In many cases, determining the beneficiaries of your estate plan is simple. If your spouse survives you, your assets go to your spouse. If your spouse doesn’t survive you, your assets are split equally among your children. But choosing who will ultimately receive your assets and in what proportions is only part of the process. Another part of it is deciding how the beneficiaries receive those assets.
Most people initially assume they will give assets to their spouse and children outright to keep it simple. For example, if your spouse survives you, your assets go outright to your spouse. If your spouse doesn’t survive you, then your assets are split equally among your children, to be distributed to them outright. Another option is to give assets to your beneficiaries in a continuing trust – meaning that you name a trustee to own the assets, invest them, and distribute them to the beneficiary over time according to the trust’s terms. After discussing the advantage of trusts with their attorneys, many people even give assets to their beneficiaries in lifetime trusts – trusts that last for the lifetime of their respective beneficiaries. The terms for these trusts can be written directly into your estate plan; they do not have to be created separately.
There are significant advantages to leaving assets to your beneficiaries in trust, some of which are set forth below.
Protection in Divorce. In most states, including Missouri and Illinois, an inheritance is not subject to division as marital property in divorce. However, with an outright distribution, it is easy for inherited assets to find their way into joint accounts or to become combined with other joint assets to become “commingled” and as a result, subjecting them to division as marital property. However, with a lifetime trust, it is much easier to keep the inherited assets separate from marital property, as the assets that remain in trust must remain in separate accounts that are titled in the name of the trust.
Protection from Creditors. A discretionary lifetime trust that contains a spendthrift provision, a clause prohibiting the assignment of the interest to creditors, will generally protect the trust assets from attachment by the beneficiary’s creditors. Assets held outright are not protected from the owner’s creditors.
Continued Control over the Disposition of the Assets. You can continue to have some say in where the assets go upon the death of the beneficiary of a lifetime trust. That is, you can continue to protect your legacy by, for example, directing that the remaining assets go only to your descendants or to charities. To provide some flexibility, you can give your beneficiary the ability to alter how those assets are divided and distributed by giving the beneficiary the power to appoint, or direct, the assets as they wish if the beneficiary desires that certain of your descendants need more than others (for example, a beneficiary with special needs).
Incapacity of the Beneficiary. In the event of a beneficiary’s incapacity, assets held by a beneficiary outright may be subject to a court-ordered conservatorship. However, with a lifetime trust, the trustee will continue to be able to administer the assets for the beneficiary, without court involvement. If the beneficiary was the initial trustee, the successor trustee simply takes over when the beneficiary can no longer serve.
Tax Benefits. If there is a risk that the beneficiary’s estate may be subject to estate taxes, a properly structured lifetime trust will allow the assets to pass to the beneficiary’s descendants without the beneficiary paying estate tax. Assets held outright are always subject to estate tax.
Beneficiary as Sole Trustee. The foregoing advantages will continue to apply even if the beneficiary is named as the sole trustee of his or her lifetime trust. While this is not always prudent planning, this will give the beneficiary much more control over the assets while not giving up the advantages of a trust.
What’s the catch? There are some differences in how a trust, as opposed to an outright inheritance, must be administered. Most of the differences are related to the trustee’s duties and legal requirements, such as filing separate income tax returns for the trust each year, managing the investments of the trust prudently, keeping accurate accounting records, and following the terms of the trust closely. Because of these additional requirements, and at times additional costs, lifetime trusts are not right for every situation or beneficiary. That said, for many beneficiaries, the benefits of trusts can far outweigh the costs or burdens of administration.
Other benefits, like planning with retirement benefits or structuring lifetime trusts to help those with special needs to qualify for governmental benefits, are also available.