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There’s no reason to hide the facts from your estate planner. Almost every family has at least child who gives the parents concerns, disappointments and even heartache. You want to provide the problem child with some financial assistance either now or through your estate, but you aren’t confident the child (who’s now an adult) will make good use of the money or property.
You should be candid with the estate planner. The estate planner has heard all the stories before. Yours probably won’t even make the planner’s list of 10 worst stories. More importantly, the planner knows actions you can take to protect the wealth while helping the loved one. The planner is likely to suggest actions such as these.
Make gifts indirectly. Annual gifts often are an important way to help loved ones as well as transfer property out of your estate to avoid future estate taxes.
You can make up to $15,000 of gifts tax free to each of any number of people in 2019 and 2020. Spouses can give jointly up to $30,000 per recipient. These gifts don’t use your lifetime estate and gift tax exemption. Gifts greater than the annual exclusion reduce your lifetime estate and gift tax exemption.
Fortunately, you don’t have to give money or property directly to a person. Instead, you can pay bills for the problem child, purchase things for him or her, pay for family vacations or take similar actions.
In addition, you can make unlimited tax-free gifts when you directly pay for qualified education or medical expenses. Make payments directly to a school or to a medical professional, and you can give an unlimited amount without worrying about gift taxes or how the child might spend cash.
Custodial accounts. When the child still is a minor, you can put money or property into a custodial account, known as either a Uniform Gift to Minors Act (UGMA) or Uniform Trust to Minors Act (UTMA) account. The gift qualifies for the annual gift tax exclusion, but an adult has control of the account. I’m not a big fan of these accounts, because the adult is in control only until the child reaches the age of majority, which is 18 in most states. After that, the child has legal control of the money.
Create family limited partnerships (FLP). The FLP primarily was popularized to remove assets from an estate at a reduced gift tax cost.
The FLP has other uses, and dealing with the problem child is one of them. You can put assets in the FLP and give each of the children limited partnership shares. Because you and your spouse are the general partners, you control what is done with partnership assets. You manage them and also decide on distributions from the partnership. The problem child has an ownership share but can’t do much with it. In addition to avoiding misuse of the assets, the FLP might be a way to help the child learn to be more financially responsible by becoming somewhat involved in decisions.
For the FLP to work in the long term, you need to establish who would become the general partner after you and your spouse. Otherwise, the property might not be protected after your lifetime.
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Marital agreements. Sometimes the concern is not so much the problem child as the problem child’s spouse or marriage. Would you like a big part of your estate to end up in the hands of someone you never knew? That could happen if you give property to one of your children and the property is divided in a divorce.
A marital agreement, either a premarital or postmarital agreement, provides protection against that and is very flexible. Ideally, your child and his or her spouse enters into one that says any gifts or bequests received by one of the spouses remain the spouse’s separate property and are not part of the marital estate. Some people say they won’t make gifts or bequests to a married child who doesn’t have such an agreement in place.
Protective trusts. Perhaps the most common and comprehensive way to help a youngster while saving the wealth from potentially destructive actions is to put it in a trust with protective provisions. There are a number of different provisions that can be put in trusts.
Ÿ Spendthrift clause: This standard clause says creditors of the beneficiary can’t force payouts from the trust. Even if the beneficiary is bankrupt, the creditors cannot invade the trust. Once distributions are paid from the trust to the beneficiary, the creditors can try to claim them. Not all states allow the spendthrift clause, and many limit the clause to $500,000 or so of the trust’s value.
Ÿ Discretionary clause: This clause gives the trustee discretion over when to make payments of income or principal to the beneficiary. The trustee determines both the amount and timing of all payments. This provision can work when the trustee knows your wishes well and especially when you provide written guidelines. The trustee also needs to monitor the beneficiary.
The choice of trustee is a key to effective use of this clause.
Ÿ Emergency clause: This is a variation of the discretionary clause. The trust initially pays income and principal to the beneficiary under a schedule or terms. But under the emergency clause the trustee is allowed to withhold payments when he considers it to be in the best interests of the beneficiary. Some people spell out the circumstances under which payments should be withheld. Others realize that they cannot anticipate every circumstance, so they give the trustee a broad, general power. Payments to the beneficiary resume when the situation that caused suspension of the payments is resolved and the trustee concludes a distribution again is in the beneficiary’s best interests.
Ÿ Milestone or stepping stone trust: Trusts with this provision initially pay the beneficiaries only income. The annual income payment might have a limit or might be restricted to payments for certain expenses, such as education and medical care.
The beneficiary receives additional income or principal distributions when certain milestones are met, such as reaching a certain age, graduating from college, being employed for a certain number of years, or virtually any milestones you set. The entire trust might be distributed upon reaching one milestone or in stages as different milestones are reached.
The milestone trust allows the beneficiary to learn how to handle money and to mature in general before receiving the bulk of the wealth. It also encourages the beneficiary to be useful and productive.
There are no guarantees that the problem child won’t waste money. But if you want an opportunity to help the child while protecting the wealth, consider these strategies.