Does your trust really protect your loved ones?
When parents or grandparents set up a trust, the goal is almost always the same: to provide for loved ones while protecting the assets that are passed down. Unfortunately, many trusts are still drafted with outdated provisions that can unintentionally create problems for beneficiaries.
Revocable living trusts—the most common trust for estate planning—are not separate from the Trustmaker who creates it. During the Trustmaker’s life, they are the Trustmaker, Trustee, and Beneficiary. That is, anything in their revocable trust belongs to the Trustmaker and is fair game for creditors. If the trust generates income, the Trustmaker pays taxes on it in the same way as any other income.
When the Trustmaker dies, their trust becomes irrevocable, because the only person who had the power to revoke it can no longer do so. An irrevocable trust is a separate legal entity: it gets its own EIN number and has to file a tax return every year. A Trustee manages the assets in the trust and makes distributions to one or more beneficiaries. Critically, unlike the Trustmaker, the beneficiaries of the irrevocable trust are not owners of the assets in the trust.
The separation between irrevocable trust assets and beneficiaries presents an important opportunity. If the beneficiary does not have a right to the asset, neither does their creditor.
With that in mind, here are three common pitfalls I see in trusts—and how careful planning can avoid them:
1. Age-and-Stage Rights of Withdrawal
When I review my clients’ old trusts, I often see provisions that give children or grandchildren the right to withdraw part of their inheritance at certain ages—for example, one-third at age 25, half at 30, and the rest at 35. On paper, this sounds like a way to spread things out and encourage maturity.
But life doesn’t always go according to plan. If your child is facing a lawsuit, struggling with debt, or going through a divorce at the time their right of withdrawal accrues, their creditor or ex-spouse may be able to claim what was meant to be protected inheritance.
A better option: Keep assets in a discretionary trust for the beneficiary’s lifetime. A discretionary trust allows the Trustee to make distributions at the Trustee’s discretion, meaning a creditor cannot compel a distribution to satisfy a debt. The Trustee can provide support when needed, while keeping the assets shielded from creditors and marital property claims.
2. Outright Distributions
Similarly, some trusts instruct the Trustee to distribute the assets outright to the beneficiary. When money leaves a trust and lands in a beneficiary’s personal bank account, it loses its protection. That inheritance may become part of marital property in divorce, subject to a lawsuit, or exposed to financial mismanagement.
A better option: Instead of requiring outright distributions, families should consider “beneficiary-controlled trusts.” These allow the beneficiary to access and even help manage the trust, but the protective shell remains intact.
3. No Special Needs Provisions
None of us knows what the future holds. A healthy beneficiary today could become disabled in the future. If their trust simply pays them outright, they may lose eligibility for important government benefits.
A better option: Every trust should include a provision allowing a Trustee to convert the Trust to a “special needs trust” if the situation warrants it. This provision gives the Trustee flexibility to design the trust so that it can supplement government benefits while retaining eligibility.
Your Trust Should be Customized for Your Unique Family
I always discuss tradeoffs with my clients: the more protection built into the trust, the more costly or burdensome the administration. We examine various factors, such as the age, strengths and vulnerabilities of the beneficiaries, the value and types of assets at play, and various family concerns. More protective provisions can be drafted to sunset when beneficiaries reach a certain age or milestone. Outright distributions can be appropriate, but Trustmakers should carefully weigh the risks versus benefits and make an informed decision. Trusts drafted for young children generally should be more protective, because we don’t know what the future holds or the kinds of challenges a child may face.
At Treetown Law, I use careful and thorough trust design and drafting to ensure your trusts provide lasting support, flexibility, and protection for the people you care about most.
