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What is a Discretionary Trust?
A discretionary trust is a type of irrevocable trust that is set up to protect the assets funded into the trust for the benefit of the trust’s beneficiary. The trust provides protection for a beneficiary’s poor money-management skills, extravagant spending habits, personal or professional judgment creditors, or divorcing spouse.
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 can make the terms and timeframes as limited or as broad as you want.
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. An added 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”).
In addition, 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. While the distribution choices that can be included in a discretionary trust are virtually endless (within certain parameters established under bankruptcy and creditor protection laws), the bottom line is that 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
What Should You Do?
If you are concerned that your children, grandchildren, or other beneficiaries will not have the skills required to manage and invest their inheritance or will lose their inheritance in a lawsuit or divorce, then talk to your estate planning attorney about how to incorporate discretionary trusts into your estate plan.