Does Your Trust Have Build-in Creditor Protection for Your Children?

When leaving property to your children or other loved ones, you can choose exactly how you want to leave it to them. You can leave property outright (with no protections), in trust until the beneficiary reaches a certain age, or the property can be held in trust for the life of the beneficiary. Any of these trust instructions can be included in your living trust to take effect upon your death. But there is a special technique that allows us to “asset protect” what you leave behind for your children from their creditors, predators and future divorcing spouses.

You can protect the assets you leave to your children (including life insurance proceeds) for as long as you like, including for your child’s lifetime. I have done this in my own trust to benefit my children. This technique is an enormous gift in addition to the actual monetary gift to your children. By including the right language in your trust and by naming the right type of Trustee, you can protect the money you leave behind for your children from the threats that could steal their inheritance away from them.

As an added benefit, this type of planning protects a younger beneficiary from inheriting too much too soon. We have all heard stories of someone we knew inheriting a big pile of money and either blowing it within 18 months or putting themselves in harm’s way by getting in with the wrong crowd, getting into drugs or buying that fancy sportscar that gets wrapped around a tree.

And if you don’t have a personal frame of reference for this, just look at some of the well-known celebrities and their children and the tragic consequences that have ensued after inheriting too much too soon. For example, Bobbi Kristina Brown, child of Bobby Brown and Whitney Houston, is a more recent story that has hit the headlines. After Whitney Houston died, the bulk of her estate was left to Bobbi Kristina in trust. But the trust called for distributions to her daughter starting at the age of 21 (we call these age or stage distributions). Based on the size of Houston’s estate, it is estimated that at least $2MM was distributed to her daughter when she turned 21. If you are familiar with the case, Bobbi Kristina died in 2015 at the tender age of 22 from falling asleep in a bathtub. Drugs were found in her system.

Now you don’t have to have an estate the size of Whitney Houston’s to be concerned about this. Most have life insurance policies that range between $500,000 to several millions of dollars and have listed their children as the contingent beneficiary on the policy. Personally, my husband and I carry $4.5MM together, but our trust is the contingent beneficiary. If my children were to inherit that kind of money without any safeguards, I would be very worried about what that would do to them. Not just the fact that they could squander it or mismanage it, but that they could do real harm to themselves with that money. They could also be easy prey for someone trying to swindle them or take advantage of them.

I also have some personal experience with this whole topic as well. When I was 19 and still living at home with my father, he was diagnosed with stage four colon cancer at the age of 40. Two months later, my father died in Grossmont Hospital in La Mesa. I was shocked and devastated. I was a good kid but because I was so close with my father, I went into a state of shock and denial. My aunt and uncle wanted me to move in with them, but I was bent on going it alone and moved into an apartment with a friend. I had dropped out of college that spring semester when my dad got sick and went into the hospital. After he died, to distract myself from the immense pain I felt, I was hanging out with the wrong crowd and partying a lot. Anytime I was alone, I would cry until I couldn’t cry anymore. It was the worst pain I have ever experienced in my life.

Now think of your kids. It is difficult to lose a parent at any age, but think about if your children lost you while they were young. Their entire world would get turned up-side-down. They would have to figure out how to rebuild themselves and if they were not in a place where they surrounded themselves with the right people, it could go very badly.

Fortunately for me, my roommate was more interested in buying clothing and shoes than paying the rent and I could no longer afford to pay both halves to live in our tiny apartment. I was forced to move in with my aunt and uncle. They made me get back into college in the fall after my father died. And my other aunt was in charge as Trustee of my father’s trust. Most of my dad’s estate was chewed up paying his business debts, but because my dad was an antique dealer, my aunt was able to give me a garage full of antiques my dad had in storage and I started a small business from it.

If my dad hadn’t had his trust in place, I would have inherited his estate directly in a probate action as his sole heir under the California intestacy statute. But thankfully he had a trust-based estate plan in place that protected me and gave my aunt the discretion to get me onto the right path financially with the assets that were left while I finished college.

Now back to that special technique to include in your trust to protect your children. If properly drafted, your trust can: (1) protect your child’s inheritance from his or her spouse in the event of a divorce; (2) protect your child’s inheritance from his or her creditors in the event of a financial hardship; (3) protect what you leave them from a lawsuit; (4) give them a measure of protection from a bankruptcy trustee; and (5) on your child’s death, direct any unused assets to your grandchildren instead of your in-laws or the creditors of your child’s estate. During your child’s lifetime, you can even have instructions in your trust that give them the option to be a Co-Trustee and/or the Sole Trustee of their own share of your trust at a certain stated age of maturity.

But if your child becomes his or her own “Sole Trustee” (at say age 30 for example) and a real creditor risk arises, that child should resign as Trustee and appoint an Independent Trustee to serve as Trustee over the assets you left to them. An “Independent Trustee” is someone not directly related or subordinate (working for them) to him or her or to you as defined under IRS Code §672(c). The reason that this is important is because a child serving as their own Trustee is considered an “Interested Trustee” and trusts that are run by Interested Trustees have less protection from creditors such as that future divorcing spouse, a lawsuit, car accident, bankruptcy, or other creditor issue.

You can also appoint a Trustee right out of the gate who is unrelated or subordinate to you and your child to get the highest level of asset protection. We get this asset protection because the Trustee is considered to be “independent” or “discretionary.” This means that the Trustee has the “discretion” whether or not to make a distribution to your beneficiary child. Now I have somewhat simplified this technique. There are special ways in which we draft to make the creditor protection as tight as possible to defend from future attacks with special language.

Your trust can also be drafted in such a way that the unused portion of your child’s inheritance can “cascade” to any future grandchildren with the same protective features. And if one of your children passed without leaving children of their own, then that child’s remaining inheritance can cascade to their surviving brothers and/or sisters.

This type of trust planning also makes it much easier for your children to keep their inherited assets separate from their spouses when these assets are left to them in this special way. Upon your death, all of your trust assets are re-titled directly from your trust to your children’s separate trusts that spring from your trust (your children should consult with a qualified attorney to help them with the trust administration and re-titling process). This allows your children to tell their spouse “my parents left this money to me in trust” vs. them receiving their inheritance outright and having to take active steps to keep those assets separate from their spouse or potentially comingling their inheritance which could transmute a separate property asset into a community property asset (which could be taken in a divorce).

Lastly, the laws of California prohibit the creation of self-settled asset protection trusts. So, your children will not be able to protect these assets themselves from creditor risks without your help (unless they set up a self-settled asset protection trust in another state like Nevada and hire a Nevada Trustee-- the cost to do that type of planning is on average about $12,000 to $15,000 and should not be for more than half of their total net-worth). But, you have the ability to give them the gift of asset protection by including this special technique in your revocable trust. If you are going to leave assets to them anyway, why not do some good planning for them today? Not only will they greatly appreciate what you’ve done for them, it will get them on the right track of planning for themselves and for future generations.

parents with children

To find out more about this special type of protective planning for the ones you love, contact us at (760) 448-2220 and ask for Lisa Logee to set up a strategy session. To inquire about getting a copy of my latest book Safeguarding the Nest, Fourth Edition (which discusses this type of planning) for you or a friend, call Lisa at (760) 448-2220 or contact us on our contact page at www.geigerlawoffice.com/contact.cfm

Be the first to comment!
Post a Comment