1. What is an Inheritance Protection Trust?
An Inheritance Protection Trust is an irrevocable trust established through a deceased person’s estate plan typically for benefit of a surviving child. Although the term “Inheritance Protection Trust” could generally describe many types of beneficiary trusts, it usually refers to a trust established for a responsible and healthy adult beneficiary. The trust is drafted to continue for the lifetime of the beneficiary, rather than end at a predetermined time or age of the beneficiary. By receiving inheritance in a trust, rather than receiving inheritance outright, the beneficiary can protect assets from various threats:
The beneficiary usually serves as sole trustee or has the right to name an independent trustee; hence, an Inheritance Protection Trust is commonly referred to as a “beneficiary-controlled trust.”
The Inheritance Protection Trust is used as an alternative to outright distribution when the amount of inheritance is expected to be substantial (generally more than $100,000). Its protective features are promoted as gifts to the beneficiary that cannot be obtained without formal estate planning.
2. What are the benefits of an Inheritance Protection Trust?
- Estate tax protection. If properly structured, the trust assets may be exempt from the federal estate tax upon the death of the beneficiary. When calculating the taxable estate of the deceased beneficiary, the trust assets would not be counted.
- Creditor protection. The trust assets are shielded from creditors of the beneficiary, even if insurance is insufficient to satisfy a judgment obtained by lawsuit. The trust can be drafted to provide enhanced levels of protection, if desired.
- Divorce protection. The trust assets are separate property of the beneficiary, and may not be converted to community property during marriage. This prevents an ex-spouse from penetrating the trust should the beneficiary’s marriage end in divorce.
- Family protection. The trust may be drafted to insure that family assets pass to the next generation rather than to surviving spouses who may remarry. This protects the intent of the original owners, who may want the assets distributed to grandchildren.
3. When is the Inheritance Protection Trust established? The provisions for an Inheritance Protection Trust are drafted into a will or living trust document. In most cases the trust would not be funded with any assets until after the death of the original owner. In some cases, the trust is established during the lifetime of the original owner, but this requires an irrevocable gift and usually loss of control over the gifted assets. Depending on whether the provisions for the Inheritance Protection Trust are contained in a will or living trust, the personal representative or trustee – as the case may be – will be responsible for creating the trust during the weeks or months following the original owner’s death. The process involves (1) formally appointing a trustee, (2) preparing a Certification of Trust, (3) applying for the Taxpayer Identification Number, and (4) opening an account in the name of the trust. 5. Who should serve as Trustee? In many cases the beneficiary will serve as trustee. However, if creditor protection is a paramount concern, the beneficiary should not serve as trustee. Rather an independent trustee – such as a bank, trust company, or attorney – should be appointed. This enhances the level of creditor protection by eliminating the conflict of interest held by a beneficiary who also serves as trustee. If an independent trustee is appointed, the beneficiary may retain a right to remove and replace the independent trustee.
A flexible option is to name the beneficiary as initial trustee and grant the beneficiary a power to resign and appoint an independent successor trustee. This gives the beneficiary discretion to choose the level of creditor protection desired.
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
