We have all seen others who are financially devastated or harmed by circumstances that are completely outside of their control. For example, a beneficiary’s spouse may take his or her inheritance in a divorce. The beneficiary may lose assets to creditors from bad luck, the poor economy or bankruptcy. In 2008, many contractors and real estate investors were forced into bankruptcy, losing their investments when the real estate market crashed.
Our society is increasingly litigious. It seems as though there must be fault with every bad occurrence. Business owners and professional real estate owners are particularly concerned by potential losses associated with lawsuits. Even the costs of defense alone can be financially devastating. If your loved ones receive needs-based governmental benefits, special needs or medical benefits, the legacy left to them may be lost to repay the government.
Even if none of those happen, the beneficiary’s family may lose the inheritance or legacy to a second estate tax upon his or her death. Assets may be subject to an estate tax upon the death of the parents. When the children die, the assets left to your grandchildren are subject to a second estate tax, further reducing the family legacy.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Note that we have seen substantial changes to the estate tax limits within the last 20 years. For example, the lifetime exemption for estate taxes rose from $1.5 million in 2005 to $13.61 million in 2024. The exemption es expected to drop to an estimated $7 million on January 1, 2026. We have no way of predicting what that limit may be in the future, or what other rules may change, particularly before the upcoming elections.
Most trusts provide for outright distribution to beneficiaries. Outright distributions provide no protection from these events. An alternative approach is for your children or loved ones to receive their legacy through a beneficiary controlled trust.
How a beneficiary controlled trust provides extra protection
Your beneficiary may choose to have the trustee give him or her complete control over all assets of the trust, including the investments, how funds are used and spent and who inherits them when the beneficiary dies. Because your beneficiary does not have legal title to the assets, there is much better protection from divorce, lawsuits, creditors, bankruptcy, government recovery for benefits and even estate tax. Note that your beneficiary can still control and enjoy the trust assets. This provides the least complexity and a lower level of protection. If needed, the trust can be modified to provide greater protection in times of need, as described below.
Your child can appoint their best friend, certified public accountant (CPA) or an independent professional to act as trustee to oversee all trust activities. Your child could fire and replace that trustee at any time. This provides maximum asset protection.
Your child could retain control of investments as the investment trustee while using your child’s desired financial advisor. Alternatively, your child may appoint an independent investment trustee. If the independent trustee does not perform as desired, your child can fire them and appoint a different trustee. Your child may utilize an independent distribution trustee who oversees trust distributions to your child, providing significant asset protection. This provides very substantial asset protection while your beneficiary retains full control of the trust investment activities.
Many lawyers use discretionary distribution provisions based upon the beneficiary’s needs for health, education, maintenance and support. That standard was actually derived from an estate tax requirement. If a claimant obtains a court order or judgment, the judge may still compel distributions to the creditor and break the trust! If your child is going through a divorce or is concerned about being sued, your child can appoint an independent successor trustee to oversee trust activities providing for purely discretionary distributions.
Alternatively, the client may act as the investment trustee and have an independent administrative trustee or distribution trustee. The beneficiary controlled trust with an independent distribution trustee (chosen by your child or beneficiary) who signs off on all distributions to the beneficiary provides much stronger protection while still permitting the beneficiary control over the trust funds and investments. This distribution trustee acts as a “personal financial bodyguard.”
A trust protector is an independent third party who can be appointed if needed to minimize tax, provide greater asset protection or otherwise improve the performance of the trust. A trust protector may also be incorporated into the beneficiary controlled trust. A trust protector may make a wide range of changes as needed in the direction of the beneficiary to further lock down the protection provisions for greater protection until the threat is resolved. Note that a trust protector is not a trustee. A trustee owes a fiduciary duty to both the beneficiaries and to the creditors of a trust. A trust protector is typically not a fiduciary, so he or she can make a wider range of needed changes. Potential changes include changing the jurisdiction and governing law of the trust to a favorable jurisdiction with better asset protection laws.
Caveats to beneficiary controlled trusts
A beneficiary controlled trust can result in higher fees at formation and during administration if multiple trustees are used. The beneficiary controlled trust can also cause some additional complexity. However, most clients believe that the enhanced protection from divorce, creditors, bankruptcy and estate tax for their future generations warrants the additional complexity and cost.
Few trusts provide this level of multigenerational asset protection. This is only a brief discussion of the benefits and protections provided by the beneficiary controlled trust.
Related Content
- Guidance on Choosing the Right Trustee (or Trustees) for Your Estate
- How to Pre-Fund a Legacy So You Can Enjoy Your Retirement Guilt-Free
- Legacy Planning: Create a Lasting Legacy
- Why Do I Need a Trust?
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
-
Original Medicare vs Medicare Advantage Quiz: Which is Right for You?Quiz Take this quick quiz to discover your "Medicare Personality Type" and learn whether you are a Traditionalist, or a Bundler.
-
Ask the Editor: Capital Gains and Tax PlanningAsk the Editor In this week's Ask the Editor Q&A, Joy Taylor answers questions on capital gains tax rates and end-of-year tax planning
-
Time Is Running Out to Make the Best Tax Moves for 2025Don't wait until January — investors, including those with a high net worth, can snag big tax savings for 2025 (and 2026) with these strategies.
