When people first come to see me to discuss preparing their Wills they often have a specific plan for the ages which they want their children or other heirs to receive assets. Some people plan to leave their assets outright to their heirs immediately upon their death. Others have thought of a distribution schedule where their heirs receive property outright at a certain age e.g., 21, or staggered distributions of principal at certain ages, e.g. one-half at age 25 and the remainder at age 30. Still others want their heirs to receive all income but to be forbidden from accessing principal. Lastly, there are people who develop an incentive plan that rewards heirs with matching distributions for employment earnings or directs distributions of specific amounts based on the professions they choose to enter.
The common problem with most of these plans is their lack of flexibility. If life teaches us anything, it is that we can never be too prepared for its twists and turns. For this reason, I generally steer clients toward fully discretionary trusts. These trusts grant the trustee(s) flexibility to distribute trust property for an heir’s health, education, support and maintenance, or for any other reason that the trustee deems appropriate. Trustees are, of course, forbidden from making any distributions to themselves and are bound to carry out the provisions of the trust—only making distributions for the trust’s beneficiaries pursuant to the trust’s authority.
There are three primary protections that such a trust affords to your children and other heirs; the trust protects heirs from: (1) themselves; (2) potential creditors and (3) future ex-spouses.
First, should you and your spouse pass away while one or more heirs are young, a discretionary trust makes sure that the heir (perhaps a sophomore in college) does not have unfettered access to several hundred thousand dollars (or even millions of dollars) that such heir might squander. With a discretionary trust, the trustee is the gatekeeper and can make a distribution to enable a child to buy a car, or live in a nicer apartment, but is there to make sure that the trust funds are not wasted. Basically, the trustee’s job is to protect your child or other heir from himself or herself. In some cases, 25 year olds have excellent business ideas that will necessitate a large distribution; whereas in other cases 25 year olds have not yet sufficiently matured to the level at which a large distribution of assets is appropriate.
Second, if your child or heir is sued for any reason, the assets of a discretionary trust are not reachable by a creditor. Thus, if your heir is in a car accident or is sued for any reason, your hard earned assets will not be used to pay a creditor.
Third, a discretionary trust protects your assets from an heir’s soon-to-be ex-spouse. If your child or other heir receives assets outright (whether upon your death or upon reaching a certain age) and puts them into a joint account with his or her spouse or otherwise commingles the assets, they will become marital assets—subject to equitable distribution in the event of a divorce. In other words, your money may end up in your child’s ex-spouse’s hands. With a discretionary trust, the trustee is again free to exercise his or her discretion in a manner so as to protect your assets (or at least a large portion of them) from this scenario.
In addition, in the event that your children or other heirs are successful enough that they never need the money you are leaving them, the first $3.5 million that your estate passes in trust for your heirs ($7 million total from you and your spouse) can pass to their children free from estate tax (by reason of the generation skipping tax exemption). If you leave them the assets outright, however, they cannot take advantage of this exemption.
The most important factor in setting up a discretionary trust is naming the appropriate trustee(s). You are trusting one or more individuals (or corporate fiduciaries) to step in and act in many ways like a financial guardian for each of your children or other heirs. You should thoughtfully select people who are: (1) close with your heirs, (2) financially savvy, and (3) likely to outlive you. Care should also be taken to name successor trustee(s) or put in place a mechanism for making sure there is always a reliable trustee in place.
Trustees are entitled to receive commissions for their services. Many trustees who are relatives or friends, however, will waive their right to commissions. In addition, you are free to limit the commissions received or to specify that trustees serve without compensation. In such an event, trustees are free to resign if they do not agree to the financial stipulations you have put in the trust instrument.
Lastly, if you are concerned with your children or other heirs never having free and full access to assets, you can designate an age at which each heir can obtain the power to remove the trustee. In this way, by age 40 (for example) if an heir does not get along with the trustee, or believes that he or she is not being fairly treated, your heir is free to remove the trustee and appoint whomever he or she wishes (subject to a few restrictions) as successor trustee. In this manner, your heirs will gain de facto control of the assets but will still have the option of keeping the trust in place in order to take advantage of its benefits.
In future blogs I will address other actions that you can take (and that are often overlooked) to reduce the impact of estate taxes and to avoid unintended and unwelcome consequences for you and your family.
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Naim Bulbulia, is the head of Hartmann Doherty’s Trusts & Estates practice. Before joining the firm, he practiced in New York City, at Dewey Ballantine, LLP and Bingham McCutchen, LLC; and most recently, at Skoloff & Wolfe, P.C. in Livingston, New Jersey. Naim is a graduate of Harvard Law School and is licensed to practice in both New York and New Jersey. Naim was recently named a New Jersey SuperLawyers Rising Star in the area of Trusts & Estates. Naim lives in Short Hills, New Jersey with his wife and three children.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.