One of the more common questions that I receive from clients is in reference to their financial accounts. Many of my clients have mutual funds, IRAs, investment accounts, stocks, bonds, and joint bank accounts. As most of us are aware, you can name a beneficiary on these accounts. So long as a beneficiary is named on these accounts, and so long as that beneficiary is living at the time of your death, then the financial account will pass immediately to the named beneficiary or beneficiaries. However, there are many circumstances where naming your children as a direct and outright beneficiary could cause significant damage to your family.
First of all, the Supreme Court recently held that inherited IRA’s are not protected from creditors and not protected from seizure by a bankruptcy court. Therefore, if you name a child as the beneficiary of your IRA and the child decides to maintain the IRA as an inherited IRA, that IRA can be seized by a creditor or even the bankruptcy court. Most families would not enjoy the prospect of the children’s inheritance being seized by a creditor.
Second, if a child or children are named as outright beneficiaries of a financial account such as an IRA, investment account, mutual fund, or bank account, and the child or children takes the funds outright, not only are they subject to income tax on the full amount of the account during that first taxable year, but the assets are subject to seizure by a creditor, a spousal claim in divorce, and of course, are also subject to the child or children blowing through their inheritance.
Example: John and Jane had one child, Jimmy. John passed away first and later Jane died. When Jane died, she had an investment account totaling $500,000. The investment account named Jimmy as the beneficiary of the account. Therefore, Jimmy inherited $500,000 from his mother’s investment account. About a year prior to Jane passing away, Jimmy was at fault in an automobile accident. The victim in the accident obtained a $2 million judgment against Jimmy, of which Jimmy’s auto insurance took care of $1 million. This left Jimmy with a $1 million unsatisfied judgment that was owed to the victim of this automobile accident. When the attorney for the victim found out about Jimmy’s inheritance, the $500,000 investment account was seized to partially satisfy the remaining $1 million of the unpaid judgment. In the end, Jimmy was left with nothing.
As you can see, under many circumstances, naming your child or children as outright beneficiaries on your financial accounts may, in fact, be the worst thing that you can do. No one wants to see their children’s inheritance go to creditors, spousal claims in divorce, or see their children squander their inheritance.
One way to protect this event from occurring, especially with your financial accounts, is by establishing a Beneficiary Controlled Trust. This a second type of trust as part of your overall estate planning strategy. For instance, you would establish a family revocable living trust, and at your death, your child’s share is distributed into the name of your child’s own trust that he or she can control. In addition, you should retitle and change your beneficiary designation forms to name the beneficiary controlled trust as the beneficiary of these financial accounts. When things are set up this way, the trust protects the child’s inheritance from creditors, claims from a lawsuit, and even spousal claims in divorce. In addition, these types of trusts can be customized so that the adult child or children can only take assets from the trust at specific intervals and for specific reasons.
Example: Using the example above, let’s say instead of John and Jane naming Jimmy as the sole beneficiary of the investment account, named the Jimmy Trust as the beneficiary of the investment account. Jimmy did incur the $2 million judgment and there is $1 million that remains unpaid. However, so long as the assets remain in the Jimmy Trust, of which Jimmy can only withdraw from under certain circumstances and for certain reasons, the $1 million judgment creditor cannot seize the assets from the Jimmy Trust.
If you have questions regarding beneficiary controlled trusts and how to structure your estate planning so that your children’s inheritance are not subject to seizure by creditors, spousal claims in divorce, or even as the result of your children themselves squandering their inheritance, then please contact our office for a complimentary visit so that we can discuss your estate planning needs and concerns in further detail.
We look forward to hearing from you!