An Estate Plan to Protect Your Children

An Estate Plan to Protect Your Children

Young couples often believe that they do not need to think about estate planning. However, this assumption is erroneous. Estate planning is very important for young couples who have one or more children.??

Without proper planning in place, problems can arise if a couple, married or not, passes away leaving minor children. Who will live with the children, make decisions regarding their well-being, and take care of them? Without a guardian, if both parents are no longer living, the court in the county where the couple’s children are living will appoint a guardian, which may be someone the couple did not choose. How will minor children be provided for financially? Without trusts for children, any assets passing to them will need to be held in joint control with the court in custodian accounts for minors. The children will receive the funds once they reach the age of majority, when they may be too young to manage their own money.?

Guardians

Parents can nominate a guardian and successor guardian under their wills. Since the appointment of a guardian is subject to the court’s determination of what is in the “best interest” of the child, a parent may even wish to add an accompanying letter explaining why the parent is naming a person as guardian. Once appointed by the court, the guardian will take care of the minor children if both parents pass away. The parents could also include requests for the guardian to follow. For example, the parents could request that the guardian (i) arrange for their children to live the same type of lifestyle in which they had previously been raised if that is feasible and (ii) allow their children to spend equal amounts of time with the families of both parents. If the parents have more than one child, they may also wish to direct the guardian to ensure the children are not separated.

Trust for Children: The Pot Trust

Parents can also include trusts under their wills for the benefit of their children. If the parents have minor children who are very young and close in age, it may make sense to initially create a “pot trust” for the benefit of all of their children. The trustee is given total discretion to make distributions of income and principal to each child. Under the so-called “total discretion” standard, the trustee is permitted to distribute some, all, or none of the income or principal to each child. The trust could then be divided into separate trusts for the benefit of each child once the youngest child reaches a certain age, such as 18 or 22 years old. Dividing the trust when the youngest child turns 22 years old or older may be preferable, as this would allow all children to finish college or other post-secondary training programs with access to the full trust assets before the trust is divided. The pot trust approach may be preferred by parents because (i) when children are very young and close in age, they likely have similar needs and (ii) administering a single trust is less costly than administering separate trusts for the benefit of each child.

Separate Trusts for Children

If the children are older, further apart in age, or both, it may make more sense to set up separate trusts for the benefit of each child. The trusts could either (i) require the trustee to distribute income and principal to provide for each child’s health, education, maintenance, and support (HEMS) or (ii) allow the trustee to distribute income and principal to each child in the trustee’s total discretion. While the standard to be selected depends upon personal preference, the total discretion standard may be preferred, as it gives the trustee more power to make decisions depending on each child’s circumstances in the future. Using the total discretion standard enables a trustee to withhold distributions to protect assets from being accessed by creditors or by a spouse of a child in the event of divorce. Allowing a trustee to withhold distributions can also be beneficial in the event that a child has an addiction, bad spending habits, or similar issues.

Payouts and Lifetime Trusts

In addition to receiving the net income and principal from the trust based upon the distribution standards (HEMS or total discretion), children can also receive required payouts under the terms of the trust. Options include (i) lump sum payments or (ii) mandatory distributions at various ages. If a lump sum payment is included, then the trust for each child will end when the child reaches a certain age, such as 35 years old. If mandatory distributions are included, then each child may receive a percentage of the trust principal at a certain age (such as half at 30 years old) and the balance at a later date (such as at 35 years old).?

Another option is to create lifetime trusts for the benefit of the children. A lifetime trust has several advantages, including protecting assets from a child’s spouse and ensuring that trust assets ultimately pass to descendants and stay in the family. It can also take the pressure off of requiring a child to execute a prenuptial agreement. If the parents’ wills include a type of lifetime trust called a generation-skipping trust, this can reduce estate taxes upon the death of the child, as the assets of the trust would be excluded from the child’s estate for estate tax purposes. A lifetime trust may also be preferable because it can provide asset protection for a disabled child or a child with an addiction or similar issues. Note that if a child is disabled and may qualify for Medicaid or other government benefits, creating a lifetime trust known as a “supplemental needs trust” or “special needs trust” may be advisable.

Under a lifetime trust, the trust for each child would last for that child’s lifetime, and each child could be given “limited power of appointment” over the trust assets in the child’s will. A limited power to appoint gives a child the power to direct what will happen to the trust assets upon the child’s death. The child can exercise this power in favor of certain individuals (such as the child’s descendants, the couple’s descendants, or both). If the child fails to exercise this limited power of appointment, the trust can provide that the remaining balance will be distributed in equal shares to that child’s children, if any, or, if none, to another person or organization.?

Since it is impossible to predict when an estate plan will need to be carried out, all young couples should have wills in place, especially young couples who have one or more children.?