Hey there, Legal Tea Listeners –This is your host, Jenny Rozelle! Today’s episode of Legal Tea is the “cautionary tales” topic. And on these “cautionary tales” episodes of Legal Tea, we normally talk about real-life cases with real-life clients that are things me or my office have worked on -or they are things that I think are generally good things to be aware of, so you don’t turn into a cautionary tale on my Legal Tea podcast one day! Well today, we are going to talk about “trust fund kids” or “trust fund babies” – and it’s a term that rubs me the wrong way because so many people associate those terms with the wealthy, the privileged, the spoiled, the whatever-you-want-to-call-it. Though, I’m here to tell you very normal, average net worth folks use Trusts all the time for their kids too – so today is all about shattering the misconceptions behind those sayings, behind those terms. And heck, maybe after this episode, you may find that you want to leave a Trust for your own kids. Hear me out!
Before I dive into why average net work folks utilize trusts for kids, I think it’s prudent and appropriate to say that yes, Trusts are used all the time for wealthy folks too to pass down family wealth down generations + do so in a tax-advantageous manner. Does that exist? 100% yes. All the time. But the reason the “trust fund kid” term drives me a little nutty is that the stereotype, like I said, is that the kid is wealthy, spoiled, etc. When you hear the term, people will say it in this tone like “Oh, he’s a trust fund kid…” signaling a very certain vibe, right? And if you have no idea what I’m talking about, just know it exists and people typically associate the term of art with being a spoiled little rich brat!
First, I’m going to explain a little about “why” many people elect to leave their kids’ inheritances through a Trust – then I’m going to finish the episode with a real life story (maybe two – we’ll see how it goes) on when average net worth people have used Trusts for kids.
So, let’s dive in … so, whether an individual creates a Will or a Living Trust, they have the ability to leave an inheritance to an individual either “outright” or “in trust.” That first way, an outright distribution, is the standard “here is your inheritance check” –it is a no-strings-attached inheritance. The second way, a distribution that is in-trust, is when a Trust is created to house or hold someone’s inheritance. You may be thinking: “Well, why would I, little ol’ me, need to leave a beneficiary their inheritance in a Trust?” –or— “I don’t want my kid [or beneficiary] to be a Trust Fund Kid!”
Well would you know … that, often the reason for leaving an inheritance through a Trust is to protect the child/ beneficiary from themselves and from any issues they are currently experiencing … like any of the following:
1. Creditors/Bankruptcy. Do you know of someone who has a phone that rings off the hook from bill collectors? If so, it is wise to leave an inheritance to such an individual via a Trust because this may protect their inheritance from either 1) going immediately to the hands of the creditors or 2) getting swallowed up in a bankruptcy proceeding.
2. Marital Issues/Divorce. What about an individual who is experiencing marital issues with the possibility of a divorce on the horizon? Again, it is wise to leave an inheritance to such an individual via a Trust because this may protect their inheritance so that 1) their spouse can’t get their hands in the money and 2) it does not get wrapped up in a divorce proceeding.
3. Medicaid. Medicaid has specific rules as to “how much” an individual is allowed to have in his/her name – and they have specific rules as to waiving an inheritance. It is best to leave an individual who is receiving a benefit like Medicaid, an inheritance via a Trust. The Trust may, again, allow them to receive an inheritance (without kicking them off) and protect it from Medicaid.
4. Addiction. It does not come as a surprise to me that it is not enjoyable to relay the message to your estate planning attorney that there is a beneficiary who struggles with an addiction – any kind of addiction. However, it is important to share this information so that we can properly plan for him/her. A possible solution is to leave an inheritance to them via a Trust, so that the addiction does not get amplified by receiving an outright distribution.
5. Age. I don’t know about you, but if I received an inheritance at the ripe age of 18 or 21 (okay, or really any age in my early 20s!), I would likely have spent it as fast I could say the word “mall.” Through a Trust, you have the option to limit how much and how often a beneficiary receives their inheritance. Consider the possibility that their inheritance is divvied up over the course of their working life – that is, a little at the age of 18, a little at the age of 25, … etc. Or even through a monthly, quarterly, or annual stipend.
So, since this is a cautionary tales episode after all, how about a couple stories? I’ll do one where a beneficiary received a Trust for his inheritance and it worked beautifully. I’ll also share a story about a beneficiary who SHOULD have received their inheritance through a Trust, but didn’t. Let’s go!
