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E-Letter

Pros and Cons of Family Protection Trusts

By Harry S. Margolis

One of our staff members recently asked why not all of our clients create family protection trusts for their children and grandchildren. After all, a family protection trust permits a parent or grandparent to protect the funds being left to a child or grandchild from the threats of bankruptcy, lawsuit, and divorce. It also permits those inheriting to qualify for public benefits if needed without spending down the inheritance and make sure that if a child dies, the inheritance passes to the grandchildren, no matter who the surviving spouse marries next.

To our staff member, this seemed like a "no brainer." Everyone would want these protections for their family.

But there are some costs, in addition to our fee for creating these trusts. The funds will have to be kept in a separate account and the trust will have to file its own tax return each year. And the protections only accrue to the trust if the children follow the trust rules. If they play fast and loose with the funds in trust, they will lose the protections they provide. If they are going to quickly spend the funds anyway, the family protection trust will provide little benefit.

On the other hand, for clients who have children at risk or whose children don’t immediately need the trust funds, a family protection trust will provide considerable protections and the kind of retirement plan few jobs now provide.  Each client needs to weigh the advantages and disadvantages to detemine whether a family protection trust will benefit his or her family.  Here's a list of pros and cons to assist in that effort:

Advantages

  • Bankruptcy protection
  • Divorce protection
  • Protects inheritance from lawsuit
  • Keeps assets in the family (for grandchildren or other children) upon the death of a child
  • Provides for management of assets for children who may need assistance
  • Permits child or child’s spouse to qualify for public benefits without spending down inheritance
  • Avoids taxation of inherited assets upon child’s death

Disadvantages

  • Cost of creating trust
  • More complicated to have separate trust account
  • Need to file annual tax return for trust
  • Works only if child follows trust rules
  • Stronger protection if trust uses independent trustee, which may entail loss of control and ongoing trustee fees
  • Little benefit if child will quickly spend the inherited funds