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In Part I we discussed the how the Planning Pyramid to craft a values-based estate plan. Here we will use an example to discuss some distribution options that are often used.

Tom and Sally Ray are two middle-aged professionals who have worked hard to build their medical practice into a successful business. Their net worth, including life insurance, pension and retirement plans is approximately $3,000,000 and growing. Their two children, John and Jane, are in their early teens. Both Tom and Sally expect to receive an inheritance from their own parents within the next ten years, which will add to their wealth.

The Rays came to me to assist them in creating a family legacy. They wished to leave their children more than just financial wealth, and they wanted to provide some asset protection in case their children encountered any trouble during their own lifetimes, including chemical addictions, divorce or bankruptcy. Their goal was to set up their plan so that the inheritance left to John and Jane would not be a burden or negative influence, but would provide a positive structure with incentives for the children – and their children’s children - to make the most of their lives.

Sally and Tom, although living at a local golf course, have tried hard to raise their children to be down-to-earth and to adhere to basic family values. For the Rays, these values included adherence to a family philosophy centered around a religious and spiritual home life, professional achievement, academic excellence, social contribution, financial responsibility, community involvement and devotion to family.

In the Rays’ case, we began with a discussion of some of the ways that we can transfer wealth to our heirs:

  1. Outright
  2. Convenience Trust
  3. Step-Distribution Trust and
  4. Lifetime Trust.

Outright Distribution: An outright distribution is just that, mom and dad die and Johnny and Jane receive their inheritance outright, in one lump sum. Simple, clean, but dangerous. Statistics show that an inheritance will be gone within 18 months of a child receiving it. And it does not matter how old the child or how much the inheritance. If a child gets divorced or goes bankrupt, the inheritance could be lost. An outright distribution does not allow for legacy planning.

Convenience Trust: With this arrangement, the inheritance is distributed to a trust, but the child can withdraw the trust assets at any time and for any reason, just by requesting it. There may be an independent trustee managing the trust, or the child may be their own trustee or co-trustee. Since no one can force the child to withdraw the income and principal from the trust, the convenience trust offers some creditor protection, and perhaps a mental barrier to withdrawing the trust’s assets, but not much else.

Step-Distribution: This method is a more commonly used method of leaving money to your heirs. I call it the “speed-bump” approach. With this type of distribution, the inheritance flows into a trust, usually with an independent trustee, that is managed and controlled for the child. At certain intervals in the child’s life, a portion of the trust’s principal is released in a lump sum to the child. For example, one third of the principal is paid to the child at age 30, one half at 40 and the remainder at 55. They still have access to income and principal for health, education and other guidelines you structure, but you can leave your children a powerful message with this type of trust – “don’t blow the inheritance!” The idea is that if they blow it the first time, they may not get any future distributions. This may act as an incentive to the child to manage their money well, but it still adds little asset protection, and once the principal is gone, it’s out of your bloodline and gone forever.

Lifetime Trust: This type of trust holds and manages the child’s inheritance for the life of the child. An independent trustee is usually chosen to manage the trust and many times the child can serve as co-trustee. Principal and income may be distributed according to various guidelines and incentives that the parent provides in the trust document. These guidelines act as a spigot or faucet: adhere to the guidelines and philosophies of the trust and assets will flow; get into trouble and the trustee can turn the spigot off. Once the child dies, any remaining assets in the trust can pass to the child’s heirs or other individuals or entities. The lifetime trust provides the most flexible vehicle for values-based legacy planning. It also provides the greatest degree of asset protection, including protections against divorce, bankruptcy and lawsuits such as malpractice or personal injury. This is by far the most popular choice of trust arrangements among my clients.

In Part III, we’ll take a look at how we designed the Ray’s estate plan to provide a values-based family legacy with the desired incentives, guidance and protections for their children and grandchildren.

 

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