Simple estate planning techniques include adding beneficiaries to retirement accounts and adding transfer on death (TOD) designations to after-tax accounts. When you use these simple techniques, assets will avoid probate and can be transferred directly to the named beneficiary when you die. When the beneficiary receives the proceeds, they are free to do whatever they want.
If having assets distributed directly to a beneficiary may cause problems, there are several reasons to consider establishing a trust.
Distribution Conditions
You should set up a trust if you prefer to impose specific conditions on the funds. Many trusts specify that distributions can only occur at future ages, for instance, one-third at age 35, one-third at age 40, and the remainder at age 50. Before the trust pays out, some clauses may require the beneficiary to pass a drug test or have stable employment.
Trusts are especially useful in second marriages where one spouse wishes to leave their assets to their children rather than their stepchildren. Clients with large IRAs may wish to leave the account to their wife for her lifetime, but only through a trust, ensuring that the remainder of the assets goes to his children or whoever beneficiaries he has designated before his death. If he leaves the account to his wife outright, she can name anyone she wants as a beneficiary, effectively bypassing his wishes.
Creditor Defense
If your profession entails a high liability risk, putting assets in a trust (once the trust becomes irrevocable) may protect funds from being attached to a lawsuit. This can be very specific depending on state law and the type of lawsuit, and you should consult an attorney before proceeding.
Leaving money outside of an estate
In the case of large estates that are expected to grow, establishing trusts and gifting assets during your lifetime can remove the growth from your estate and lower future estate taxes. If your estate is likely to be larger than the exemption (currently $12.06 million per person for federal estate taxes, but often much less in some states) and you have more funds than you need. Establishing an irrevocable trust now may be advantageous.
Also, remember that revocable (or living) trusts become irrevocable upon your death, so anything in the revocable trust will be excluded from the beneficiary’s estate.
Beneficiaries Who Are Complicated
You may need to use a trust if you have many beneficiaries in different proportions and need to specify who gets what – for example, if you have four children and want to leave 25% to each child. Still, if a child dies, their share goes to specific charities. Also, leaving a specific amount to one beneficiary can become complicated. Complex beneficiary requests are sometimes reviewed and accepted by custodians, but they are usually reviewed and modified by their legal department.
Children in Adolescence
Trusts are essential when dealing with minor children because you will also need a legal guardian who may also be responsible for their finances. Because minors cannot own assets outright, you must ensure that the funds are safeguarded. The trust should state your intentions for the funds and the conditions that prevent the child (or guardian) from misusing the funds. If you leave the funds to the minor outright, the guardian can easily spend them or name their own beneficiaries.
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Taking Care of Grandchildren
If you intend to provide for grandchildren after your death or don’t trust the parents to set aside inheritance funds for their children, establishing trust for the grandchildren (or future grandchildren) is an option. There is no guarantee that funds will trickle down if assets are left to their parents outright.
Guard Against Fraud and Beneficiary Changes
There are numerous reports of elder abuse and fraud. Older people may be coerced or tricked into updating their beneficiaries when they are in the hospital or under hospice care. This can be a problem if the older person can sign a form and their signature match the information on file, but no one in their immediate family is aware of the change.