entire inheritance.

Seven of the most significant benefits of lifetime protection trusts are listed below.

1. Protection from creditors and lawsuits.

A creditor cannot seize property that is not owned or possessed by the individual. Consequently, the property in a lifetime protection trust is shielded from creditors because it is not owned by the beneficiary. Instead, it is owned by the trust. Under the terms of the trust, the trustee retains complete control over the timing of the distributions. The beneficiary is never entitled to a distribution. A creditor can only assert claims against trust income and principal that were distributed to the beneficiary.

The trustee has complete authority to decide how and when trust funds are released based on the beneficiary's needs and circumstances. They will not distribute assets at a time when they would be lost to creditors. For example, the trustee would not distribute funds when the beneficiary is going through a divorce, bankruptcy proceeding or lawsuit.

Asset protection appeals to parents whose children are financially irresponsible or work in an occupation with a high risk of lawsuits, such as in the legal, medical or construction industries. However, even if your child is responsible, unexpected life events can occur, and asset protection can suddenly be essential.

2. Protection during divorce.

In most states, inherited property is typically not subject to division during a divorce. However, if the inherited property is transferred to a joint account or otherwise “commingled,” the court may consider it marital property subject to division. Keeping the property in a lifetime protection trust will ensure that it remains separate property and will not be divided.

Even if there is no indication that your child will get a divorce, you never know what the future holds. It does not hurt to plan for the unexpected. Most people do not want somebody who is leaving their family to get a slice of the estate. When you create a lifetime protection trust, you can rest assured that the property will not end up in the hands of your child's former spouse.

3. Protection for beneficiary's bad decision making.

It is not uncommon for people to make poor financial decisions when they receive a large cash windfall. A lifetime protection trust stops your beneficiary from squandering their inheritance all at once on fancy cars, extravagant trips, risky investments and other bad decisions. Instead of receiving the funds in a lump sum, the trustee distributes the property based on the beneficiary's ascertainable standards of health, education and welfare.

The trustee has the discretion to stop making distributions when it is in the beneficiary's best interest. For example, if the individual is struggling with a substance abuse or gambling problem, the trustee can withhold distributions until the beneficiary is willing to receive the proper treatment.

Furthermore, a lifetime protection trust can help ensure that your heirs do not become complacent and that the inheritance does not undermine their motivation. A young adult who receives a lump sum, direct inheritance may lose the drive to succeed in their career.

4. Continued control of the property.

Under the terms of the trust, the trustee has the discretion to make distributions based on the beneficiary's ascertainable standard of health, education and welfare. These are very broad terms, and you can decide to provide non-binding guidance to the trustee. The guidance ensures that the trustee is aware of your values and wishes when they make distribution decisions. For example, you could include information about what you would like to happen in different scenarios, like the purchase of a home, wedding, start of a business, travel, etc.

Furthermore, you can control who will receive the property left in the trust if anything remains when the beneficiary dies, such as grandchildren or a favorite charity. You can also decide to give your beneficiary the power to decide the final distributions of the trust assets upon their death. You can ensure that your legacy will be protected for future generations.

5. Continued support if the beneficiary becomes incapacitated.

If your child received a direct inheritance and becomes incapacitated due to illness or injury, the court can impose a guardianship and end up controlling the inheritance. Whereas, if you leave the inheritance in a lifetime protective trust, the trustee can continue to manage the trust assets for the benefit of your incapacitated child without any court involvement. The trust will continue to operate and can pay for the beneficiary's medical bills and other expenses. If the beneficiary was the trustee, the successor trustee would automatically take over control of the trust when they become incapacitated.

6. Creates an educational opportunity.

When creating a lifetime protective trust, you must choose a trustee (or co-trustees) to manage the trust assets. The trustee can be a third party or the beneficiary themselves. Some parents choose to name their child as a co-trustee until they reach a specific age or stage of life. They also designate a third party as a co-trustee whose main job is to supervise and teach your child how to handle their inheritance. This option creates an educational opportunity and allows the child to have more control over their inheritance.

However, naming the beneficiary as the trustee can have implications on asset protection, and depending on your state's laws, it may give creditors the ability to reach the trust property. If this option is something that you are considering, you should discuss it thoroughly with qualified estate planning professionals.

7. Tax benefits.

For some individuals, there are tax benefits to creating a lifetime protective trust. For example, if the beneficiary's estate may be subject to estate taxes, a lifetime protective trust allows the assets to pass outside of the estate. Assets in a lifetime protective trust are not subject to estate tax. In 2021, the estate tax exemption was $11.7 million.

What are the negatives of a lifetime protective trust?

Although lifetime protective trusts have many benefits, there are some negatives, mainly the added costs and expenses. There are additional legal, accounting and trustee fees that you must consider. A lifetime protective trust is not needed in every case. You should discuss your unique situation with qualified estate planning professionals.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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