When deciding who you want to inherit your estate after you die, aside from figuring out who will get what, you'll need to determine how and when they'll get it. If your plan will involve one or more minor beneficiaries, legally they can't inherit property, so anything left outright and directly to a minor will either end up in a court-supervised guardianship or conservatorship or in a restricted account as dictated by a judge and state law. You'll need to plan carefully for a minor beneficiary by choosing one of three options: leaving their inheritance in a restricted account, leaving it in in stages, or leaving it in a lifetime trust.
Leaving Assets in a Restricted Account
If the amount that you are leaving to the minor is not significant, then the easiest thing to do is to direct that the minor's inheritance is held in a restricted account for the benefit of the minor until they become an adult. Restricted accounts include those established under an applicable state Uniform Transfers to Minor Act (or UTMA account) or a Uniform Gifts to Minors Act (or UGMA account). These types of accounts can be used to provide for the health, education, and maintenance of the minor until they reach the age of 18 or 21 (the age at which the account must terminate depends on applicable state law). Another type of restricted account that can be established is a 529 account, which must be used to pay for the minor's college education.
The main drawback of using a UTMA or UGMA account is that the beneficiary will receive what's left in the account outright and without any strings attached at the age of 18 or 21. Thus, these types of accounts should only be used for small inheritances.
The main drawback of using a 529 plan is that the inheritance must be used to pay for the education of the beneficiary. Thus, if the beneficiary decides not to go to college, then the 529 plan will need to go to another beneficiary.
Leaving Assets in Stages
Another option is to hold a minor beneficiary's inheritance in trust and pay the beneficiary one or more lump sums in stages. In other words, when the beneficiary reaches a certain age or achieves a specific goal, then they'll receive an outright distribution of their inheritance.
For example, you could pay a beneficiary 50% of their inheritance when they reach the age of 25 and then the balance at 30, or 50% when they earn a college degree and then the balance when they complete graduate school. Meanwhile, the property held back in the beneficiary's trust could be used by the Trustee to pay for the beneficiary's college or graduate education, medical bills, or housing and other day-to-day needs.
Once the beneficiary receives a lump sum outright and free of trust, the property will be vulnerable to divorcing spouses, lawsuits, and the beneficiary's own bad decisions. Other drawbacks of using a staggered trust include the added costs of accounting and legal advice during the term of the trust and the fee that the Trustee will be entitled to receive for services rendered while administering the trust.
Thus, when considering the use of a staggered trust for the benefit of a minor beneficiary, the amount of the inheritance must be weighed against the costs and expenses associated with administering the trust.
Leaving Assets in a Lifetime Trust
The final option is to leave a minor beneficiary's inheritance in trust for their entire lifetime. There are many benefits to choosing this option:
- Assets held in the trust will be protected when the beneficiary becomes an adult from divorcing spouses, lawsuits, and, if a third party trustee is used, then from the beneficiary's own bad decisions and outside influences.
- If there's anything left in the trust when the beneficiary dies, you can control who will receive what's left.
- If you want to create a lasting family legacy, then you can set up the lifetime trust as a generation-skipping trust that will avoid estate taxes in the estate of the beneficiary as well as the estates of all of the beneficiary's descendants.
- You can use a third party trustee while the beneficiary is a minor but then make the beneficiary their own Trustee at an age when you think that they'll be responsible enough to take full control, such as 25 or 35.
Nonetheless, the drawbacks of using a lifetime trust are the same as those of using a staggered trust, all the added costs and expenses for accounting and legal advice and trustee fees. Thus, when considering the use of a lifetime trust, the amount of the inheritance must be weighed against the costs and expenses associated with administering the trust as well as your own long-term estate planning goals.