By Nancy Burner, Esq.
When creating estate planning documents for clients, a common concern is how to protect the beneficiaries of the estate.
When it comes to providing creditor protection for oneself, there are not many estate planning options available, aside from giving assets away. This could result in undesired consequences, such as the loss of ownership of the assets or creating a taxable event. Fortunately, this is not the case for beneficiaries — there are certain planning techniques to provide beneficiaries with creditor protection, and other protections, that one would otherwise not be able to provide for themselves.
The Internal Revenue Code states that if a trust limits the distribution of principal to an ascertainable standard, the trust qualifies as a creditor protected trust. Limiting distributions to the beneficiary for their health, education, maintenance, or support (HEMS) falls within the IRS guidelines of an ascertainable standard that creates creditor protection for the beneficiary.
While this type of trust may sound restrictive, the trust can essentially be used to maintain the beneficiary’s lifestyle. The principal of the trust can be used to pay for the beneficiary’s schooling, rent, taxes, medical expenses and more.
Additionally, assets, such as a real property, can be bought directly in the name of the trust, thus protecting the assets immediately upon purchase. Lastly, the beneficiary can be their own trustee of the trust and have the right to withdraw the income generated from the trust, all while still maintaining creditor protected status.
If there is a concern that the beneficiary may want or need access to the trust beyond HEMS distributions, or that the trust may become too burdensome or impractical to manage, the estate planning document creating the trust can provide various ways to either completely undo the trust or to authorize a distribution of principal beyond the beneficiary’s health, education, maintenance, or support.
Aside from creditor protection, there are additional benefits that come with beneficiary trusts. If, for example, there is a concern that a beneficiary may end up with a taxable estate, any assets transferred to them in trust will not be includable in the beneficiary’s estate.
This could help reduce, if not eliminate, a large estate tax on the beneficiary’s death. Another benefit is the ability for the creator to maintain control of the distribution of trust assets should the beneficiary die before the complete distribution of their trust.
If the beneficiary is unable to manage their personal finances for any reason, the document can name someone other than the beneficiary to be the Trustee of the trust. The document can include specific instructions on how to administer the trust, thus ensuring that the beneficiary is properly cared for and that assets of the trust will last for an extended period of time.
Beneficiary trusts can exist both within a last will and testament, also known as a testamentary trust, as well as a free-standing living trust. Either document can take advantage of this powerful tool.
Because it is not always immediately clear whether a beneficiary trust or outright inheritance is the right distribution method, it is important to meet with your estate planning attorney and provide them with as much information as possible in order for them to properly advise on the creation of your documents.
Nancy Burner, Esq. is the founder and managing partner at Burner Law Group, P.C with offices located in East Setauket, Westhampton Beach, New York City and East Hampton.