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In last week’s blog we discussed what a living trust and addressed some of the most common claims made about living trusts.  This week we will take a closer look at some other issues that should be considered in deciding whether a living trust is right for you.

1.  Creditor Protection

A Living Trust Can Protect Trust Assets From the Beneficiary’s Creditors – TRUE.  As long as the beneficiary is not the person who funded the trust, a living trust can protect assets held inside the trust from creditors of the beneficiaries of the trust if the trust is designed properly.  Whether a beneficiary’s creditor can reach the beneficiary’s interest in the trust depends upon whether the beneficiary can reach those assets, has an absolute right to the use and enjoyment of the assets or compel a trustee to distribute those assets to the beneficiary.  If the beneficiary has an absolute right to the use and enjoyment of the assets, then so does the beneficiary’s creditor.  Likewise, if a beneficiary can compel a trustee to distribute assets to the beneficiary, then so can that beneficiary’s creditors.  Whether this right exists depends upon whether the distribution standard is mandatory or discretionary.

Mandatory or Discretionary Distributions? If a living trust requires the trustee to distribute assets to a beneficiary, then a beneficiary’s creditor can reach any and all assets the trustee is required to distribute.  A common distribution provision found in many living trusts requires the trustee to distribute the beneficiary’s share in three equal installments at preset intervals, i.e. “My trustee shall distribute one-third of the principal and accrued interest when the beneficiary attains the age of thirty, one-third when the  beneficiary attains the age of thirty-five, and all remaining principal and accrued interest when the beneficiary attains age forty.”  This is a mandatory distribution.  The trustee must distribute assets of the trust as directed and a beneficiary could compel the trustee to make the distribution if the trustee fails to do so.

A discretionary distribution scheme may read something like “My trustee may distribute such amounts of trust income, principal, or both, as my trustee, in its sole, absolute, and unfettered discretion deems appropriate for the beneficiary, which shall include the power to make no distribution at all.” Here, the trustee has no obligation to distribute anything to the beneficiary and the beneficiary has no power to compel the trustee to make a distribution.

Why Would Someone Want to Protect a Beneficiary’s Share from That Beneficiary’s Creditors?  The most common scenario is the protection of family assets from a division and distribution of those assets through a property settlement in a divorce. The estranged or soon-to-be ex spouse cannot reach assets that the beneficiary cannot reach themselves, so family assets would be preserved for future generations instead of distributed to an ex-spouse in divorce. This can be accomplished through a discretionary distribution standard because the beneficiary has no mandatory right to the trust assets. On the other hand, if the trust contains a mandatory distribution formula, an ex-spouse could reach the beneficiary’s interest in the trust.

2.    Protect and Enhance A Minor’s Inheritance

Leaving assets outright to a minor can be a classic example of the law of unintended consequences.  Parents, grandparents, and other relatives may leave money to a minor thinking the parent or guardian will invest the inheritance so that by the time the minor reaches the age of majority, the inheritance has grown into a nice sum.  They may have even established an account under their state’s version of the Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA).

There are several issues that should be considered with this approach.  Among the issues are:

  • Assets held in a UTMA or UGMA account is not necessarily protected from the custodian’s creditors.
  • Assets held in a UTMA or UGMA account may prevent the minor from receiving financial aid for college.
  • Assets held in a UTMA or UGMA account must be distributed to the minor when he or she turns 18, or at the latest 21, without regard to whether the person’s circumstances, i.e. substance abuse issues, financial issues, etc.

In the absence of a UTMA or UGMA account, some states require a minor’s inheritance to be paid to the clerk of court for safekeeping until the minor reaches the age of majority.  By state law funds held by the clerk may only be invested in US bonds or state bonds.  Currently the rate for a one year constant maturity US Treasury Bond is .66%. The average annual rate of inflation since World War II is 3.94%. The longer money is held and invested by the clerk, the more inflation erodes the value of the gift.

On the other hand, if the minor’s inheritance were gifted in a properly worded trust, the trustee could be permitted to invest in assets that may provide a better rate of return, one higher than the inflation rate so that the minor’s inheritance actually increases overtime by outpacing inflation.

Trusts are not just for tax planning.  A properly drafted trust can provide a number of other benefits.  To see if a trust is right for your estate plan, speak with your estate planning lawyer.

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