Protecting Inheritance with Lifetime Trusts

We kindly ask you to please complete this brief survey after you read the article to provide any feedback you may have or to suggest any future topics that you would like to see us write about. Completion of this survey will enter you into a giveaway of Financial Consulate merchandise..

Written by: Andrew V. Tignanelli, CPA, CFP®

Our job is to educate, not to tell anyone what to do. An educator will still have an opinion, but one must be careful not to let their opinion impact one’s decision. One topic I have an opinion on is lifetime trusts for children if each child is likely to inherit $1 million or more. My opinion is that my children will not get the funds outright to just do what they want. Let’s start by explaining a lifetime trust and then move on to the pros and cons.

Assume I have a $5 million net worth and two children. When I pass each, is likely to get $2.5 million. I can leave it to them outright to do as they please, or I can place the funds in a trust with a trustee to oversee the trust and allocate to my children per the provisions of the trust. The concept of having a trustee oversee the funds is critical if I know the child would mismanage or unwisely expend the funds. That is not the concept I am referring to, but instead leaving the money in trust to competent and wise beneficiaries. If my children are competent and wise, then why would I do a trust? The answer lies with lawsuits, divorce and legacy reasons, which are the main pros. The cons include the cost of overseeing a trust, which is about 0.4%, the complexity of a trust, and the potential distaste of children needing to ask a trustee for funds.

Let’s start with the pros and then the cons. Liability lawsuits abound for many reasons, especially if you have assets. If you inherit $2.5 million, then you become a target, which can be mitigated by good liability insurance, but not totally. Assets held properly in a trust are liability proof assets. Therefore, if your child works as a professional with personal liability such as a lawyer, doctor, financial advisor, etc., a lifetime trust is important. Divorce is also rampant, and even what appears to be a good long-term marriage can end up collapsing.  If my child inherits assets outright, then the chance of being split in a divorce settlement is highly likely. Assets properly held in a trust are likely divorce proof. Lastly, legacy planning requires a trust to assure that if a second marriage takes place, the new spouse, who is not even a parent of my grandchildren, will not end up with all or even a portion of my child’s inheritance. After watching the evolution of inherited estates over 40 years this is the one that scares me the most. My child inherits at 60 years of age, and their spouse passes five years later. My child gets remarried or lives long term with someone at 72 and then passes at 90, still with this new partner. The new partner normally inherits a very large part, if not all, the assets. Do I really want to trust that these assets will now go totally to my grandchildren when this new partner passes? I have seen this too many times, even with those who thought they were doing everything right. Nothing can protect a legacy better than a lifetime trust.

The negatives are the costs of holding assets in a lifetime trust after you pass, which should not cost more than 0.4% (based on what Schwab Trust Company charges). You can mitigate these costs using your own family members, but that has potential for family turmoil.  Another negative is the complexity of the trust, how it operates, and how the tax liabilities are paid. If done improperly, then a trust can cause a substantial increase in the taxation of income, retirement plan distributions and capital gains. This is why it is imperative to have a tax expert as part of your team if doing a lifetime trust. Lawyers are rarely any good at tax planning, so the comprehensive financial advisor needs to be excellent at tax planning. Last is the distaste of my heirs wanting to ask a trustee for funds. This to me is totally irrelevant because they will get plenty each year to do as they please, but if they want to do something more, they can ask the trustee. The norm is, “I am the heir, so give me my money,” and it should be, “this is not your money just because you are my heir.” Smaller estates, when the children are getting sums well under $1 million each, unfortunately cannot handle the costs associated with a trust because most trusts come with minimum expenses that, percentage-wise, will be too costly.

This is just the preliminary information and there is a lot more to consider. The purpose of this article is to help you to better choose your preference. The pros of the lifetime trust may make it worthwhile to you, or the cons may make you say, “not doing a lifetime trust.” Let your Consulate Advisor know if you want to thoroughly vet the lifetime trust as a part of your estate plan.

Financial Consulate aims to help lessen the worry and burden of wealth management and enhance financial wellness so our clients can pursue relationships and true fulfillment. Choose the professionals at Financial Consulate as your Certified Financial Planners™ (CFP®) to take advantage of our educational, ethical approach to financial planning. Our services are comprehensive, including tax planning, investment planning, retirement planning, estate planning, and more. We operate completely independently and offer fee-only services to keep your vision in line with our recommendations at all times. While we have offices in Hunt Valley, Maryland, Fernandina Beach, Florida, and Gettysburg, Pennsylvania, we serve clients across the nation. To begin your partnership with a trustworthy wealth advisor, please contact Financial Consulate today.