by Doug Warren, JD
When preparing your estate plan, one of the major decisions you will need to make is not only WHO your beneficiaries will be, but also HOW you will your assets to them. Most people assume because they do not have millions of dollars and all their beneficiaries are adults, a trust fund is not the right choice for them. They instead opt to leave the inheritance to their beneficiaries all in one lump sum (what is called an “outright” bequest). If this is you, please take a moment and read this brief article, and see if I can convince you to reconsider your plan in light of all the benefits a trust fund could afford to your beneficiaries.
My article will briefly touch on what I believe to be the three most significant reasons for leaving assets in a trust fund, and they all have to do with protecting the inherited assets. Trust funds protect inherited assets from:
- divorce, and
- inheritance leaving the bloodline.
Protection from Creditors
Perhaps the most significant benefit of leaving assets in a trust fund is, in most cases, the assets in the trust fund cannot be reached by a creditor of the trust beneficiary. Consider the Illinois Code of Civil Procedure, which states:
“No court … shall order the satisfaction of a judgment out of any property held in trust for the judgment debtor if such trust has, in good faith, been created by … a person other than the judgment debtor.”
While we may not think our beneficiaries are in danger of a lawsuit, the reality is we live in a heavily litigious society. The U.S. Financial Education Foundation estimates there are 40 million lawsuits filed in the U.S. every single year. That is one lawsuit for every eight people!
In addition to lawsuits, life can take unexpected turns for our beneficiaries, sometimes causing significant debts. The two most common reasons for bankruptcies are medical expenses and job loss – two things which are largely uncontrolled by a beneficiary. Inheriting funds while in a bankruptcy wreaks havoc on a beneficiary – they just lost a loved one, and then they risk losing some (or all!) of their inheritance to their creditors.
Since life can be so uncertain, it is only prudent to consider protecting your beneficiary’s inheritance from their potential creditors by leaving it in trust.
Protection from Divorce
A second protective benefit of a trust fund is it can help keep inherited assets from being divided up as a marital asset in the event the beneficiary gets divorced. While it is true that Illinois statutes direct that property acquired from an inheritance is initially non-marital property, a beneficiary who is married can “transmute” an outright inheritance into marital property (which is subsequently divisible in a divorce). This is done, for example, by depositing an inheritance check (non-marital property) into a jointly-held bank account (marital property).
When an inheritance is left in trust, however, these funds cannot be transmuted. They remain separate from the beneficiary’s other assets (separate account, separate tax ID number). This means in the unfortunate event of the beneficiary’s divorce, the trust assets will not be deemed to be a marital asset, and would not be subject to the judicial division of marital assets.
Protection from Leaving the Bloodline
A final benefit of leaving assets in trust is the creator of the trust (e.g., a parent) can control what happens with the trust assets when the beneficiary dies. This control can prevent assets from leaving the family / bloodline. For example, if an inheritance is left outright to a beneficiary who is on their second marriage, when that beneficiary dies, they may choose to leave those inherited funds entirely to their spouse. But the beneficiary’s spouse may not then leave the assets to the beneficiary’s child when they subsequently die – they are much more likely to leave it to their own family. By leaving an inheritance in a trust fund, this type of scenario can be prevented. When the beneficiary of the trust dies, the creator of the trust (not the beneficiary) dictates where the trust assets will go (e.g., to the creator’s grandchildren).
This article just scratches the surface of the protective benefits of leaving assets in trust, but my hope is it provides you with enough incentive not to dismiss immediately the idea of leaving assets in a trust for your beneficiaries, but to evaluate your situation carefully and plan accordingly.
If you have any questions or would like a second opinion, please feel free to reach out. We’re here to help.