When to Consider Discretionary Trusts for Your Estate Plan

Takeaways

• A discretionary trust protects inherited assets from creditors, predators, and divorcing spouses by placing them under the control of a trustee, not the beneficiary.
• These trusts can be tailored to your specifications, allowing the trustee to provide funds to your chosen loved ones for certain types of expenses, such as education or health care.
• Discretionary trusts can also help minimize estate taxes through generation-skipping planning and ensure that your assets pass to your chosen beneficiaries.

Leaving your hard-earned assets outright to your children, grandchildren, or other loved ones after you die may seem like the simplest way to pass on your legacy. But what appears straightforward can often expose those assets to unnecessary risk – from creditors and lawsuits to financial predators and divorcing spouses.

To provide greater protection and long-term security, it may be wise to consider leaving assets in a discretionary trust. This estate planning tool gives your trustee the flexibility to manage and distribute funds according to your intentions – while shielding your beneficiaries from potential threats.

Instead, you may want to consider designating certain loved ones as beneficiaries of a discretionary trust in your estate plan.

Why Choose a Discretionary Trust?

A discretionary trust protects inherited assets from creditors, predators, and divorcing spouses by placing them under the control of a trustee, not the beneficiary.

These trusts can be tailored to your specifications, allowing the trustee to provide funds to your chosen loved ones for certain types of expenses, such as education or health care.

Discretionary trusts can also help minimize estate taxes through generation-skipping planning and ensure that your assets pass to your chosen beneficiaries.

What Is a Discretionary Trust?

Amid today’s number of frivolous lawsuits and high divorce rates, you want to ensure that the money and property you hope to pass down to your loved ones will remain safe and secure, benefiting them for years after you are gone. Discretionary lifetime trusts can be a useful tool for estate planning, whether your beneficiaries are children or adults.

A discretionary trust is a type of trust you can set up to protect your assets for your loved ones if you have concerns about anything from a beneficiary’s poor money-management skills, extravagant spending habits, or personal or professional judgment to their creditors or divorcing spouse.

A discretionary trust protects the money or property you leave behind by giving the trustee control over when and how your loved ones receive their inheritance. Since your beneficiaries do not have an automatic right to the trust funds, those assets are usually protected from things like creditors, lawsuits, or divorce. This kind of trust can also make it less likely that someone will try to sue, and it gives the trustee more flexibility to handle any legal or financial challenges that may come up.

This kind of trust is irrevocable, meaning you cannot change it once it has been created. The trust holds funds or property that you place into it. (This is known as “funding” the trust. You can fund the trust while you are alive or have the assets transferred to the trust after your death.)

The assets in a discretionary trust are set aside for the benefit of your loved ones, just as you have chosen. However, they do not legally own the assets – the trust does.

You then name a trustee to manage the trust for your loved ones. The trustee can be a person, a professional trustee, or an institution, such as a bank. The trustee distributes assets to your beneficiaries according to your wishes.

The trust is “discretionary” in that you typically have the discretion to dictate the specific circumstances regarding when and how much of the trust funds your loved ones will receive.

For example, you may want to permit the trustee to use trust funds to help a beneficiary pay for education expenses, health care costs, a wedding, a new home, or the launch of a new business. If you worked with an experienced estate planning attorney to create the trust, funded the trust with sufficient assets that have been invested prudently, and have chosen a reliable trustee to carry out your wishes, the trust funds could last for the beneficiary’s entire lifetime.

You can make the terms and time frames as limited or as broad as you want. For example, you may want to provide that the trustee distributes the trust funds only for health care needs after the beneficiary reaches the age of 21. Or, you can provide that your beneficiaries receive payments for health care needs and educational expenses at any age.

The goal of a discretionary trust is to help protect your loved ones’ inheritance from potential risks. This can be especially helpful if a beneficiary is inexperienced with money, struggles with spending, is in a troubled marriage, works in a high-risk profession, or is concerned about lawsuits or future debts.

Instead of the funds being available to pay off a beneficiary’s creditors, the trust keeps those assets safe and under the trustee’s control.

These discretionary provisions can also be added to other types of trusts, depending on your overall planning goals.

As stated above, you can fund a discretionary trust while you are alive or after you die. If you plan to fund the trust after you die, your assets will be transferred into the trust for the benefit of your beneficiaries after your death.

How Does a Discretionary Lifetime Trust Protect an Inheritance?

With a discretionary lifetime trust, each of your beneficiaries will have a fighting chance against lawsuits and divorcing spouses because their inheritance will be segregated inside of their trust, away from their own personal assets, and out of their control.

Creating this type of protective “box” around the inherited property shows the world that the inheritance is not the beneficiary’s property to do with as they please. Instead, only the trustee can reach inside the box and, based on your specific instructions, pull funds out for the benefit of the beneficiary. Creditors, predators, and divorcing spouses are generally blocked from reaching inside the box and taking property out.

When the beneficiary dies, what is left inside their box will pass to the heirs you choose. You could decide, for example, to have the assets pass to your grandchildren inside their own separate boxes and on down the line, thereby creating a cascading series of discretionary lifetime trusts that will protect the inherited property and keep it in your family for decades to come.

Estate Tax Liabilities

Setting up discretionary trusts as part of your estate plan comes with an added bonus: These trusts can be designed to minimize estate taxes. This is because the trust assets pass down from your children to your grandchildren (this is referred to as “generation-skipping planning”). In addition, you can dictate who will inherit what is left in each beneficiary’s trust when the beneficiary dies, which will allow you to keep the trust assets within the family.

While the distribution choices that can be included in a discretionary trust are virtually endless (within certain parameters), the bottom line is that a properly drafted discretionary trust protects a beneficiary’s inherited assets from creditors, predators, and divorcing spouses, avoids estate taxes when the beneficiary dies, and ensures that assets ultimately pass to the beneficiaries of your choice.

Work With an Estate Planning Attorney

If you are concerned that your children, grandchildren, or other family members do not have the skills required to manage and invest their inheritance or will lose it in a lawsuit or divorce, work with an experienced estate planning attorney to discuss how to set up discretionary trusts into your estate plan.

Keep in mind that estate planning includes executing other key documents as well, such as your last will and testament, durable power of attorney, and living will.

For additional reading on trusts and other aspects related to passing your assets on to your loved ones, check out the following articles:

• 5 Rights a Trust Beneficiary Has
• Inheritance Tax: What States Have It and When It Applies
• Make Sure Your Beneficiary Designations Match Your Estate Plan