Beneficiary Controlled Trusts: Balancing Asset Protection and Flexibility

A comment that I hear from many people is that they want their kids to have access to their inheritance, but they also don’t want the assets to be mismanaged or go to a divorcing spouse or other creditor.  In their minds, how their kids (or their surviving spouse) receives their inheritance is all or nothing:  total freedom or no control.  However, it is possible to get your cake and eat it too.

I generally recommend that substantially all assets passing to your beneficiaries remain in trust for their lifetimes.  These trusts may be designed with as much control and flexibility as you choose to provide.  Additionally, the assets in the trust can be managed by the children themselves.

Allowing each child to serve as sole trustee of his or her own separate trust share will provide additional beneficiary control.  As trustee, a child can invest his or her trust share in any manner he or she chooses.  However, the share is completely asset-protected for the child’s benefit.  This type of planning is much more favorable than outright distributions.

For additional flexibility and asset protection, a Trust Protector should be appointed for each trust share.  The Trust Protector has three purposes:

(i)  To make complete discretionary distributions to a child at any time, up to the entire trust amount, if prudent to do so.  Unanticipated changes in tax or creditor protection laws are examples of why complete distributions may be warranted.

(ii)  To shut down all distributions from a trust in the event a lawsuit, divorce, or beneficiary impairment event occurs.  The Trust Protector is essential in maintaining protection of the assets.  Without a Trust Protector to shut down trust distributions, there will be nothing to serve as a barrier between the beneficiaries and their creditors.

(iii)  To modify or amend the trust agreement to account for changes in law or to correct an ambiguity, either following your death or during any period of your incapacity.

Upon a child’s death, the assets will continue to be held in trust for the child’s descendants according to the same terms.  Additionally, the child can be given the power to appoint assets to their descendants, spouse, or charities.  Because these shares could be held in trust for the child’s descendants, the shares would provide both tax planning and asset protection benefits to your family for several generations.

Generally, beneficiaries should prefer to receive assets in trust rather than outright.  Holding assets in trust and keeping them in trust protects the assets from the claims of the beneficiary’s potential creditors, including a divorcing spouse and creditors in bankruptcy.  This protection is available because the beneficiary individually “owns” nothing until assets are distributed out of the trust.

To maximize the asset protection feature of the trusts, a beneficiary should take distribution of trust assets only as needed for personal consumption.  Any investments the beneficiary wishes to make should be done through the beneficiary’s trust share.  In this manner, all wealth generated through the beneficiary’s investment decisions will remain asset protected for the ultimate benefit of the beneficiary.

In Kansas, a person cannot irrevocably transfer assets to a trust, retain an interest in the assets, and prevent his or her creditors from reaching the assets.  By providing for the creation of a beneficiary controlled trust in your estate plan, you can provide your beneficiaries with the ultimate in creditor and divorce claims protection, making the use of the asset protection trusts far superior to outright distribution of the assets.

The beneficiary controlled trust is legal, effective, and flexible.  It balances asset protection with the flexibility to change with circumstances, time, and tax laws.  With a little bit of planning, you really can have your cake and eat it too.

If you have questions about this Article, please feel free to contact our Estate Planning Group for an appointment at (316) 631-3131.