Making inheritances available to children

The importance of having a Last Will and Testament and related documents in planning your estate can never be overstated. Yet so many individuals and families seem to delay preparation of these documents because of the complex decisions that often come with them; decisions such as choosing an executor for the estate or potential guardians for minor children. There’s also another complex decision that has caused many well-intentioned individuals to pause their planning: determining when children will have access to their inheritance.

Before I discuss the options available, I want to point out that inheritances can be created through a trust formed from a will (testamentary trusts) or through a trust created during your lifetime (inter-vivos trusts). A key difference between the two is that with testamentary trusts, you have the freedom to update your will during your lifetime; with an irrevocable inter-vivos trust, you may be restricted with changes and require permission from the courts. In this article, I will focus on testamentary trusts (created by will), though the same distribution considerations can be applied to inter-vivos trusts if you’re beginning the process of creating one.

Types of distributions

In general, the distributions for an inheritance can be discretionary, mandatory, or situationally based on events. In my experience, the most effective solutions are those that include a hybrid of mandatory and discretionary distributions. For example, you could take the most common approach and establish mandatory distributions when a beneficiary reaches certain age levels, such as ages 25, 30, and 35. In such a case, the trustee would also have the power to make distributions before or in between these periods. These discretionary distributions could be made according to some established need or standard, such as health, education, maintenance, or support. The trust can specify how broad or narrow the criteria could be for making these distributions.

Gifting to young children

When it comes to minor children, age-based mandatory distributions are a common choice. It is, however, not uncommon for parents to raise these age limits as their children and they get older. Perhaps they don’t have the confidence that their children are equipped to manage their inheritances as they approach the age limits, or that the amount of the inheritance has grown to warrant them worrying about their children managing a large sum of money. One possible alternative would be for the parents to set aside a portion of the principal in the trust for their children’s lifetimes, and at the same time, give their children the power to appoint their own beneficiaries (their heirs). In this scenario, I would also recommend combining mandatory and discretionary distributions to protect assets and meet the changing financial needs of the beneficiaries.

Ensuring asset protection and flexibility

Another method of distribution involves mandatory distributions based on events, such as graduating from college, getting married, having children, or even passing drug screenings. I believe this approach greatly limits a fiduciary’s ability to adapt the plan to meet changing life circumstances of the beneficiary. A recent example of this involved a beneficiary who finished his medical residency and chose to specialize in high-risk surgery. As a fiduciary, I would have altered the plan to maintain a portion of the principal in the trust. This would have provided asset protection for the beneficiary who could face liability exposure in his high-risk profession.

Income distribution strategies

Distribution decisions shouldn’t just consider the principal of the inheritance, but also the income generated. Often, individuals will permit income distributions when beneficiaries reach a designated age, such as 21. The challenge with making these considerations in building the estate plan is that the full amount of the inheritance — and the income it could generate — may not be known at the time the estate plan is created. This could result in the beneficiary receiving large sums of money at a young age. One solution is to formulate an income stream in today’s dollars and build in increases to account for inflation. Another solution would be to give the fiduciary or trustee the discretion to make income distributions based on the beneficiary’s needs at the time.

The importance of prudent planning and completing your estate plan

There’s no question that you have many options for distributing income to your heirs. That’s why it’s imperative to take the time to understand and weigh all your options, make prudent decisions, and of course, complete the all-important task of finishing that estate plan.

More information

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