When creating a last will and testament or a living trust, there are certain planning techniques that can be advantageous to those who inherit your assets. One such technique is distributing assets to your beneficiaries in trust to provide them with creditor protection, which they would be unable to create for themselves.
The IRS rule is that when a trust limits the distribution of principal to an ascertainable standard, the trust is protected from creditors and divorce. Limiting distributions to beneficiaries for their health, education, maintenance, or support (HEMS) falls within the IRS guidelines of an ascertainable standard that creates creditor protection for the beneficiary. While this type of trust may sound restrictive, HEMS is very broad and the trust can essentially be used to maintain the beneficiary’s lifestyle. The principal of the trust can be used to pay for the beneficiary’s schooling, rent, taxes, medical expenses and more. Additionally, assets, such as a real property, can be bought directly in the name of the trust, thus protecting the assets immediately upon purchase. Lastly, the beneficiary can be their own trustee and have the right to withdraw the income generated from the trust, all while maintaining creditor protected status.
If you are concerned that a beneficiary may want or need access to the trust beyond HEMS distributions, or that the trust may become too burdensome or impractical to manage, your estate planning documents can provide for ways to either completely undo the trust or to authorize a distribution of principal beyond the beneficiary’s health, education, maintenance, or support.
Aside from creditor protection, there are additional benefits that come with beneficiary trusts. If, for example, there is a concern that a beneficiary may end up with a taxable estate, the beneficiary trust can be structured so that the assets are not includable in the beneficiary’s estate. This could help reduce, if not eliminate, a large estate tax on the beneficiary’s death.
Another benefit is the ability for you to maintain control of the distribution of trust assets should your beneficiary die before the complete distribution of their trust. You can name individuals and/or charities as remainder beneficiaries of the trust should something happen to the initial beneficiary. Alternatively, if you want the beneficiary to have the power to choose the remainder beneficiaries of their trust, you can authorize them to do so by giving them a testamentary power of appointment to appoint their share under their own estate planning documents.
Finally, if your beneficiary is unable to manage his or her own finances for any reason, you can name someone other than the beneficiary to be the Trustee and manage the trust assets. You can include specific instructions on how to administer the trust, thus ensuring that the beneficiary is properly taken care of and that assets in the trust will last for an extended period of time.
Because it is not always immediately clear whether a beneficiary trust or outright inheritance is the right distribution for your beneficiaries, it is important to meet with your estate planning attorney and provide them with as much information as possible in order for them to properly advise on the creation of your documents.