Perhaps you’re a parent expecting your first child, adopting, or maybe you’re a grandparent looking forward to another bundle to bounce on your knee. The joy of a new arrival can be all-consuming. But as we all know, the anticipation must give way to action, planning everything from daycare to diapers. Of course, it’s hard not to start immediately daydreaming of the child’s future—perhaps you’ve already created a college fund. But one more step is essential for protecting a child’s future: putting together (or updating) your estate plan.
As a new parent, thinking about your estate plan is probably among the last things you want to contemplate. But the reality is that you’ve likely already begun the process, considering who you’d like to be godparents or guardians for your children. However, you may not realize that—whether you had a naming ceremony, baptism, or simply everyone knows this person would care for your child—none of that matters in the eyes of the law. It bears repeating: None of that holds any legal force.
The only way to legally designate a guardian for your child is to include that in a Will or a Texas Declaration of Appointment of Guardian for Children. Without it, your child would become a ward of the state, and it would be up to a judge to decide guardianship. Sure, the judge may consider your ceremonies as evidence, or the judge may not. Would you want to risk it?
The guardian you select will step into your shoes as a surrogate parent and raise the children through adulthood. When selecting a guardian, choosing people who will be willing participants in your estate plan, who share your values and parenting philosophy, and who you trust to raise your children is essential.
And then a second concern: the child’s financial well-being. A child under 18 will not be allowed to inherit property directly. If you do nothing, a costly court proceeding called conservatorship will manage the funds. And once again, a judge is involved, making usage of the money challenging, needlessly complex, and expensive.
But an adequately prepared estate plan can address all of these concerns and fully protect the new addition to your family. In a will, you can designate someone to care for your child and appoint a trustee to manage the child’s inheritance.
There are a variety of ways that you can leave money and property to your children, and you can choose the method you think best takes your goals, including their well-being, into account.
When people think about planning for their children’s inheritance, the outright gift often comes to mind. The first option for leaving a legacy is to make an outright gift using a will to all children over the age of majority in your state (usually 18, 19, or 21). This may be a satisfactory solution for parents with financially responsible adult children who will leave a small amount of property and money to them. However, leaving an outright gift using a will is not the best option for most people. If your children are minors, they cannot legally take control over an inheritance, so it will likely have to be held in a particular account or managed by a court-supervised conservator until they reach adulthood. But even if your children are young adults, they may not be mature enough to make sound financial decisions.
Further, it is impossible to foresee the future, even for mature children who typically exercise good financial judgment. They could, for example, experience a divorce or be sued and have a judgment entered against them. In that event, they would have to use your legacy to satisfy those claims. Certain types of trusts can prevent the money you have worked hard to save from going to your children’s creditors or divorcing spouse while enabling the trustee to make distributions for your children’s benefit following your wishes.
Suppose you make your adult child the trustee of a trust that your will establishes when you pass away, and they are also the beneficiary. In that case, the trust terms will specify the amount of discretion your child will have in making distributions to him or herself. Like an outright gift, this is often not the best choice for parents concerned about immature children or children with present or future money problems. If your child can exercise control over the trust money and property in the role of trustee, then their creditors may be able to reach those assets to satisfy their claims. There is also the possibility of conflict, especially if the siblings don’t get along, if multiple siblings act as co-trustees, or if one sibling is the trustee and the other siblings are beneficiaries.
You can address some of these concerns with a beneficiary-controlled trust. This type of trust enables a beneficiary to be a trustee, but the trustee/beneficiary can only make distributions for their health, maintenance, education, or support. An independent co-trustee may be empowered to distribute for the beneficiary’s benefit for reasons beyond health, maintenance, education, or support. Typically, the terms of this type of trust enable the beneficiary to remove and replace their co-trustee if the beneficiary is not satisfied with the co-trustee’s performance. Although the trustee/beneficiary has some degree of control over their inheritance, this type of trust prevents the money and property intended for your child from being used to satisfy the claims of creditors, divorcing spouses, and lawsuits.
One of the most common–though not necessarily the best–choices parents make regarding how to distribute money and property held by a trust is to include terms requiring mandatory distributions at a certain age or at several ages. For example, a trust could require one-fourth of the trust’s principal to be distributed at age 25, one-fourth at age 30, and the balance at age 35. This distribution scheme may address parents’ concerns about their children receiving a large sum of money before they have the maturity to handle it responsibly. Still, it does not provide as much protection against creditors as many parents would prefer—which is a concern regardless of the age of the beneficiaries. If a beneficiary can require a trustee to make a distribution from the trust, their creditors or divorcing spouses can also look to it to satisfy their claims. In addition, once a distribution is made to one of your children, it is vulnerable to present or future creditors’ claims.
