Which Distribution Method Is Best? Showing Your Children the Love

If you are a parent, you probably love to do good things for your children—and leaving them an inheritance is one of the most tangible ways you can show your love once you are gone. What you may not know is that there are a variety of ways that you can leave money and property to your children, and you can choose the method you think best takes your goals, including their wellbeing, into account.

The Outright Gift

The first option for leaving an inheritance is to make an outright gift using a will to all children over the age of majority in your state (usually 18, 19, or 21). This is often what comes to mind first when people think about planning for their children’s inheritance. This may be a fine solution for parents who have financially responsible adult children and who will be leaving a small amount of property and money to them. For most people, however, leaving an outright gift using a will is not the best option. If your children are minors, they cannot legally take control over an inheritance, so it will more than likely have to be held in a special account or managed by a court-supervised conservator until they reach adulthood. But even if your children are young adults, they may not have the maturity to make good financial decisions. Further, it is impossible to foresee what the future holds, even for mature children who normally exercise good financial judgment. They could, for example, experience a divorce or be sued and have a judgment entered against them, and their inherited money could be used to satisfy those claims. Certain types of trusts can be used to prevent the money you have worked hard to save from going to your children’s creditors or divorcing spouse, while enabling the trustee to make distributions for your children’s benefit in accordance with your wishes.

In Trust with Child as Trustee

If you make your adult child the trustee of a trust to be established when you pass away, and he or she is also the beneficiary, the trust terms will specify the amount of discretion your child will have in making distributions to him or herself. Like an outright gift, this is often not the best choice for parents concerned about immature children or children who may have present or future money problems. If your child is able to exercise control over the trust money and property in the role of trustee, then his or her creditors may be able to reach those assets to satisfy their claims. There is also the possibility of conflict, especially if the siblings don’t get along, if there are multiple siblings acting as co-trustees, or if one sibling is the trustee and the other siblings are beneficiaries.

Some of these concerns can be addressed by a beneficiary-controlled trust. This type of trust enables a beneficiary to be a trustee, but the trustee/beneficiary can only make distributions for his or her health, maintenance, education, and/or support. An independent co-trustee may be empowered to make distributions for the beneficiary’s benefit for reasons beyond health, maintenance, education, or support. Typically, the terms of this type of trust enable the beneficiary to remove and replace his or her co-trustee if the beneficiary is not satisfied with the co-trustee’s performance. Although the trustee/beneficiary has some degree of control over his or her inheritance, this type of trust prevents the money and property intended for your child from being used to satisfy the claims of creditors, divorcing spouses, and lawsuits.

Distribute percentage at certain ages

One of the most common–though not necessarily the best–choices parents make regarding how to distribute money and property held by a trust is to include terms requiring mandatory distributions at a certain age or at several ages. For example, a trust could require one-fourth of the trust’s principal to be distributed at age 25, one-fourth at age 30, and the balance at age 35. This distribution scheme may address parents’ concerns about their children receiving a large sum of money before they have the maturity to handle it responsibly, but it does not provide as much protection against creditors as many parents would prefer—which is a concern regardless of the age of the beneficiaries. If a beneficiary can require a distribution to be made from the trust, his or her creditors or divorcing spouses can also look to it to satisfy their claims. In addition, once a distribution is made to one of your children, it is vulnerable to present or future creditors’ claims.

Incentive trust distributions

Many parents want to pass on their values to their children, and an incentive trust is sometimes used as a mechanism for encouraging children to achieve important goals by authorizing trust distributions based upon the beneficiaries’ achievement of certain conditions, e.g., graduating from college, or denying distributions to beneficiaries who use drugs. Although this trust protects the money and property held in the trust from the beneficiaries’ creditors until the funds are distributed, there are some possible downsides. This type of trust has the potential to trigger resentment in the beneficiaries whose behavior you wish to influence, especially if they believe the trust’s conditions are unfair: For example, a trust that rewards high income by increasing distributions as income increases may be perceived as unfair by a beneficiary who has chosen a laudable but low-paying career such as teaching or social work. In addition, this type of trust may not provide trustees with much flexibility in making distributions and may be difficult and expensive for trustees to administer, as substantial investigation or proof may be necessary to establish whether the trust conditions have been met by the beneficiary.

Distributions for specific purposes

A trust providing for distributions for the beneficiaries’ health, maintenance, education, or support is quite common. It is also possible to set up a trust that gives the trustee the discretion to make distributions to beneficiaries for other specific purposes, for example, starting a business or buying a house. In those circumstances, the trustee may need to evaluate, for example, whether the beneficiary is able to afford the monthly payments, home maintenance, and taxes before making a distribution to be used as a down payment on a house. Like other types of discretionary trusts, the money and property held by the trust will be protected from claims by creditors, divorcing spouses, or lawsuits.

Complete discretion by the trustee

A fully discretionary trust authorizes a trustee to make distributions to beneficiaries but does not require distributions to be made. Although this type of trust protects the money and property held in the trust from being used to satisfy claims made by the beneficiary’s creditors, some parents may be concerned that this type of trust gives the trustee too much control. Because the trustee does not have to make distributions, your children will not be able to depend upon receiving money at certain intervals or occasions, which may make financial planning more difficult. There is also the risk that unequal distributions among multiple beneficiaries could lead to family conflicts and resentment when the trustee is the only one to decide who gets money when.

Let’s Meet to Talk about the Best Option for You and Your Family

Each type of trust has its pros and cons. The right strategy–or combination of strategies–for your family depends upon your unique circumstances and goals. Call our office today to set up a consultation so we can make sure your will and/or trust will provide for your children in the way you intend after you pass away.