By Thomas Hackett
The Daily Record Newswire
Dede and Jay were married with two daughters: Ella and Sophie. When Dede’s parents died, she inherited $400,000. Tragically, a few years later, Dede died and Jay inherited all of her assets. Jay remarried and had a son, Joe, with his new wife, Melissa. When Jay died, everything he had went to Melissa. Ultimately, when Melissa dies, Joe will inherit all of his mother’s assets — including what may remain of the $400,000 that Dede had inherited from her parents. By allowing for outright inheritance of assets according to state law, Ella and Sophie were effectively disinherited.
This could have been avoided with an inheritance trust. An inheritance trust allows people to identify who will receive their assets and also protects against other life tragedies, including divorce, serious illness, financial reversal and even taxes.
Trust beneficiaries
In an inheritance trust, the person who sets it up (the “settlor”) decides who receives the trust funds (a “beneficiary”). The settlor can be very specific in identifying who will be a beneficiary now, and later – after the initial beneficiary or beneficiaries die.
Most typically, the settlor designates their children as initial beneficiaries and their grandchildren as secondary beneficiaries at each child’s death. Sometimes, the settlor will name a child’s spouse as a beneficiary when their child dies, provided they were still married at the child’s death. The settlor can even give their child the power to decide who receives the trust funds when he or she dies.
In simple terms, an inheritance trust allows the settlor to make sure money and property stays in the family.
Creditor and spendthrift protection
An inheritance trust also protects against a beneficiary’s future creditors. When the settlor establishes a trust for beneficiaries, it includes “spendthrift provisions” that prohibit the trust from benefiting a creditor of the beneficiary.
Potential creditors can include a beneficiary’s business partners or tort victims (such as those injured when the beneficiary is driving a car). However, a beneficiary’s most likely future creditor is a divorcing spouse. An inheritance trust keeps the inherited assets separate from the marital assets. Although a family law judge can consider the inheritance trust when dividing marital assets, he or she cannot award the inheritance trust assets to the divorcing spouse.
Furthermore, an inheritance trust can restrict distributions to a beneficiary such that the beneficiary is not permitted to receive distributions unless that beneficiary complies with the provisions. For example, the settlor can provide that a beneficiary will no longer be a beneficiary of the inheritance trust if the person marries without the spouse signing a prenuptial agreement. An inheritance trust can also be crafted with provisions to protect against other potential problems, such as substance abuse.
In all these instances, because the beneficiary does not own the trust assets, the beneficiary cannot transfer or assign the trust assets to those creditors. The beneficiary’s lack of control over the assets can frustrate creditors. If it makes sense to settle with a creditor, this lack of control provides leverage to settle disputes at a discounted amount. The decision to settle or not settle a beneficiary’s dispute with a creditor is generally left to the trustee of the trust. The trustee is the person in charge of administering the trust based on the trust’s rules, which are drafted by an attorney at the direction of the settlor.
Controlling the trust: beneficiary as trustee
In many cases, the settlor wants his or her child to have access to the trust funds as if a trust did not exist. While certain powers must be limited or abandoned under certain circumstances, the beneficiary can generally serve as his or her own trustee. This gives the beneficiary the authority to make the discretionary decisions.
One such circumstance that requires the beneficiary abdicate authority as trustee is if a creditor makes a claim against the beneficiary. In this instance, the trust generally provides for appointment of a co-trustee or a new trustee who will take on the discretionary authority of the trustee and deny the creditor’s claim against the trust assets.
As an example, if a beneficiary is getting divorced, the trust may provide that the beneficiary’s sibling becomes trustee. The beneficiary’s sibling, as trustee, would refuse to distribute trust assets to the beneficiary or to the beneficiary’s divorcing spouse. After divorce proceedings are finalized, the beneficiary can generally return as trustee of the trust.
If estate taxes are a concern for the beneficiary, then the settlor can impose limits on a beneficiary serving as trustee to protect against the trust assets being included in the beneficiary’s taxable estate at the beneficiary’s death. For each individual, the federal estate tax exemption is currently $5.34 million and the Oregon estate tax exemption is $1 million. By placing limits on the trustee’s power to prevent estate inclusion, the trust assets may pass to the next generation without being reduced by estate tax attributable to the death of the first beneficiary.
While some settlors may want to have their child serve as trustee, other settlors are worried about their child’s spending habits or generally question the child’s ability to manage significant wealth. In those instances, the settlor can select another family member or a professional to serve as trustee.
Establishing an inheritance trust can generally address three major concerns: 1, creditors receiving a child’s inheritance; 2, nonfamily members receiving a child’s inheritance; and 3, taxes eroding a grandchild’s inheritance. An inheritance trust should be tailored to each particular family’s situation to achieve the legacy desired by the settlor.
Unfortunately, an inheritance trust cannot be created after an inheritance is received. As such, potential settlors shouldn’t wait to engage in discussions about what can go wrong transferring wealth between generations as well as possible solutions.
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Thomas Hackett is a member of Sussman Shank LLP’s business group. Contact him at 503-227-1111 or thackett@sussmanshank.com.