Many parents want to pass on their values to their children. Such parents can use an incentive trust to encourage children to achieve essential goals by authorizing trust distributions based upon the beneficiaries’ achievement of certain conditions, e.g., graduating from college or denying distributions to beneficiaries who use drugs.
Although this trust protects the money and property held in the trust from the beneficiaries’ creditors, there are some possible downsides. This type of trust can trigger resentment in the beneficiaries whose behavior you wish to influence. This is especially true if they believe the trust’s conditions are unfair. For example, a trust that rewards high income by increasing distributions as income increases may be perceived as unjust by a beneficiary who has chosen a laudable but low-paying career such as teaching or social work. In addition, this type of trust may not give trustees much flexibility in making distributions. It may be difficult and expensive for trustees to administer, as substantial investigation or proof may be necessary to establish whether the beneficiary has met the trust conditions.
A trust providing distributions for the beneficiaries’ health, maintenance, education, or support is quite common. It is also possible to set up a trust that gives the trustee the discretion to make distributions to beneficiaries for other specific purposes, for example, starting a business or buying a house. In those circumstances, the trustee may need to evaluate, for instance, whether the beneficiary can afford the monthly payments, home maintenance, and taxes before making a distribution to be used as a down payment on a house. Like other types of discretionary trusts, the money and property held by the trust will be protected from claims by creditors, divorcing spouses, or lawsuits.
A fully discretionary trust authorizes a trustee to make distributions to beneficiaries but does not require them to make distributions. Although this type of trust protects the money and property held in the trust from being used to satisfy claims made by the beneficiary’s creditors, some parents may be concerned that this type of trust gives the trustee too much control. Because the trustee does not have to make distributions, your children will not be able to depend upon receiving money at specific intervals or occasions. This may make financial planning more difficult. There is also the risk that unequal distributions among multiple beneficiaries could lead to family conflicts and resentment when the trustee is the only one to decide who gets money and when.
Being a new grandparent changes everything -- including how you approach your finances -- and is one of the most joyous occasions in life. The excitement of a new baby -- and all of the firsts that come with this bundle of joy -- can grab your attention and focus. Nonetheless, there is one thing that every new grandparent must do as soon as possible that many often overlook. Specifically, every new grandparent should immediately create (or revise) an estate plan to include your family’s latest generation.
An intentional financial strategy for incorporating your new grandchild’s future in your overall estate plan is essential to address your growing family’s needs.
Not having an estate plan can have unintended results for your surviving family members. This is because intestacy -- or your state’s applicable laws that determine who receives your assets upon your death if you have no estate plan -- may not work the way you’d expect. As a result, it can have disastrous consequences for grandparents with other intentions or goals for their assets. Instead of having the government decide who gets your asset when you die, now is the time to take control while you can still put your wishes down on paper.
Failing to update an existing estate plan when a grandchild is born can be just as disastrous as intestacy. While you may have contemplated the birth of grandchildren in your initial estate plan, you may not have put a mechanism in place to ensure your grandchild receives the maximum benefit you intended. Likewise, failing to review or revise a beneficiary designation may inadvertently disinherit a grandchild. A comprehensive trust with coordinated asset ownership is the best way to protect your multi-generational family fully.
There are several ways to plan for your grandchildren’s future. Grandparents can use different tools to incorporate this newer generation into an estate plan.
One way is to give the gift of education. With college tuition rising yearly for private and public universities, setting aside money for your grandchild’s education is one way to plan for their future success. With a 529 plan, you can set money aside that has the potential to grow tax-free until it is needed. Better still, the 529 investment remains tax-free when spent on qualified higher education expenses.
Another way to provide for your grandchildren is by establishing a trust. The child’s parent, or even grandparents themselves, can be listed as the custodians of the account. As a custodian, the designated adult can make spending decisions on behalf of the minor child until they reach the age of majority in their state of residence -- or the age listed in the trust instrument. You can set aside a specific amount of money that the trustee can only distribute for your minor grandchild’s benefit.
If you already have an estate plan and are expecting another child or grandchild, don’t forget to update the plan as soon as possible. Although some plans are flexible enough to account for new children, some are not, and it’s not worth the risk. Additionally, the birth of a new child is always a great time to verify who you want to care for your children (and update the paperwork).
And if you’re a soon-to-be grandparent, consider passing this information on to your kids. But before you do, consider how you might want to provide for your grandchildren. Should you create a trust dedicated to a grandchild’s education, giving them a home, helping them start a business or some other kind of benefit? What legacy do you want for this new, next generation?
We are here to answer questions, address your concerns, and ensure you have everything you legally need for your growing family. Book a Call to schedule an appointment today.
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Austin, TX 78738