The first story, the one where a beneficiary received a Trust for his inheritance and it worked perfectly, is a good “success story” to start with. We have a Dad, Mom, and Son – Son was the only child. In Dad and Mom’s estate plan, they had shared they had immense concerns around their son’s spending habits. While he is an awesome human, he’s a terrible saver and any dollar he has in his hand, is POOF gone. All the time. This Son is a full grown adult, by the way. When Dad and Mom came to us, they were in their 70s, I think. They ended up passing away very quickly back-to-back and I think they were both in their 80s at that point, so the Son was in his 50s or 60s. When I say “Son” I’m not talking about a young kid by any means. They had plenty of evidence showing that the Son would eventually get his inheritance and blow it. What did they do? They did two things:
First, they had their Son inherit through a Trust which dictates an annual distribution to the Son. The amount of the distribution is like “5% of the Trust Estate or $X amount of dollars, whichever is greater.” So, that gives him a set distribution to look forward to every year. The Trust has under a million in it, but the percentage, so far, has been what is the “greater” amount – and you know what, it's working beautifully. The second thing I wanted to mention about this Trust is that they also put someone else in charge of it – as the Trustee. So, the Son is not in control of it. Otherwise, if you think about it, he could just clean it out and move on. So, there’s someone else serving as Trustee and is responsible for making the distribution, filing the tax return, communicating with the advisor and CPA, etc. We’re about four years down the road now – so the Son’s parents passed away four-ish years ago and the Son has received four annual distributions – and it’s working super, super well for everyone. Actually, last time I talked to the Son, he was like, “You know … when I found out how things were setup, I was pretty annoyed with my parents … but now, I like the setup!” Funny when that happens!
Alright, a quick second story, the one about a beneficiary who SHOULD have received their inheritance through a Trust, but didn’t – well, unfortunately, but maybe not surprisingly, I have a lot of examples of these, but I’ll stick to one for the sake of time! This has a super sad ending and it’s a touch on the extreme side, but it emphasizes my point. We have Mom, who had a child, daughter, who had a very bad gambling addiction. Mom knew about it, but didn’t want to “control from the grave” and leave the daughter’s inheritance by a Trust.
Fast forward time, Mom passes away, the daughter inherits from her Mom, and sadly proceeds to gamble nearly the entire inheritance away. That’s not the worst part. Shortly after exhausting her inheritance, she found out that she had cancer. At the time, she was only in her 40s, so very much still working. Due to the cancer treatment, she had to take time off work and eventually, lost her job due to being away from work so much. The inheritance was gone, she had very little in savings, and was out of work. Imagine if Mom had left the daughter’s inheritance in a Trust to protect the money from her daughter’s addiction. That could have been the piggy bank that she, the daughter, really, really needed given the loss of her job. I still think about that daughter often – and wonder what ended up happening to her.
As you can see from the examples of “why” someone would consider leaving their kids’ inheritance in a Trust as well as the “success story” that I went over before this last story, just because an individual inherits funds in a Trust does not mean he/she is a wealthy, spoiled, entitled, whatever other words you may want to add… “Trust Fund Kid” or “Trust Fund Baby.” In fact, the reasons I gave earlier – remember them? Those are not the only reasons I have seen individuals have Trusts created for their beneficiaries. There are other reasons it may be worthy to consider it. The point is – every single family is different and sometimes a family’s situation calls for a beneficiary to receive their inheritance in a Trust. It is important to me to extract the “I don’t want my kid [or beneficiary] to be a Trust Fund Kid!” mindset because one of the most important things about your estate plan is that your beneficiaries are protected from themselves and others. So, now do I dare ask – do you want your kids or beneficiaries to receive their inheritance through a Trust? Maybe it’s a good idea, maybe you don’t need it – regardless, hope you learned something!
Alrighty, let’s shift to a sneak peak of next week, which we’re circling back to the “current trends” topic where we talk about things that are going on currently that impact my estate and elder law world – or maybe, things that I have stumbled upon on the news or social media that is relevant to this podcast. Well for next week, as we are through the Presidential election and near the transition from President Biden to President Trump, there are a lot of conversations happening about what the future may hold for estate taxes and estate tax planning. So tune in for that topic next week, Legal Tea Listeners, so until then, be well and talk soon!
Sources:
None.