When to Leave Your Money in a Trust

scales of justiceMy Comments: Recently, two clients have asked me about asset protection and whether they should start thinking about a trust. The answer is maybe.

First, I have to remind everyone that I am not an attorney, and cannot advise people on legal matters. However, I can share basic knowledge that I’ve picked up over the years.

There are any number of reasons to think about asset protection. We live in a litigious society, and people find reasons to sue all over the place. If you think someone might sue you because your minor children got into a scrape, then certain assets you own could be at risk.

Certain kinds of trusts do offer asset protection, but in the State of Florida, there are tools you can use that allow you to retain control over those assets even while they are protected against the claims of creditors. I can help you explore those options, given my status as a financial advisor here in Florida.

By Joanne Cleaver / February 27, 2014 / US News & World Report

Not everything about the future is unknowable. Some family circumstances are all too predictable: divorce, disability and dumbfounding behavior.

Trusts can be a defense against these asset-shattering factors, estate lawyers say.

In the past, trusts have been the moat protecting the wealthy from estate taxes. But only about 0.3 percent of estates are likely to be hit with federal estate taxes, thanks to the high ceilings for such taxes ($5.34 million for single taxpayers and $10.68 million for married couples), says California lawyer Dennis Sandoval, who is also the director of education for the American Academy of Estate Planning Attorneys. Now, trusts are coming in handy as a first line of protection against illness and other potential complications.

“A trust gives you control and makes sure that the money is protected for the people you care about, and that it’s spent the way you’d like it to be spent,” says attorney Bernard Krooks, a specialist in elder law with Littman Krooks in New York.

Divorce. Sandoval estimates that more than 80 percent of the trusts he drafts are intended to protect an adult child’s inheritance in case that adult child divorces. The effort can be worthwhile for estates as low as several hundred thousand dollars, he says.

Continuing trusts, also known as “family access trusts,” protect the children’s inheritances. “It’s a relatively simple trust with the main purpose of keeping the child’s inheritance segregated and unavailable to a potential ex-spouse,” he explains.

Such trusts can also be used to ensure that a deceased spouse’s assets flow to his or her children, if the surviving spouse remarries (assuming there’s no prenuptial agreement). This is useful in second or third marriages in which one spouse is much younger than the other.

Disability and debilitation. A trust can extend protection for a disabled child or spouse, especially if the family wants to protect its assets from Medicaid payback provisions.

A special needs trust can wall off assets for a family member with chronic physical or mental needs and is especially valuable when planned well in advance with a trustee who understands the family’s intentions for caring for their loved one, both Sandoval and Krooks say. It’s important for the trustee to be fully conversant in the circumstances of the dependent family member. It’s also important to understand your intentions for leaving assets to others and know the rules of administering a special needs trust.

A “trust protector” is a third party who monitors the trust, providing an additional layer of accountability for fulfilling the purpose of the trust. Of course, adding a trust protector might also add another layer of cost to administering the trust.

A special needs trust should be set up as part of an overall estate plan and is not the same thing as a living trust.

Dumbfounding behavior. Drug addiction. Dangerous credit habits, including bankruptcy. Dereliction of personal responsibility.

H. Clyde Farrell, an attorney with Farrell & Pak in Austin, Texas, has a solution for heirs who are unlikely to use their newly inherited assets wisely: a trust, backed up by a contingent trust directive in the will.

“I recommend providing for contingent trusts that may apply to any beneficiary at the time of death, even if no trust would be needed as of the time the will or living trust is drafted,” Farrell says.

As it implies, a contingent trust is created when a certain theoretical situation becomes a reality. For instance, Farrell explains, if a beneficiary declares bankruptcy within 180 days before the death of the parent, a will including a clause for a contingent trust may be triggered, thus protecting the family assets from creditors.

Similar contingencies could be set up for drug abuse (no clean drug test, no money) and for those with chronic credit problems.

Do you want to prod your beneficiary to clean up his or her act? An “incentive trust” is your big stick from beyond the grave, Sandoval says. As one would guess, this type of trust rewards specific behavior, such as earning a college degree or taking time off work to care for a dependent.

Tightly drawn directives leave very little wiggle room for either an heir or a trustee to invoke a judgment call, should circumstances change. “In my experience, it is not the contingencies that lead to disagreement, it is whether particular discretionary distributions should be made,” Farrell says.

When trustees and beneficiaries disagree about the letter or intent of contingencies, or other elements of a trust, disputes can escalate. The very nature of contingent trusts tends to invite disputes, Farrell says, because the trusts rely on the “broad discretion” of the trustees. Usually, the disputes center around differing definitions of what is “reasonable” in terms of distributions, he says.

In Farrell’s experience, a trust is only as good as the trustee, who must exercise discretion and common sense to fulfill the intent of the trust.

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