Protection for Beneficiaries Using Discretionary Lifetime Trusts

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A discretionary lifetime trust provides asset protection by creating a legal barrier between the property it holds and a beneficiary's creditors or spouse if they should become divorced. These trusts can be especially helpful if any of your beneficiaries are children. It all comes down to the language and terms included in the trust's formation documents.

What Makes a Trust Discretionary?

A discretionary trust is pretty much exactly what the name implies: Distributions are made at someone else's discretion, namely the trustee. They're not a sure thing with respect to when and how they'll be transferred to beneficiaries, and beneficiaries have no control over and can't demand distributions.

Many state courts have taken the position that if this is not the case—if the terms for bequests and distributions are set in stone in the trust's formation documents and according to the wishes of the grantor or creator of the trust—these inheritances are something of a present-day ownership situation.

They can therefore be reached by creditors and by ex-spouses in divorce situations, and their values can be incorporated into alimony and child support obligation calculations.

It can also be helpful to name an institutional trustee rather than a friend or family member to act as trustee. This provides an additional degree of separation between the beneficiary and the terms of the trust.

Irrevocable trusts that include "spendthrift" language can safeguard against these eventualities to some extent, but they're only foolproof if they're discretionary. Many states have taken the position that assets held in a spendthrift trust are otherwise reachable in divorce situations.

Discretionary Trusts for Minor Beneficiaries

Minors can't legally manage their own property or accounts, so an adult must do so for them. The court will appoint someone to oversee their inheritances for them until they come of age if you don't name anyone in your estate plan. A discretionary trust avoids this. 

Many parents and grandparents choose to terminate a minor's trust when the child reaches a certain age, such as 25 or 30—a time when they believe the minor will be mature enough to invest, spend, and manage their own inheritance. The trust is terminated by distributing the remaining assets outright to the beneficiary when they reach that specified age.

But the assets are considered to be the beneficiary's own property at this point and they therefore become available for creditors' claims, including judgment holders in lawsuits. The property becomes vulnerable to a spouse in divorce proceedings.

Continuing the Trust

You can continue the trust for the benefit of a young beneficiary so it lasts through their entire lifetime. There's no rule that says the trust must terminate at a certain age.

A discretionary lifetime trust can create an asset protection barrier between the beneficiary and the beneficiary's creditors as the beneficiary gets older if it's drafted properly. The assets held in the trust remain there for their benefit and out of the pockets of creditors and spouses because they don't technically own them—the trust does.

Asset Protection for Adult Beneficiaries

You can also set up a discretionary lifetime trust for the benefit of a beneficiary who is already an adult, even your spouse. You might consider doing so for the same reasons you created one for a minor—lifetime asset protection against creditors, judgments, and divorcing spouses. AB Trusts or ABC Trusts can both be designed to include asset protection for your spouse.

When a Discretionary Trust Makes Sense

A discretionary trust can be drafted to not only protect adult beneficiaries from outside influences but from themselves as well if you know that they're not good with managing money and you worry that they'll deplete their inheritance in record time. It can safeguard inheritances against a beneficiary's own bad decisions or excessive spending habits.

State Laws Can Differ

Consult with an attorney in your state if you're considering establishing a discretionary trust. The exact rules and provisions can vary from jurisdiction to jurisdiction. The information contained in this article is not intended as legal advice and it is not a substitute for legal advice.