Estate planning involves more than just figuring out who will inherit your property when you die. You must also decide how and when these people will receive their inheritances. You have three options for adult beneficiaries: They can inherit outright, they can receive their bequests in stages, or you can create a discretionary lifetime trust to hold their assets.
It can be a very important consideration. Approximately 70% of families have lost their wealth by the second generation, and this number jumps to 90% by the third generation, according to the Texas law firm of Romano & Sumner.
Leave Assets Outright
Giving adult beneficiaries their inheritances in one lump sum is often the simplest way to go because there are no issues of control or access. It's just a matter of timing. The balance of the estate is distributed directly to the beneficiaries after all the decedent's final bills and taxes are paid.
But there are a few drawbacks to this approach. A beneficiary's inheritance might be gone in no time if they're bad with managing money. Their inheritance could be lost in a divorce settlement. Your bequest could be taken in a lawsuit if they're in a high-risk profession.
The amount of the inheritance you're leaving should be weighed against the beneficiary's age, experience, and family and financial situations.
Leave Assets in Stages
Another option is to hold an adult beneficiary's inheritance in a trust fund, then pay it out in one or more lump sums over time. A beneficiary might receive a final, outright distribution of their inheritance when they reach a certain age or when they achieve a specific goal.
For example, you could pay a beneficiary 50% of their inheritance when they reach the age of 25, then the balance at age 30. Or you could give them 50% when they earn a college degree and the balance when they complete graduate school.
But be careful with any restrictions you impose. You could open the door to legal challenges by beneficiaries if they perceive them as being too strict or unreasonable. For example, a court might overturn your wishes if you try to prevent any funds from going to political inclinations your offspring supports. They fly in the face of their constitutional freedoms.
It's generally not possible to set conditions on inheritances that are passed in a last will and testament, and the federal Benefit-of-the-Beneficiary Rule states that even a "trust and its terms must be for the benefit of its beneficiaries."
Meanwhile, property that's held back in the beneficiary's trust fund can be used by the trustee to pay for the beneficiary's college or graduate education, medical bills, a car, housing, or other day-to-day needs. Just keep in mind that you risk the same drawbacks as leaving an entire inheritance outright when the beneficiary receives a lump sum distribution.
Other drawbacks of using a staggered trust include the added costs of accounting and legal advice during the term of the trust. The trustee will most likely charge a fee for services rendered as well, and all this will deplete your beneficiaries' inheritances.
Leave Assets in a Discretionary Trust
Your third option is to leave a beneficiary's inheritance in a discretionary trust fund for their entire lifetime. This type of trust leaves the distribution of income or property up to the discretion of the trustee, although some restrictions can apply.
Assets held in a discretionary lifetime trust or asset protection trust remain protected from divorcing spouses and lawsuits if the trust agreement is written properly. Your assets will be protected from the beneficiary's potentially bad decisions and outside influences as well if you appoint a corporate trustee such as a bank or trust company.
You can name the beneficiary as trustee when they reach a certain age and if you believe that they'll be responsible enough by then to take full control, or you can designate a corporate trustee during the entire term of the trust.
You can control who will receive what's left in the discretionary lifetime trust if there's anything remaining when the beneficiary dies. Meanwhile, the trust can pay directly for the beneficiary's needs...but no more. No lump sums will be at risk.
Consider setting up the trust as a dynasty trust if the beneficiary already has a sizable estate, or if you want to create a lasting family legacy. This will avoid estate taxes being paid by the estate of the beneficiary, as well as the estates of the beneficiary's descendants.
All these benefits aside, the drawbacks of using a discretionary lifetime trust are the same as those of using a staggered trust. There will be added costs and expenses for accounting, legal advice, and trustee fees.