Inheritance Protection
Parents spend a lifetime saving and investing to endeavor to leave their wealth to their children—who sometimes spend and/or lose it quickly. A trust can safeguard assets left to beneficiaries that will inevitably have lawsuits, creditors, divorces and other life-changing events that need protection from threats to an inheritance. A plan to protect beneficiaries is a wise decision and an irrevocable trust could be the best vehicle because the assets can be excluded from a taxable estate, provided that the grantor lives at least three or more years thereafter.
Most advisors advocate restraint in making large gifts to children during the lifetime of a wealthy individual. Lifetime gifts to children can reduce a taxable estate, however the gifts run the risk of being squandered and the giver loses control over the assets. While a trust is an option, it is not always be best strategy.
A wiser solution may be to title assets in a limited partnership with the giver and spouse as its general partner that can transfer to children, through a trust, a portion of the limited partnership interests each year. By following this practice, the taxable estate is reduced as value is transferred from the limited partnership interest to a child's trust. Simultaneously, assets will remain safe from creditors because they are titled to a limited partnership and the giver remains in control of their assets as the general partner. As a result, a child's inheritance is double protected; once by the LP and again by an irrevocable trust. At the time of death, any remaining partnership interest will have a discounted estate tax valuation and the remaining limited partnership interests can be bequeathed to the children's trust.
There are hundreds of ways to effectively combine trusts, FLPs, LLCs, and corporations to achieve various protection and estate planning objectives while retaining lifetime control over your assets, which should be the primary goal of any wealth preservation program.
In order for a trust to fully safeguard the interest of its beneficiaries, proper provisions must be placed into effect at the time of trust formation. These provisions will prevent a beneficiaries' creditors from making a claim against their perceived share of the trust's principal or income. The provisions will also stop the creditor from asserting any rights that the beneficiaries may have to the income or exercise other powers that could forfeit a beneficiaries' protection.
The most important clause in any trust is the anti-alienation or spendthrift provision. This directly protects the trust assets from the beneficiaries' creditors. The anti-alienation clause prohibits the trustee from transferring the trust assets to anyone other than the beneficiaries—including the trust beneficiaries' creditors. The spendthrift or anti-alienation clauses expressly preclude any individual whose interest is adverse to the beneficiaries (such as a creditor, ex-spouse, etc.) from claiming the beneficiaries' share, whether it be from principal or income distributions resulting from the trust.
It is important to note that the spendthrift clause will not completely protect the beneficiaries, as some limitations do apply. Many states do not enforce spendthrift provisions and it a spendthrift clause will not always protect beneficiaries from claims. It cannot protect income distributions previously received by the beneficiaries and in many cases a spendthrift provision that poorly drafted is interpreted with minimal significance by a court. The use of the spendthrift clause is entirely dependent on the skill of the legal advisor that drafts the provision.
Another important protective clause is to provide a trustee with distribution discretion. For example, a trust may stipulate that the beneficiaries receive trust distributions at age 25. But the trustee should be able to establish that the distribution was unsafe if the beneficiary had a judgment creditor or a divorce was imminent and delay the distribution in the best intentions of the trust. Further, if a beneficiary has a history of irresponsible spending behavior, a protective clause can be used to preserve the trust and avoid the risk of a creditor attacking the assets while still permitting the trustee to make third-party payments as authorized under the trust. This circumvents a creditor attempting to seize funds from the beneficiaries and allowing the intentions of the trust to be fulfilled.
Sprinkling provisions are common in trusts that are expected to remain in force for ten or more years and where each beneficiary's future income or tax situation is uncertain. Under the sprinkling provision the trustee can modify trust distributions and either disburse or retain the principal and income for the duration of the trust. The trustee determines what each beneficiary will receive, and when; however, the trust grantor does specify criteria for the trustee to follow when making distributions. Required minimum income distributions are recommended when the beneficiary is a spouse or dependent child.
The sprinkling provision adds protection but the trust remains irrevocable and sprinkling (and other) provisions cannot be modified. And, as with all trusts, the beneficiary cannot be a trustee in order to maintain protection from creditors; a trustee that can distribute trust assets to himself as the beneficiary provides his creditors the same right to force distributions, which can then be seized by creditors.
PROTECT YOUR ASSETS TODAY!
The best defense is a good offense.