Not Your Father's Estate Plan

Contra Costa Lawyer Magazine Online Edition
August 1, 2011

Estate planning attorneys commonly hear war stories from clients who served as the successor trustee of their parents’ estate. Some stories are more memorable than others.

Last year, a client was recounting her experience as trustee and beneficiary of her father’s estate. Dad’s trust divided the estate equally amongst the children. One of her siblings, while a “nice person,” never really grew up. The sibling had creditor problems, could not hold down a job, divorced a few times and had recently filed for bankruptcy. This was not an unusual story.

Unfortunately, her hands were tied as the trustee. Dad’s trust required her to distribute each beneficiary’s assets “outright and free of trust.” There were no provisions to withhold distributions. Just as she had suspected, the inheritance evaporated the moment she wrote the distribution check. The bankruptcy judge immediately attached the funds and the inheritance disappeared.

I had heard variations of this story but this was the first time I had met a family who personally experienced this. As a planner, it was very frustrating to know this could have been prevented. Dad’s hard-earned money could have been sheltered from his child’s creditors if the trust was structured differently.

I have heard many clients’ fears about leaving money to family members who rack up debt, are in litigious occupations or in a rocky marriage. Far from being grumpy curmudgeons, these clients have legitimate concerns. According to the American Bankruptcy Institute, more than 1.5 million people filed for personal bankruptcy in 2010, up 9 percent from 2009. According to the U.S. Department of Health and Human Services, the mean medical malpractice amount for physicians in 2006 was $311,965. More than fifty-percent of marriages in the U.S. still end in divorce.

Estate planning has evolved to address these issues and the changing nature of society.

Classic trust distribution provisions typically provide either an outright distribution or a structured trust. A structured trust pays the beneficiary a portion of assets at specified ages until the trust is depleted. While outright and structured distributions are easy to administer (and for the client to understand), funds can be taken by the beneficiary’s creditors once trust funds are distributed directly to the heir.

By contrast, if the trust provides that the heir’s inheritance shall be distributed to a Beneficiary Controlled Trust, funds are not distributed outright. Funds remain in trust and are administered by the beneficiary as trustee. Assuming that the heir is savvy enough to keep the assets in trust, these funds are beyond the reach of creditors and divorcing spouses.

As the Trustee, the beneficiary may remove funds from his or her own trust. However, once trust funds are removed, they lose the “protective wrapper” and can be exposed to creditors. To maximize asset protection if a creditor problem develops, the beneficiary should resign as trustee. A third-party trustee who is not related or subordinate to the beneficiary under IRC § 672(c) should then be appointed.

I always ask clients whether they would like to have trust funds distributed outright or remain in trust after their death. Even some clients whose heirs have sterling credit and are excellent savers prefer beneficiary controlled trusts. Some clients are persuaded by the asset protection features. Others believe that segregating assets from the beneficiary’s own estate creates a greater awareness that the inheritance was a result of another’s hard work and efforts.

There is no one-size-fits-all for clients and beneficiary controlled trusts are not for everybody. I have some clients who believe that they are too complicated or are turned off because of the additional expense of an ongoing administration. Others reject the idea of a beneficiary controlled trust because, in their mind, an heir with creditor problems deserves to lose his or her inheritance.

My client, the Trustee who could not save her sibling’s inheritance from bankruptcy creditors, chose a beneficiary controlled trust for her own estate. Fortunately, in the twenty years since her father drafted his living trust, estate planning techniques have evolved to offer additional choices that may better suit our client’s needs.

The article can be found at the Contra Costa Lawyer Magazine Online Edition:’s-estate-plan/

This Article was selected by Contra Costa Lawyer Magazine Best of the Web Edition, 2012.

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