How to Protect Your Legacy from Immature Financial Decisions

discussing finances

Sometimes the ones we love the most are also the ones we have to work the hardest to protect from themselves. Substance abuse, debt, and immature financial decisions can create trouble for your loved ones and threaten your ability to provide for them after you are gone. However, an irrevocable trust with discretionary distributions and spendthrift provisions can protect your estate from creditors and your beneficiaries’ own bad choices.

What to Do When a Direct Inheritance is a Bad Idea

There are many reasons why you may be cautious about naming a family member as an heir in your will. They may be prone to falling for scams or making risky investment decisions. They may receive means-tested disability benefits that could be threatened by a sudden influx of money. They could have a substance abuse disorder or gambling problem. Perhaps they are simply young and inexperienced in financial planning.

However, any of these reasons pose challenges when planning for your assets after death. Without careful estate planning, you could inadvertently hand your legacy over to beneficiaries before they are ready. Where your loved ones have debts or tend to spend their money quickly that could leave them without the financial support you intend.

The solution to this problem is an irrevocable trust. Whether you create such a trust during your lifetime (an inter vivos trust) or upon your death (a testamentary trust), this entity can retain your assets and manage your legacy for years after you have passed away. When carefully prepared by an estate planning attorney, an irrevocable trust can help protect your legacy from immature financial decisions and the consequences of those choices.

Trustees Manage Discretionary Distributions on Your Terms

An irrevocable trust is “irrevocable” because once you put money or assets into it, you can’t change your mind and take them back out. Instead, those assets are managed by a trustee for the benefit of all trust beneficiaries (including yourself while you are alive) according to the terms of the trust document itself. In Florida, you can generally be the trustee of your own irrevocable trust without adverse estate tax consequences as long as you distribute property according to an “ascertainable standard” such as the health, education, maintenance, and support of the beneficiary (these are called HEMS discretionary distributions). After you pass away, your appointed trustee will continue to make discretionary distributions to your beneficiaries according to those same terms.

The ability to control when and how trust funds are distributed protects your assets from the poor decisions of a spendthrift beneficiary. Your 20-year-old nephew may want to buy a sports car he can’t afford with his minimum wage job, but your trustee does not have to give him the money to do so. In other words, the trustee of an irrevocable trust can withhold distributions to a beneficiary to protect the trust property from third parties, including creditors.

Creating a trust with discretionary distributions can protect your legacy while still providing for family members most in need of support. The limits on discretionary distributions can help to curb a beneficiary’s unnecessary spending, keep a disabled individual below means-tested limits to receive state benefits, and provide an objective eye for potentially risky financial investments.

Spendthrift Provisions Shield Trust Assets from Collections Efforts

Most irrevocable trusts contain a “spendthrift provision”. This is legal language that prevents your beneficiaries from assigning, disposing of, pledging, or encumbering trust assets to a third party. That means your nephew can’t offer the trust principal or interest as security for that sports car, and your daughter can’t assign her right to receive distributions to her doctor or mortgage lender.

From a legal perspective, a spendthrift provision prevents creditors from collecting debts out of the trust assets. The funds in a spendthrift trust remain the property of the trust until they are distributed to -- or for the benefit of -- the beneficiaries. As long as the money stays in the trust, the creditors can’t reach it. Instead, their access to trust funds will be limited to the amounts of periodic or discretionary distributions the beneficiaries receive and deposit in their own bank accounts.

However, there are some exceptions to the spendthrift rule for creditors. Certain “creditors of last resort” can reach a beneficiary’s share of trust assets even before they have been distributed. These special creditors include:

  • The beneficiary’s children in the form of child support--although this is difficult in Florida
  • The beneficiary’s former spouse recovering spousal support and maintenance--although this is very difficult in Florida
  • The State of Florida
  • The IRS or federal government

Practically speaking, a spendthrift beneficiary may pay off or settle with their other creditors with the distributions, leaving creditors of last resort to collect from the trust directly. However, by limiting creditors’ access to the trust principal and interest, you can help ensure that your assets are spent for your loved one’s best interests, rather than funding their flights of fancy.

At Harrison Estate Law, we know how to make your trust documents work for you and your family. We can help you create and manage an irrevocable trust with discretionary distributions and spendthrift provisions, that will protect your legacy and provide for your family for years to come. Please contact us online or via email or call 352-559-9828 to schedule a free consultation. If you don’t live close to Gainesville or are practicing social distancing, we are happy to set up a phone or Zoom call.

Categories: Trusts