Discretionary Trusts – Protection for Bad Decisions

As parents, we always want to be there for our children and help make them avoid making bad decisions.  Sometimes we’re too involved and should let our children make mistakes to help them grow.  Other times we are not there to help our kids and have hope we raised them to make responsible decisions.

If you leave an inheritance to your children or grandchildren outright, then you are hoping they will make responsible decisions because you won’t be there to help them.  But no matter how well you raised your children, it may be difficult for them to avoid creditors, predators or divorcing spouses that want to take advantage of them.

One way to protect them is by using a discretionary trust for the benefit of each of your children.

What is a Discretionary Trust?

discretionary trust is a type of irrevocable trust that is set up to protect the trust’s assets, so your children or grandchildren can benefit from them and not be impacted by poor decisions.  Commonly, discretionary trusts are used to protect from a child’s poor money management skills, extravagant spending habits, personal or professional creditors, or a divorcing spouse.

How Does It Work?

Under the terms of a typical discretionary trust, the trustee is limited in how much can be distributed to the beneficiary and when the distributions can be made.  You have the flexibility to make the terms and timeframes as limited or as broad as you want.  The distribution choices that can be included in a discretionary trust are virtually endless (within certain parameters established under bankruptcy and creditor protection laws).

For example, you can provide that distributions of income can only be made for health care needs after the beneficiary reaches the age of 21, or you can provide that distributions of income and principal can be made for health care needs and educational expenses at any age.

A bonus of incorporating discretionary trusts into your estate plan is that the trusts can be designed to minimize estate taxes as the trust assets pass down from your children to your grandchildren (this is referred to as “generation-skipping planning”).

Lastly, you can dictate who will inherit what is left in each beneficiary’s trust when the beneficiary dies, which will allow you to keep the trust assets in the family.

A properly drafted discretionary trust will protect a beneficiary’s inheritance from creditors, predators, and divorcing spouses avoid estate taxes when the beneficiary dies, and ultimately pass to the beneficiaries of your choice.

Where Should You Include Discretionary Trusts in Your Estate Plan?

Discretionary trusts should be included in all of the trusts you have created that will ultimately be distributed to your heirs, including:

  • Your Revocable Living Trust
  • Your Irrevocable Life Insurance Trust
  • Your Standalone Retirement Trust

Next Steps …

You should talk with an estate planning attorney about how you can incorporate discretionary trusts into your estate plan.