The role of parents is to protect their children and raise them to be independent adults. So it comes as no surprise that when most parents plan for their own death, a primary concern lies with the future well-being of their children and grandchildren. Parents want to be sure the financial assets they have worked hard to earn are used intelligently for things such as higher education and retirement, and are protected from being spent carelessly or all at once. A solution is to set up a trust for a child.
Unlike a will, a trust can dictate how cash and property are distributed over an extended period of time. It is a legal entity, similar to a corporation, that holds assets for the benefit of an individual, group or organization. The person who sets up a trust is known as the grantor.
Parents setting up a trust can run into many traps if they do not think through all possible circumstances in advance. The following are four questions every parent should answer before setting up a trust for a child.
What Type of Trust Should You Set Up for Your Child?
There are three types of trusts: irrevocable, revocable and charitable. The revocable trust, also referred to as a living trust, is generally preferred for parents because it provides the most flexibility for the grantor. So long as the grantor is still alive, he or she can adjust the trust, add or remove income, and change beneficiaries. Only after the grantor dies does the revocable trust transfer to the beneficiary.
How Much Income Does Your Child Need?
A trust is made up of principal that can earn income, such as dividends, interest or rent. The grantor has the option to chose how much principal and / or income the beneficiary can obtain at a given time. One mistake parents often make is setting up the trust so that no matter what, the child can get only the income.
Life often throws us curveballs, so it can be helpful to think about future scenarios. What if that child loses his or her job, or faces a medical crisis? In those instances, will the child have the resources to pay the mortgage or the medical bills without dipping in to the trust?
Another thing to consider is interest rates. For example, imagine an inheritance is expected to be around $250,000. At a four percent interest rate the child would receive $10,000 per year, which could be a reasonable amount. However, a four percent interest rate environment is not always the case. At a two percent interest rate, the trust might not provide any significant income to the beneficiary.
Who Will Be the Trustee?
The next step in setting up a trust for a child is designating a trustee and successor trustees to decide when distributions are appropriate. A trustee can be an institution, such as a bank; a family friend; a professional, such as an attorney; or another family member, such as a sibling of the beneficiary. There is not any one perfect answer here. Each option has pros and cons so it is important to weigh the options. It is also possible to designate co-trustees in order to balance the power.
When Should the Assets Be Distributed?
Understanding your intention of the trust is a key factor in determining when the assets of a trust should be distributed. For example, if the idea is that a grandparent wants to ensure a grandchild receives the funds for college, a provision can be set for when the beneficiary attains a certain age or reaches a milestone, such as high school graduation. Other types of distribution timelines include, but are not limited to, tying it to future earnings, yearly installments or specified time allotments.
After a decision is made on how often the beneficiary should receive the assets, it is important to communicate that in detail. One way is to provide separate instructions for the trustee. Very detailed examples of how the grantor would like to see the money used guarantees the trustee can continue to carry out his or her wishes long after the grantor is gone- no matter what unexpected circumstances might develop.
It is then recommended to talk to the beneficiary about the purpose and intentions of the trust. This not only serves as a teaching opportunity, but also allows the grantor the chance to communicate with his or her heirs about their future.
Setting up a revocable trust is a great way to help your child in years to come. While the general process may seem simple, the unlimited options make it a complicated matter that should be handled by a legal professional with extensive experience in estate planning.
Beck & Estate Planning and Elder Law in St. Charles, MO, has been helping parents set up revocable trusts for their families for more than 45 years. Contact us today for more information and to set up an appointment with one of our attorneys.