Hey everybody, I’m Stuart Green, the founding and managing attorney of Stuart Green Law. Today, I’m going to talk about the best way to receive an inheritance—or said another way, the best way to pass an inheritance to someone else. This is rarely a question people think about when planning their estate, but it’s crucial, and I’ll explain why throughout this video.
First, just ask yourself: what is the best way to pass an inheritance to someone else? The answer is through an inheritor’s trust. There are a few different acronyms for an inheritor’s trust that you might hear; BDIT is probably the most common one, standing for Beneficiary Defective Inheritor’s Trust. Essentially, any taxable activity inside that trust just ends up going on the beneficiary’s 1040—their personal tax return that they file each year. So, it’s not a separate taxable entity during the beneficiary’s lifetime. Now, that could change, and that’s a conversation for another day. But today, let’s focus on why it’s most beneficial to pass an inheritance through an inheritor’s trust.
Why Use an Inheritor’s Trust?
The primary reason is protection. Typically, when someone receives an inheritance, they just receive it outright through a will. For example, Joe Smith says he wants his estate shared equally among his four kids, so they each receive a quarter of any assets after creditors are paid. While that might seem straightforward, it has a fatal flaw—those assets are not protected.
By “protected,” I mean they are vulnerable to lawsuits, creditor claims, bankruptcy, divorcing spousal claims, and potentially even estate inheritance tax. While you may not currently face state inheritance tax issues, future generations might, as the inheritance grows and appreciates over time. So, if you can plan for estate inheritance tax now and completely eliminate it for future generations, why not do it?
Protecting Against Spousal Claims
Let’s dive into spousal claims, which can be a concern for many. Imagine you’re not worried about your child getting divorced, but what if your child passes away and their spouse remarries someone you don’t know? Now, all of a sudden, the inheritance you left for your daughter could end up benefiting a new family—people you never intended to receive those funds. This could fund vacations, education, and more for this new family. Most people don’t want to take that risk.
So, even if you aren’t concerned about divorce, an inheritor’s trust can protect against these unforeseen situations. The point is, any time someone sets up a trust for the benefit of another, as long as those assets remain inside the trust, they’re protected from lawsuits, creditors, spousal claims, and estate inheritance tax.
Common Mistake: Staggered Distributions
Another common mistake people make is setting up a trust for their children but making staggered distributions. This usually looks like: at age 25, the child gets a third of the inheritance, another third at 30, and the final third at 35. The problem is, once those assets come out of the trust, they’re no longer protected. If you can have the same type of control over the assets inside the trust, and they remain protected, why wouldn’t you keep them there?
Structuring the Inheritor’s Trust
The best way to structure an inheritor’s trust is to make it a beneficiary-controlled trust. This means your child, the beneficiary, controls the trust. There are two ways to structure this:
- Basic Creditor Protection: You could make your child the trustee of the trust. You need to be careful with how distributions are structured, ensuring they fall under an ascertainable standard like HEMS—Health, Education, Maintenance, and Support. This protects the assets from creditors, as long as distributions are made only for these purposes.
- Enhanced Creditor Protection: Use co-trustees. You might have a third party or a corporate trustee alongside your child, who would be the investment trustee, managing how the assets are invested. A separate distribution trustee would handle when and how distributions are made, offering even stronger creditor protection.
Why Irrevocable?
An inheritor’s trust is irrevocable, which is what provides its protection. Some people are wary of irrevocable trusts, thinking they lack flexibility. But that’s not entirely true. You can amend or change provisions if needed, as long as you have a trust protector—a person designated with the authority to amend or alter the trust if circumstances change.
Final Thoughts
So, the best way to pass an inheritance is through a well-structured inheritor’s trust. This allows for control, protection from creditors, and protection against unforeseen life events like remarriages. Always consult a legal professional when setting up your estate plan. If you have questions, reach out to us at Stuart Green Law—we’d love to help you.
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