Trusts designed to receive future inheritances can provide protection against creditors and taxes. If currently funded, these "anticipatory trusts" can even own businesses started by the inheriting generation.
Most affluent elders who are savvy about wealth preservation funnel assets to succeeding generations through trusts. Some cutting-edge estate attorneys are now suggesting that members of the inheriting generation take matters into their own hands and establish trusts in anticipation of future inheritance.
By establishing a trust "in contemplation of an inheritance," says Steven Oshins of the Las Vegas law firm Oshins & Associates, the future inheritor can overcome possibly "inferior single-generation planning by the attorney for the future decedent." (Oshins's firm has trademarked the term "Inheritor's Trust.") In other words, if your clients' parents haven't planned properly by setting up a dynasty trust to pass their wealth to succeeding generations, your clients may want to take the initiative.
Of course, they will then have to foot the bill, which can come to $10,000 or more in setup costs plus ongoing annual trustees' fees. The parents, in turn, must pay their own attorney the relatively nominal fees necessary to amend their wills so that their money goes into the trust.
The parents must also be willing to do so—and the conversations broaching the subject can be awkward at best. The parents may consider it meddling, but your clients can ease the way by making it clear that they don't want to know how much money is at stake, only that the money is protected and preserved for future generations. Arguing on behalf of grandchildren may do the trick if parents are reluctant.
Trust benefits
The conversation may be worth having because there can be significant advantages to receiving an inheritance in trust. Attorney Gideon Rothschild of Moses Singer in New York points out that outright inheritances are subject to the claims of creditors, litigants, and divorcing spouses. In fact, he says, "mentioning the 'D' word" is enough to prompt many people to leave money in trust. No matter how seemingly stable, marriages can falter—and no one wants a child's ex-spouse to collect family assets in a divorce and then pass them on to a new spouse following remarriage.
The other factor prompting the use of trusts is fear of litigation. People want to protect their assets, whether they are professionals fearing claims of medical or legal malpractice, business owners with personal guarantees out to vendors, or directors of public companies. When your client has a trust waiting to receive family assets, those assets can be preserved. What's more, those assets can be preserved indefinitely by using a dynasty trust in a state with no time limits on trusts, or a limit extending hundreds of years (popular states for these trusts include Alaska, Delaware, Florida, and South Dakota).
Oshins also points out that a trust in anticipation of inheritance can be used as a marital agreement. In the absence of a pre-nup or post-nup, or as a supplement to those planning tools, assets received through a trust are not subject to division as marital property. Better yet, earnings within the trust are never treated as community property even if the inheritor lives in a community property state.
Pre-funding the trust (assuming parents are willing to put up some money during life) creates "opportunity shifting," permitting the younger generation to start a new business and shield it from creditors. This works best when the new enterprise is a service or consulting business with no inventory and minimal start-up costs. The pre-funding can then fall within the annual gift tax exclusion.
The trust can also be used, Oshins says, "to own the general partnership interest in a limited partnership or the voting interest in a corporation or limited liability company." The entity could be newly formed or, instead, the future inheritor "can recapitalize an existing business or investment entity" into 1% voting and 99% nonvoting interests, selling the 1% voting interest to the trust. The trust then owns the controlling interest in the entity, creating a wall between the voting interest and any creditors. This strategy has the additional benefit of creating valuation discounts in the inheritor's estate. This is true, Oshins notes, even when the inheritor controls the entity as trustee of the trust.
Trust structure
Your client can be sole trustee of his or her trust, but there are significant advantages to using co-trustees. One trustee can be the primary beneficiary while the other can be a friend of the beneficiary or, alternatively, a corporate trustee.
Using an independent co-trustee beefs up the tax and creditor protection elements of the trust. It's a safe move from your client's point of view because the primary beneficiary can retain investment control. He or she can also retain the right to change the trustee, so long as the replacement trustee is not what the IRS terms a "related party."
Some clients are reluctant to enter into trusts because they believe them to be rigid structures that can restrict the lives of future generations with obstinate trustees and administrative red tape. This is an old-fashioned view, according to Rothschild. If clients consult knowledgeable estate attorneys—essential in this type of planning—trusts can be drawn with enormous built-in flexibility. Flexible provisions can give the primary beneficiary the maximum amount of control that will still keep assets out of the hands of creditors and divorcing spouses.
With broad powers of appointment, Rothschild points out, the inheritor can even rearrange the terms of the trust. That way, at his or her later death, the trust can be divided into equal shares for each grandchild of the original decedent. Or, if one child needs more than another, or if one is estranged from the family or there are other extenuating circumstances, the inheritor can determine who will get what at his or her death.
The end result is the same, whether the parent or the child sets up the trust. But it may be easier, Rothschild notes, "if the child knows what he wants, has his lawyer draft the documents, and pays for it. Then the parent needs only to make a slight modification to his documents so that the trust is funded at his death."
Of course, as New York estate attorney Sanford Schlesinger points out, "most people are control freaks." Instead of being motivated by asset protection, they would rather receive inheritances outright and not be limited by the terms of even the most flexible trust. "No matter how flexibly drawn," he says, beneficiaries lose some ability to handle their own lives. One sticking point with long-term trusts is designating the trustee in the next generation or in the generation after that. The issue, in Schlesinger's view, "is not drafting trusts, but living with them."
Nonetheless, thinking through the pros and cons of trusts for each client's personal situation—and working with an estate attorney—can help your clients identify their goals and plan their estates to fulfill those goals. Within that context, an anticipatory trust, or what Schlesinger calls a "variation on the theme of asset protection," may be the perfect solution.
