Leaving Assets Can Be Tricky – Part 2

Maybe you grew up without much. You worked hard. You earned a good education. You succeeded in life even though the streets weren’t paved with gold where you grew up. In fact, maybe you grew up in a very impoverished, oppressed community.

Now you (and your spouse if you’re married) have accumulated enough so you’re comfortable. Maybe you’re not a billionaire, but you feel like you’ve achieved a reasonable level of material success. After your death, you’d like to provide for your loved ones so they can be a step up the ladder of financial stability and so they can get a good education and get a good start in life.

Deciding to whom you want to leave your assets is often the easy part. Often the difficult decision is determining the best way to leave them your assets. Let’s say you want to leave your assets to your children at your death. What’s the best way to do it?

You could leave your assets to them outright. That might be the right solution sometimes, but all too often, that’s not the right solution. This is the second in a series of blogs that will examine different ways to leave assets to a beneficiary and when and why that might be appropriate.

The first article in the series discussed the “Divorce Protection” Trust or “Access” Trust. The second way which is the topic in this article is a fully discretionary trust, often called an “Asset Protection” Trust or a “Sentry” Trust. In many ways these trusts are opposites. While the beneficiary of an Access Trust has the right to demand whatever they want, whenever they want it, the beneficiary of a Sentry Trust cannot demand anything ever. The distributions from the trust are in the complete discretion of the Trustee.

A completely discretionary trust has many benefits. First, it allows the trustee to use their discretion and withhold distributions if they think the beneficiary is acting unwisely or inconsistent with their best interests. For example, this type of trust might be good for someone with a substance abuse problem or a gambling addiction.

This type of trust also is the best way to provide asset protection. A creditor of a beneficiary stands in the beneficiary’s shoes. So, if the beneficiary can access funds so can their creditor. In this trust, the beneficiary cannot demand anything, so neither can their creditors.

Let’s look at a quick example. Jasmine is leaving assets to her son, Willie. Willie has a history of substance abuse and drunk driving. In fact, Willie is currently incarcerated related to his substance abuse issues. Jasmine would like to be sure Willie’s inheritance is protected and used for his best interests. Jasmine leaves the assets in a Sentry trust for Willie’s benefit.

The trustee, who should not be Willie, can use the assets for Willie’s benefit, in the trustee’s discretion. But Willie cannot force any distributions from the trust. This way, the assets are protected from Willie’s creditors and Willie’s indiscretions. If there is a victim of the crime, there could be restitution owed. Even if it is a victimless crime, most states charge inmates for the privilege of being housed and fed during their stay.

For example, for a recent three-year stay, Florida charged $55,000. As prisons pay inmates little or nothing, they often come out with large debts that could wipe out an inheritance if it weren’t left in a protected trust. Here’s an article from the Huffington Post describing the issue.

From an income tax standpoint, this trust is treated as a separate taxpaying entity. A separate tax ID number is needed for the trust. The trust’s taxable income might be carried out to Willie if there are distributions to Willie that year. Otherwise, the trust pays its own taxes (at a compressed rate schedule).

A Sentry Trust allows someone serving as Trustee to watch over the assets of the beneficiary and distribute them to the beneficiary in the Trustee’s discretion. This protects the beneficiary from the beneficiary’s creditors or misjudgment.

In the next article in the series, we’ll look at the best way to leave assets for a beneficiary who may have special needs.

Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com