Family Protection Trusts for Seniors

By Harry S. Margolis

While much of elder law involves planning to protect seniors, their spouses and their estates from the costs of long-term care, that is far from the only concern that older clients have when doing their estate planning.

A significant purpose of long-term care planning is to protect hard-earned assets so that they can improve the lives of children and grandchildren. But in many instances the best laid plans and hopes go awry when those children and grandchildren come up against the realities of life. Inherited funds may be lost under any of the following circumstances:

Divorce. If a child is divorced and the marriage had lasted for longer than ten years, anything she inherited from her parents is likely to thrown into the pot to be divvied up between her and her spouse. If the parent has been divorced herself, she’ll recognize the economic, as well as emotional, havoc that divorce can wreak.

Death. When a child dies, his estate will pass according to his estate plan, assuming he has one. In most cases, with our without a plan, if the child has a surviving spouse she will receive his entire. This may be fine for some clients, but not for others, especially after the child’s spouse gets remarried, sometimes meaning that the assets don’t ultimately pass to the clients’ grandchildren, but instead to the new spouse or to his children.

Problems. Do any of the client’s children, or their spouses, have issues with drugs, alcohol or gambling? Do they like to spend money a bit too much? Do they have trouble holding down a job? A yes answer to any of these questions means that an inheritance may not be a gift that keeps on giving. Instead it could lead to more trouble than it’s worth.

Health. If a child or her spouse is in ill health, two issues can arise with an inheritance. First, it may be difficult for the child to manage the funds. Second, the funds may have to be spent down before Medicaid will pick up the cost of the child or her spouse’s care.

Bankruptcy. This probably goes without saying. If a child faces the prospect of bankruptcy or has a history of financial difficulties, she should not receive an inheritance directly. It could all go to paying creditors.

Blended Families. Does the client have a child married to someone with children form a prior marriage? Does the client care where his money ultimately goes? He may say it’s none of his business, but then again he may not.

Disability. Does the client have any children with a disability or special need? If so, a direct inheritance carries with it the same management and public benefits issues as do health challenges. In addition, an inheritance can upset eligibility for Supplemental Security Income and subsidized housing.

Taxes. As someone said, nothing’s certain but death and taxes. But they don’t always go together. Only a very small percentage of estates are subject to the federal estate tax, currently only those worth more than $2 million. A higher percentage are subject to the Massachusetts estate tax, which kicks in for estates exceeding $1 million, but the Massachusetts estate tax rate is much lower than the federal one. The issue for clients concerned about planning for their children is whether their children have taxable estates. Giving them more money directly can subject the inheritance to a combined tax of more than 50 percent at the child’s death.

Lawsuits. Have any of the client’s children been sued? Are they in a profession where there’s a high rate of lawsuits, such as doctors? Again, a direct inheritance would be subject to claim to pay off a lawsuit.

Stretch IRAs. There’s been a lot written lately about the compounding advantages of tax deferral. If a senior leaves an IRA and properly names his children as beneficiaries they can withdraw the IRAs over their lives. If they properly name their children as the next beneficiaries, they too can stretch out what’s left of the IRAs over their life expectancies. Due to the fact that earnings are not taxed until the IRA funds are withdrawn, if heirs only withdraw the minimum required by law over the years IRAs can grow to large family legacies. But to make this happen, beneficiaries must withdraw the minimum, not break the piggy bank with early spending.

This litany of woes is not meant to depress the client or her advisor, but as a call to action. While these challenges can face the children of clients of any age, older clients are more likely to have experienced one or more of them themselves and to understand the costs involved. A client who has been sued or who has been divorced, will want to protect her children from at least some of the potential losses. Fortunately, there is a way to do so.

The Solution

Under the common law, parents and grandparents have always been able to leave their estates in so-called "spendthrift" trusts for their impecunious offspring. If properly drafted and administered, heirs can be discretionary beneficiaries of such trusts while at the same time the trust funds can be protected from their creditors.

Wealthier clients have used these trusts all along both for asset management and protection purposes and to escape repeated taxation at every generation. But there is no reason that their protections cannot be extended to not-so-wealthy clients.

These have typically been called "generation-skipping", "dynasty" or "bloodline" trusts. Armond Budish in his book Why Wills Won’t Work (If You Want to Protect Your Assets): Safeguard Your Estate for the Ones You Really Love calls them "SAFE" trusts. We find some of these terms a bit off-putting and in our practice, we call these trusts "family protection" trusts.

Choice of Trustee

Ideally, family protection trusts have an independent trustee with discretion to make or withhold distributions to the beneficiaries. However, clients often object to the cost and lack of control involved in turning trust assets over to a professional trustee. It is possible for a child to be trustee of his own family protection trust. But he must follow the terms of the trust assiduously and resign as trustee if he sees the possible occurrence of any of the unfortunate events listed above.

The problem is that family trustees often do not follow the terms laid out in the trust instrument and even if they do, the trusts may offer less protection than they would if administered by a completely independent trustee. These are tradeoffs the client and attorney must discuss in preparing the trust. Even with the child as trustee, the trust will offer more protection than would a direct inheritance.

Drafting Issues

Family protection trusts may be drafted differently depending on their primary purpose – asset protection in the event of lawsuit, keeping the funds in the family line, or avoiding repeated taxation. Depending on the purpose or purposes, the beneficiary may have more or less access to the trust funds. She may have a right to income. Distributions may be limited to health, education, maintenance or support, or made for any reason. The beneficiary may have the right to withdraw up to 5 percent of the trust principal each year.

The grantor may want to create an incentive trust – permitting distributions of principal if the beneficiary achieves certain goals. The grantor may or may not want to include grandchildren as beneficiaries while the children are alive. Children may or may not be given powers of appointment to determine who receives the trust assets upon each child’s death. The trust may be drafted to minimize IRA withdrawals and protect IRAs from creditors.

In short, there are many ways to tailor a family protection trust to the client’s situation and goals.

Conclusion

Due to their own life experiences, seniors are more apt than younger clients to take advantage of the opportunity to protect what they leave behind for future generations. Some may object that they should not control their children and grandchildren from the grave. But that is not necessarily what this is about. Instead it is an opportunity to take advantage of trust law to leave a lasting legacy. All clients should be given this opportunity.

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