There are various reasons why it may be unwise to directly leave someone an inheritance. The beneficiary might be a minor, he might be disabled, or he might have issues with drugs or alcohol. From a planning perspective, it is easier to simply leave a person their inheritance outright and free of trust, but a simple plan may not be the best plan.
Minors, someone under the age of 18, cannot directly inherit assets without creating issues. If a person dies and leaves an inheritance to a minor without leaving that inheritance to a trust, then a guardian will need to be appointed for the minor. If a person who is disabled inherits assets, then he might lose his government benefits, such as Medicaid. If a person who suffers from alcoholism inherits assets, then he might simply drink his inheritance away.
Many issues can be resolved by drafting a trust into the Will to receive the inheritance of the beneficiary. A trust in a Will is called a testamentary trust. As with all terms of a Will, a testamentary trust is fully revocable until the person dies. After the person dies, a Will becomes irrevocable and any trust in the Will becomes irrevocable.
Irrevocable simply means that the terms of the Will and the trust in the Will cannot be modified or revoked. Money can, and in most cases will be, distributed to the beneficiary of the trust; in fact, all of the assets of the trust might be distributed to the beneficiary of the trust, in which case the trust would terminate due to a lack of assets.
Distributing an inheritance to a trust is more complicated than distributing the assets directly to a beneficiary, but there are numerous benefits to leaving an inheritance to a trust. For one thing, a trust can contain a spendthrift clause.
A spendthrift trust is a clause in the Will that protects the assets that are being held in the trust from the creditors of the beneficiary. For instance, assume that Mrs. Smith has a son Joe. Assume that Joe owes a number of people money. Joe is a spendthrift. If Mrs. Smith dies and leaves her money directly to Joe, Joe’s creditors might take the inheritance; the creditors might already have judgments against Joe.
On the other hand, if Mrs. Smith leaves Joe’s inheritance to a testamentary trust for Joe’s benefit and the Will contains a spendthrift clause, then Joe’s creditors cannot get at the inheritance that Mrs. Smith left to Joe. Joe can actually benefit from the inheritance. Furthermore, someone else could be appointed as trustee of Joe’s trust, so Joe is not spending the money frivolously.
I believe that a spendthrift clause is such a powerful tool in the estate planning arsenal that I frequently mention to clients the prudence of leaving their estate to trusts for their children’s benefit. If the child does not have spending problems, the child could be the trustee of their own trust. In this way, the child does not have to ask anyone else for his money, but the money is still protected from potential creditors. If Joe doesn’t have spending problems but causes a car accident and is sued, the creditor could not get at the money that Mrs. Smith left to the trust for Joe’s benefit, even if Joe is the trustee of his own trust.
Aside from the benefit of a spendthrift trust, there are other benefits to a trust. If Joe is disabled and a Medicaid beneficiary, a special needs trust could protect Joe’s Medicaid benefits and allow him to enjoy the inheritance and continue to benefit from the money in the trust.
If Joe is a minor, a trust can permit someone else to manage his money appropriately until he attains a designated age. For instance, Mrs. Smith might leave Joe’s inheritance to a trust until Joe attains the age of twenty-five. The money in the trust could be used to pay for Joe’s education.
Leaving money directly to a beneficiary is simple, but simple is not always the best plan. While a trust does add complexity to an estate plan, that complexity might be a good thing.
A trust can offer flexibility, privacy, and control that many people don’t realize until they need it. Even if it’s not right for everyone, knowing the ways a trust can help makes it easier to decide whether it belongs in your planning toolkit.
When people hear the word trust, they often think about taxes or wealth. In reality, many trusts are designed to create flexibility, prevent family disputes, and make life easier for the people left behind when difficult transitions occur.