No client wants to leave an estate to a child only to find that the money is lost later on in a divorce. The estate planning answer for a lot of parents is to leave inheritances in trust for the benefit of their child. But trusts vary widely, and because this is a message many clients miss, planners must reinforce the idea.
Most clients continue to use trusts that will provide modest protection - or perhaps none - if a child later divorces. There are far better options. To understand the alternatives, the nuances of will and trust provisions have to be addressed. Advisors need to assess the fine print of every trust to see what it will really do. Poorly crafted trusts are the weak link in most clients' wealth transfer plans.
Before starting a conversation about trusts, it helps to understand a client's mind-set. They usually make two common mistakes when they plan wealth transfers via trusts: They insist on simplicity, and they insist on control. This is a classic estate planning double fault, and their kids will not only lose the point, but also the money.
Begin by explaining that simplicity should never outweigh protecting heirs. Planners can play a vital role in helping clients understand and gain comfort with the recommendations of the estate planner to achieve these protective goals. As for control, clients must understand that a properly structured trust is more about providing an heir flexibility and security, not about setting limits.
Once those points have been established, consider the typical trust a client will want to set up for a child, and be prepared to explain why it's insufficient. Here are the features most clients will want in a trust they set up for their heir:
* The trust ends at some specified age, typically when a client feels the child will be mature enough to handle money. Many end at 25 or 30. Some divide up the principal and make distributions in segments, for example, at age 25, 30 and the balance at 35.
* The child is named co-trustee at some age, say 21, so that the child can be in control of his or her financial future.
* Trustees can distribute money to maintain a child's standard of living. In tax jargon, this is often referred to as a health, education, maintenance and support standard.
* Children often have the right to distribute to themselves to maintain a standard of living.
While there are no reliable statistics on trust terms, most estate planning lawyers would tell you the above approach has been the norm. That's too bad, because clients can get better results.
COMMON TRUST PROBLEMS
The typical trust will accomplish what has historically been most parents' main goal: to protect a child from imprudence until that child attains an age and maturity to be able to handle money. But this is one of many goals. The reality is that distributing money outright at any age is often a mistake. What if a divorce occurs the year after the distribution? Not knowing when a divorce might occur indicates that trusts should be made to last as long as possible.
Naming a child as trustee or co-trustee is common, but it also vests the child with power over distributions that might undermine the protection the trust would otherwise afford if the child trustee divorces. If the child can make distributions to himself or herself during a marriage, might a court be inclined to try to force a child trustee to continue making distributions after a divorce?
Distributions to maintain a child's standard of living have considerable appeal to most clients. They want a safety net for a child to assure a reasonable lifestyle, and setting up in advance what seem like reasonable distributions for this type of support might allay parents' concerns about a child's potential to spend money on extravagances.
But might a court interpret the requirement to maintain a child's standard of living as including in that standard the care of a minor child? What about child support? This could well be a hole in the trust, and trying to stem the bleeding of assets through this hole during a divorce will be a weak attempt to rectify what proper planning could have secured from the start.
A recent landmark case in New Jersey, Tannen v. Tannen, held that the wife's trust could not be touched to satisfy divorce claims. The wife's parents created the trust for her, and named themselves and the wife as co-trustees.
