It’s not unusual for parents to create a trust and make their adult children (or grandchildren) both the beneficiaries and trustees of their own trusts. That option may be fine legally and offer several advantages. However, it can also cause significant problems if the trust is not structured properly. How do you decide whether your children should be trustees of their own trusts? You should consider these issues:
When Can Your Children Be Trustees and Beneficiaries?
You can name your children as trustees provided they do not have full discretion to make distributions to themselves. That’s because if a beneficiary can force a payout from the trust at any time, the IRS and creditors may deem that the trust is fiction and the funds are the property of the beneficiary. As a result, any tax benefits are lost and the assets can be seized to pay debts and subject to division in divorce.
However, children can be trustees if there is an ascertainable standard for making distributions. For example, the trust would provide that the trustee can only pay out funds for the beneficiary’s health, education, maintenance, and support.
What Are the Benefits of Naming Your Children Trustees?
One advantage of having family members as trustees is that they may waive the right to compensation. Generally, trustees are paid for their services in managing the trust and the fees can be significant for a large trust. Your child may not seek payment since they are getting the trust funds anyway.
Having children serve as trustees also provides a powerful tool to educate them in managing family wealth. As trustees, they will have to learn how to administer the trust, hire professional advisors (accountants, attorneys, money managers, etc.), make investment decisions, and see the results of their actions. However, it is recommended to name an independent trustee to assist them if they have little experience with money.
What Are the Risks of Naming Your Children Trustees of Their Own Trusts?
Unfortunately, naming children as trustees can lead to family conflicts and litigation in some instances. Personal relationships and rivalries can affect the ability of children to cooperate. However, you can mitigate some of the risks by naming a trust protector who has the power to add or remove beneficiaries and/or trustees of the trust. This reduces the risk of litigation because the trust protector can threaten to remove a beneficiary from the trust if they sue the trust without an adequate justification, or if applicable, remove a trustee who is acting against the best interests of the beneficiaries.
As noted above, it is also important to make sure that your children do not have unlimited discretion to make distributions to protect them and the trust.
How Do You Choose the Right Trustee?
Selecting appropriate trustees, whether they are your children or third parties, is a serious concern. Always consult an attorney to help you make well-informed decisions and minimize the risks of litigation.
Contact our firm for comprehensive estate planning advice. We can help you find the best solution to protecting and preserving your legacy.