Investor Education | When a spendthrift trust makes sense

If you have accumulated significant wealth during your lifetime, you may be concerned that beneficiaries may squander the funds after you are gone. For instance, one or more of your heirs may not have the financial acumen to manage the assets, or may have previously shown inclinations to spend money without much, if any, restraint. In that case, you might take steps, such as using a "spendthrift trust" to protect the wealth.

How it works: With assistance from an attorney, you set up a trust according to state law and transfer assets to the trust. Usually, the assets will include securities such as stocks and bonds, and possibly other property, such as real estate and some cash. You then designate someone—typically a professional— as the trustee to manage the assets.

Significantly, the terms of the trust restrict the ability of beneficiaries to spend the money or sell off assets in the trust account. So your 18-year-old child can't go out and buy a Lamborghini or take a yearlong cruise around the world. In addition, the assets transferred to the trust are protected from the reach of the beneficiary's creditors.

In lieu of direct access, beneficiaries may receive payments from the trust regularly or at the discretion of the trustee. For instance, if a beneficiary is in college, the trustee may provide payments to the school. However, once an amount is in the hands of a beneficiary, he or she has control over it.

Naming the trustee is critical to the process. Depending on the trust terms, the trustee may have wide discretion over the use of funds. For instance, the trust may empower the trustee to make payments to a beneficiary on an "as-needed" basis. Alternatively, the trustee may be responsible for making scheduled payments or be authorized to act upon the occasion of a specific occurrence (e.g., a child reaching a certain age).

Whom should you name as the trustee? Technically, it is not illegal to act as the trustee yourself, although this may lead to complications and generally is not recommended. More often than not, the trustee will be a professional, such as the attorney who helps to create the trust. Or you might choose a family member or close friend. Ultimately, it should be someone with the requisite financial knowledge.

It is also important to name a successor trustee—someone who can handle the responsibilities should the designated trustee die before the term's end or otherwise be unable to handle the duties. At the very least, you should name a professional as the successor trustee.

There are several other important aspects to consider when setting up a spendthrift trust, including provisions for terminating the trust and addressing contingencies, such a a beneficiary's predeceasing the grantor. Along the same lines, the trust may have to be revised to accommodate changes in the tax law or other new developments.

Final words: Do not try to go it alone. Consult your estate-planning team to determine if this approach makes sense for your family.

This newsletter/advertisement is produced for our clients, friends and associates through an arrangement with WPI Communications, Inc. for the representatives’ use. Although the editorial content is professionally researched, written and edited, neither our firm nor any of its agents, representatives or associates make any representations regarding the accuracy of the content or its applicability to your situation. The information in this communication is not intended as tax or legal advice. In accordance with IRS Circular 230, the information provided herein may not be relied on for purposes of avoiding any federal tax penalties. Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing or recommending to another party any transaction or matter addressed herein. You are encouraged to seek tax or legal advice from an independent advisor.

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