Over 40 percent of all marriages in the United States end in divorce. Regardless of how you feel about your child’s spouse, the reality is that they could become your child’s ex-spouse. Without proper planning, money and assets that you leave to your child could be subject to a division of marital assets. With careful estate planning, however, your child’s inheritance can be kept safely out of the hands of their spouse or former spouse.
Separating Inheritance Money from Marital Money
During marriage, the lines between what each partner owns can blur. Generally, whatever is acquired during the marriage by either partner becomes marital property that is subject to division in the event of a divorce, but there are exceptions.
One exception is a bank account that is kept separate during the marriage. Inheritance money that you leave to your child or monetary gifts that you give to your child during your lifetime can theoretically go into a separate account. However, in practice, it can be difficult for spouses to avoid commingling bank accounts. Even something as simple as depositing marital money into the account or using it to pay bills during the marriage could make the account marital property.
A better way to keep your child’s gift or inheritance separate from their spouse is for it to be held in a trust. Regardless of the amount you are giving to your child, a trust is an excellent way to protect it. A trust is a flexible and powerful estate planning tool that allows parents greater control over the money and property that they pass transfer to their children.
Trust Management and Third-Party Trustees
Holding your child’s inheritance in trust involves doing the following:
- You place money and assets in a trust
- You name a trust beneficiary (your child)
- You name a trustee (somebody to manage and distribute the trust assets)
- You leave written instructions (the trust document) specifying how the trust assets are to be used
Your child could be named as both the beneficiary and the trustee of the trust, but without some additional measures, such an arrangement would not provide protection. Just as commingling can occur with a separate bank account, if your child uses money in the trust for marital expenses and then gets divorced, the court could consider the trust funds to be marital property.
A third party could be named as trustee who would use their discretion or the instructions in the trust to determine how the trust assets are used.
Instead of distributing money from the trust directly to the beneficiary (which raises the possibility of commingling and trust division in a divorce proceeding), the trustee can pay third parties on the beneficiary’s behalf. For example, if the beneficiary needs a new vehicle, the trustee can pay the car dealership directly. Or, for larger purchases such as a home, the trustee could loan the money to the beneficiary. The house would be used as collateral to secure the debt to the trust and protect it from asset division.
Child and Trustee as Co-Trustees
Giving a single third-party trustee sole discretion over trust fund distributions provides the most protection against asset commingling, but it provides your child with limited flexibility over how they can spend their inheritance. If you prefer to give them more options but still protect the funds you leave to them in the event of a divorce, you can name a third party to serve as co-trustee with your child. However, other restrictions may be appropriate for creditor protection and tax purposes.
When setting up a trust, there are several types of trustees that you can choose from, each with a different set of responsibilities and obligations. For example, you might name your child as an investment trustee, giving them the authority to invest and manage the assets held in the trust. In this capacity, your child is acting on behalf of the trust (not in a personal capacity), so the trust money is not commingled with marital assets. At the same time, with good investments, the trust assets can grow. You can then have a co-trustee handle distributions for your child’s benefit.
Naming co-trustees has other benefits as well. In the event of a divorce or creditor issues, your child can resign as trustee, leaving the other trustee with sole discretion over trust distributions. You can also set up the trust in such a way that an independent co-trustee can make distributions to your child for any purpose, but your child as trustee is limited to making distributions for health, education, maintenance, or support, considered a safe harbor under federal law. While this arrangement does not provide the maximum creditor protection (because any distributions made to the child could be susceptible to creditors), amounts remaining in the trust may still be protected. In addition, special consideration must be given to the beneficiary’s ability to remove and replace another co-trustee.
To create a strong trust strategy to keep your child’s inheritance out of their spouse’s hands, you must consider many contingencies. One such contingency is what happens when your child passes away.
Should your child either predecease you or pass away before receiving the full benefit of the trust that you establish for them, the trust may, by default, be inherited by their spouse — unless you have planned for this event. You can keep your child’s spouse from receiving the trust assets by naming a contingent beneficiary to your child. You could name your grandchildren, your child’s sibling, a charity, or any other party that you specify as the next beneficiary.
In addition, be careful when giving a testamentary power of appointment to your child. This power would allow your child to direct trust property (or their share of trust property) to another individual upon their death, and that person could be their spouse. As the creator of the trust, though, you can limit who the trust property can go to, such as your child’s children or other descendants only.
Take Control of Your Legacy
If your child is in a new marriage, or one that you have concerns about, you can take steps to protect what you give them, making sure that the assets benefit your child and family as you intend. Giving assets in trust, rather than outright, builds in the desired protection.
There are many varieties of trusts. A trust can be customized in a way to address your goals and concerns.
Remember that your estate plan can—and should—be revisited. You can include restrictions in the trust now and remove them later if circumstances change. You can also decide to do away with the trust altogether. Whatever plans you have for your money and assets, make the most of them by getting help to build a comprehensive estate plan. Contact us to set up an appointment.