What is a Discretionary Trust?

You have worked hard your entire life to acquire assets. So, what is the plan for after you are gone? Most people leave their assets to family members like children and grandchildren. But, how will you leave the assets to your loved ones? There are several options to consider. The one option this article will discuss will be “outright” distribution of assets and what it means legally.

Essentially, the term means the beneficiary can receive the inheritance in his or her name.

Example of Discretionary Trust

John leaves $500,000 equally to his 2 children (Sam and Sally), outright. This means that upon John’s death, each of his children will receive a check for $250,000.

Leaving an inheritance outright to a beneficiary means that the beneficiary becomes an easy target for creditors, divorcing spouses, not to mention the negative outcomes if the beneficiary declares bankruptcy or gets sued.

Negative Outcome Example Number 1

When Sam receives his inheritance of $250,000, he deposits it into a joint bank account he holds with his wife. Five years late, Sam gets a divorce and his wife takes half the inheritance.

Negative Outcome Example Number 2

Sally, on the other hand, was smarter. She kept her inheritance in a separate bank account and did not share it with her husband. But, Sally loved to run up her credit card bills. Within a few short years, she has $76,000 in debt owed on various credit cards. She stops making payments and the credit card companies sue and recover the debts owed from her inheritance.

The use of a discretionary trust could have helped John secure the inheritance for his children.

So, what is a Discretionary Trust?

A discretionary trust is a type of irrevocable trust that is set up to protect the assets for the beneficiary.  This can mean protection from Sally’s poor money-management skills, extravagant spending habits, personal or professional judgment creditors, or Sam’s divorcing spouse. Short of any provision that is against public policy, a discretionary trust can be as limiting or broad as needed with virtually endless distribution choices.

With a discretionary trust, John could limit how much can be distributed to the beneficiary. This is if and/or when the distributions can be made.

Discretionary Trust Example

John creates a discretionary trust for his children. The trust for Sam provides that income can only be distributed to Sam after he reaches the age of 21, and the principal should be distributed at age 50.  If Sam divorces at 48, his spouse will not be able to touch the amounts in the principal of the discretionary trust. Due to it not yet being distributed.

By incorporating discretionary trusts into your estate plan, the trusts can be designed to minimize estate taxes as assets pass from your children to your grandchildren (referred to as “generation-skipping planning”). The trust can also be designed to dictate who will inherit what is left in each beneficiary’s trust if the beneficiary dies. This will keep the assets in the family.

The end goal of a discretionary trust is to protect a beneficiary’s inheritance from creditors, and divorcing spouses, avoid estate taxes when the beneficiary dies, and ultimately pass to the beneficiaries of your choice.

If you are concerned that your children, grandchildren, or other beneficiaries will not have the skills required to manage and invest their inheritance or will lose their inheritance in a lawsuit or divorce, then consult with our office. We can discuss how to incorporate discretionary trusts into your estate plan or create a new estate plan. (818) 649-9110.