Trusting your heirs
The ins and outs of an inheritor’s trust

Multigenerational trusts have existed for many years, but an inheritor’s trust puts a different spin on the age-old strategy: It allows heirs to take control of their future inheritance.

An inheritor’s trust lets you transfer wealth to future generations. It’s similar to a dynasty trust, except your heir creates the inheritor’s trust — with your permission — to receive his or her inheritance in trust rather than outright.

Assessing the benefits

Having assets pass directly to a trust not only protects them from being taxed on future transfers, but also shields them from other creditor claims, such as divorce. For example, if your son is having marital problems and is concerned that his inheritance could one day become community property, establishing an inheritor’s trust can provide asset protection. Why? Because everything you gift or bequeath to the trust (including growth and income from the trust) is owned by the trust, and therefore can’t be treated as community property. An inheritor’s trust can’t replace a prenuptial or postnuptial agreement, but it can provide a significant level of asset protection in a marriage.

An inheritor’s trust provides other benefits as well, such as:

Wealth building opportunities. If you fund an heir’s trust before you die, your loved one can use a portion of the money to, for example, start a new business. In addition to starting a business, a prefunded inheritor’s trust can own the general partnership interest in a limited partnership or the voting interest in an LLC or corporation. If you decide to fund the trust now, your initial gift to the trust can be as little or as much as you like.

Protection from creditors and lawsuits. Because the trust, rather than the heir, legally owns the inheritance, and because the trust isn’t funded by the heir, the inheritance is protected from the heir’s creditors and claimants in lawsuits.

Additionally, other than modifying your will or living trust to indicate that your heir’s inheritance will be directed to the trust already created on his or her behalf, your estate plan will not be affected.

Creating the trust

To ensure full asset protection, your heir must create an inheritor’s trust before he or she receives the inheritance. The trust is drafted so that your heir is the investment trustee, giving him or her power over the trust’s investments. Your heir then selects an unrelated person — someone whom he or she knows well and trusts — as the distribution trustee. The distribution trustee will have complete discretion over the distribution of principal and income, which ensures that the trust provides creditor protection.

Your heir should design the trust with the flexibility to remove and change the distribution trustee at any time and make other modifications when necessary, such as when tax laws change.

Your heir sets up the trust and will incur the bulk of the fees, which will vary depending on the trust. In addition, he or she may have to pay annual trustee fees. Your cost, however, should be minimal — only the legal fees to amend your will or living trust to redirect your bequest to the inheritor’s trust.

Gifting control

Think an inheritor’s trust is right for your family? Before you give your consent, your heirs should consult with an estate planning professional to ensure the trust is established in accordance with tax codes and laws to avoid potential IRS audits and court challenges, and to maximize protection of their inheritance. •