Planning for Spendthrift Beneficiaries
The purpose of this article is to address an issue that is more common than you may think - Spendthrifts. These are beneficiaries who, for one reason or another, cannot be allowed to have direct access and control to their inheritance. This article will take a look at some of the strategies available to you when creating your estate plan to provide for loved ones, without placing additional burdens on them.
Often times I will have clients who intend on disinheriting certain family members. Sometimes these are children, grandchildren, or entire sections of the family. Their reasonings are varied, but the number one reason that my clients provide is that the beneficiary (or their spouse) cannot have any assets because these assets will harm the beneficiary in some way. From there, I may learn that the beneficiary will lose access to certain state or federal benefits which may be means-tested. Other times, it is because the beneficiary cannot be trusted and will squander the money, or use the money to feed a substance addiction, such as drugs or alcohol, and even other addictions, like gambling. Whatever the case may be, additional planning strategies should be utilized at this point, to make sure that the beneficiary can still be provided for, without simply placing the assets in the hands of the spendthrift beneficiary.
There are several strategies available to planners which will be discussed in greater detail below. Of course, you could simply disinherit a beneficiary. You can also utilize special needs trusts, as well as spendthrift provisions with independent trustees. Your documents can have age restrictions, conditional requirements, and more to limit the beneficiary’s ability to access funds. Each of these options carry pros and cons, so it is important to explore them thoroughly with an attorney, as it relates to your specific case.
Strategy: Disinherit. It is rarely the case that the only solution available is to fully disinherit a beneficiary, although it can be the most simple solution. Essentially, the idea here is that your Will, Trust, or other estate planning documents will deliberately leave little to no assets to this particular beneficiary. Some practitioners believe it is safer to leave the beneficiary a nominal sum of money, something like $1,000. Other practitioners feel that leaving $1 is sufficient. However, leaving any money at all may be unnecessary, including language in your documents which states that an individual is “specifically disinherited” is usually going to be sufficient to convey the grantor’s wishes. Ultimately - the purpose of any of these provisions is to make it clear to the reader that: No, I did not forget to provide for this person, I intentionally and deliberately left them out.
The issue I have with just disinheriting a beneficiary is that it may not be what my client actually wants to do. A lot of times the situation may have the client feeling trapped, like they have no other option available to them. Of course, they do not want to have their child or grandchild lose access to the very important healthcare or income stream on which they depend. The good news is, there are other planning tools which can allow a spendthrift or special needs beneficiary to both receive their assets, restrict their control, and protect their benefits.
Strategy: Special Needs Trust. If you have a beneficiary with a disability or if they are otherwise receiving state or federal benefits - usually Medicaid, SSI, Food Stamps, or Housing Assistance - you may want to wait before placing assets directly in their name. By utilizing a properly structured Special Needs Trust, or sometimes called a Supplemental Needs Trust (“SNT”) the assets can be held for the beneficiary’s use, but without giving them direct control, or counting towards their income or assets limits. The SNT’s structure depends primarily on who created the trust. The beneficiary themselves is allowed to establish such a trust to protect an unanticipated inheritance, lawsuit settlement, or other windfall, but these “First-Party” or “Self-Settled” SNTs include mandatory repayment provisions. Which means that any assets remaining in the trust upon the beneficiary’s passing, must be first utilized to repay any benefits earned during lifetime, usually towards Medicaid first.
The other option is to catch the assets before the beneficiary receives them by placing their anticipated inheritance into a “Third-Party” SNT. The difference here is that somebody other than the beneficiary is creating the trust, and funding the trust with their own money, rather than that of the beneficiary. Because this trust holds funds which where never in the hands of the beneficiary, the trust has no mandatory repayment provisions, meaning the beneficiary can utilize the assets during their lifetime, and after they pass away, a contingent or secondary beneficiary can be named to enjoy the assets.
Strategy: Independent Trustee. Not every beneficiary is going to be concerned with maintaining benefits, and depending on the amount of wealth being transferred, it may be a moot point. Still, that doesn’t necessarily mean that you need to give the beneficiary complete control and access to the funds. When looking to pass along assets, many planners hope to achieve creditor protection over the funds - protecting the inheritance from things like a divorcing spouse, lawsuit, or accrued debts. When we have spendthrift beneficiaries, the biggest threat to the inheritance is often the beneficiary themselves. Because of this, it is not wise to allow a spendthrift beneficiary to have direct control or access to their inheritance.
With the use of trusts, we can establish a vehicle in which an independent trustee is able to manage the funds. They will be able to write checks, choose investments, acquire real estate, and determine the best use of the funds, either at their sole and absolute discretion, or under the guidance of the grantor who established the trust. The beneficiary, who is not allowed to serve as trustee, is still entitled to funds. Sometimes these distribution patterns are spelled out by the grantor - providing for the beneficiary at certain intervals or at specific ages. Other times, the discretion and decision-making on when to spend money, when to write a check, when to give the beneficiary money directly, is in the hands of the appointed trustee. Relying on the trustee to make the decisions can offer better creditor protection, but it also requires someone to serve in that role, which can be a difficult decision.
Choosing a Trustee. When selecting an trustee, we want to look at who makes the most sense. Often times siblings of the beneficiary or other relatives are considered for the position. This can be problematic, depending on the dynamic of the family. A lot of times the responsible siblings may not have the best relationship with the spendthrift beneficiary. It also places a large burden on that sibling to be a caretaker of sorts for their spendthrift sibling for the rest of their joint lives. However, having someone who intimately knows and understands the situation can also have benefits. Any trustee is also entitled to a fair and reasonable salary. So, if your trustee is going to charge a fee, at least there is some comfort in knowing that the money is going to another child, rather than a third party.
Of course, professional trustees exist as well. When looking at a professional trustee, cost it the most prohibitive factor. Typically, a professional trustee is going to have a management fee. Depending on the number of assets, the value, the trust, the restrictions placed, and the beneficiary, the fee could be substantial. On average, expect to pay around 1 - 3% of the trust value, annually. If the cost is tolerable, then a professional trustee can be ideal. They will follow the rules of the grantor to the letter, ensure that your trust is administered seamlessly, and that your spendthrift beneficiary is provided for in exactly the manner in which you described.
These are not the only options available, but are often seen as the most practical. Your individual situation may be different, and there may be other strategies which could be utilized in a more effective way. I highly encourage you to speak with an attorney who is capable of explaining all of these options in greater detail and working through your particular situation to best plan and provide for your loved ones.
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