Questions:
Are you worried about a beneficiary losing part of their inheritance because of the high divorce rate or the risk of lawsuits?
Are you worried about your children losing part or all of their inheritance to lawsuits, divorce, bankruptcy, or medical bills?
Do you have a child, grandchild, or another beneficiary who you’re worried might squander or waste their inheritance after your death?
Do you have a beneficiary who suffers from a substance abuse problem or gambling addiction, a mental illness, a history of making poor spending decisions, or unwise investments?
Do you have a beneficiary who always seems to be in debt?
If you have any of the above concerns, you’re not alone, and you should keep reading. But first, here’s a simple diagram showing what happens after death with and without Beneficiary Asset Protection.
As Northern Virginia estate planning lawyers, and as Maryland estate planning lawyers and DC estate planning lawyers, one of the strategies that we often recommend to our clients is the Beneficiary Asset Protection Trust (also called a Spendthrift Trust or Dynasty Trust), which we can build into your Revocable Living Trust or your Living Trust Plus Asset Protection Trust, to take effect upon the death of the trust creator. Whether your trust is created in Virginia, Maryland, or DC, a Beneficiary Asset Protection Trust / Spendthrift Trust creates a sub-trust for each beneficiary. Typically, the beneficiary of each sub-trust acts as his or her own trustee and can use the assets in the trust for his or her own health, education, maintenance, and support (the latter two — maintenance and support — encompass almost anything). If you have beneficiaries who you’re afraid will be irresponsible in managing their own sub-trusts (or if a beneficiary is or becomes subject to a lawsuit or judgment or under attack from other potential creditors), then a responsible third party — another family member or a professional trustee — can be named to act as trustee of a sub-trust to manage and disburse the funds in accordance with your desires as the creator of the trust.
- The beneficiary can have direct control of the assets as trustee of his or her own sub-trust, but the assets are protected from divorce, lawsuits, bankruptcy, and medical bills. The beneficiary can purchase assets in his or her name as trustee of the sub-trust. This can include primary homes, second homes, rental property, vacation property, land, vehicles, etc. — anything that has a title can be titled in the name of the sub-trust and protected inside the sub-trust.
- If you don’t trust the beneficiary to act as the trustee, then you can name a different trustee who can make direct payments to landlords, mortgage lenders, schools, doctors, hospitals, etc. Or the trustee could make regular payments to the beneficiary, similar to an allowance.
Although the Beneficiary Asset Protection Trust may be the best solution for people who want to protect inheritances for their beneficiaries, or who have fiscally irresponsible beneficiaries, there are several ways a Beneficiary Asset Protection Trust can fail or be thwarted:
Beneficiary Acting as Trustee Removes the Assets: If the beneficiary is serving as the trustee of his or her own trust, the beneficiary could thwart the protection of the trust by distributing assets out of the trust and into the individual name of the beneficiary. Worse yet, the beneficiary could then commingle those distributed assets to a joint account with a spouse or another individual, thus possibly subjecting those assets to divorce and/or to lawsuits or other creditor attacks against the joint account owner.
Trustee’s Actions: If you are not using a professional trustee, such as a qualified trust company or an experienced Virginia trusts and estates attorney or Maryland trusts and estates attorney or DC trusts and estates attorney, as the trustee of the Spendthrift Trust, you should be careful that the person you pick will make the best decisions for your beneficiary. Simply put, trusts may not work well if the trustee doesn’t do a good job. For example, the trust may not work well if your trustee doesn’t use a professional money manager or distributes too much money to your beneficiary or refuses to make appropriate distributions to the beneficiary or commits outright fraud or embezzlement.
Exempted Creditors: In some states, certain entities are not considered creditors and can access funds in the trust, even though they might have to go through the courts. For instance, a parent seeking child support or an ex-spouse who is owed alimony may be allowed to bring suit to access the funds in the trust. Some states also allow creditors who provide “necessary” goods and services — such as food, housing, and medical care — to go after funds in the trust. Lastly, the IRS can sometimes go after money in a spendthrift trust. This IRS Memorandum explains that the IRS may levy on certain assets of the trust, despite the existence of spendthrift provisions, if the taxpayer possesses fixed and determinable property rights in the trust. A levy will seize the taxpayer’s fixed right to trust income and the taxpayer’s fixed right to obtain a future distribution from the corpus. Also, if a trustee distributes funds that the trustee knows are encumbered by a federal tax lien, the trustee can be liable for tortious conversion, i.e., intentionally impairing the security of the IRS lien.
Many people have some or all of the concerns mentioned at the beginning of this article. If you share any of these concerns, the Beneficiary Asset Protection Trust / Spendthrift Trust may be your best option. Talk to a qualified Virginia estate planning attorney, Maryland estate planning attorney, or DC estate planning attorney about this and other trust solutions.
