Beneficiary Protection Trust

Beneficiary Protection Trust

Like some, you probably have a will or a trust to pass your assets to your children. Ironically, many of us did not consider that 83% of estate beneficiaries are in their 50s at the time they received or could have received their inheritance distribution. What are their risks and needs in the middle of their 50s? Would we want to pass some of the inheritance sooner – before we die so they better enjoy it now and could support them longer? Perhaps the critical question should be "Could our assets, that we are passing to them, be TAKEN AWAY FROM THEM?"

While some people have proper succession plane; some of us have inadequate such as counting on things like naming beneficiaries on our IRAs or 401(k)s to distribute our assets when we die potentially resulting in the worst tax liabilities possible or even wrong plans. Actually AARP reported that 60% of its members (People over 55) have no arrangement in place at all which usually results in the least asset protection and the most tax.

Unfortunately, we live in the most litigious society in the world. Over 55% of our children will go through divorce settlement alone, not counting bankruptcy, tax liens and other business and personal litigation. The causes are endless. You intended to pass your assets to your children- not to their creditors. Sadly, this is often not the case. What you intended to pass to your loved ones often ends up TAKEN by their creditors even BEFORE they receive it. But, it doesn’t have to be this way. A very simple yet very effective layer of asset protection can be added to your estate plan that will ensure this will not happen so only your children will receive them, just as you intended. After you pass away and your assets pass to your children, your assets become their assets. As such, their creditors can potentially take all of it. While this is the most common mistake people make in transferring wealth to the next generation, it can easily be avoided or corrected.

This protective layer is the irrevocable, non-grantor, domestic or foreign, discretionary trust also called the Irrevocable Estate Protection Trust ("IEPT").

During your lifetime, your children's’ creditors such as ex-spouses, the IRS or any other of their creditors DO NOT have any legal claims to your assets. You are not responsible for paying anything to someone else’s creditors- including the creditors of your children. You want to make sure that this continues after you die. This means that your children should not become the owner of your property after you die because once it passes to them and becomes their property, their past current or future creditors can take it. Instead, they should just be the beneficiaries of your assets, which is what you want anyway. If you do this, your estate is preserved only for your children, not their past or future creditors. Their creditors will have no possible legal claim against your assets ear tagged to be used by your beneficiaries. So, how should this be structured?

First, an IEPT is drafted by an estate and tax attorney who is experienced with this type of planning. Make sure the attorney you choose possesses substantial specific experience in asset protection trusts, specifically in drafting them as well as defending them or challenge them in courts. IEPT is a unique and legally complex type of Trusts. The trust is irrevocable; there is no room for errors. And if attached by the creditor, the last thing you want is to have their attorneys pierce it on any grounds. Further, the trust shall be drafted with the intention to provide a specific objective for specific circumstances, to this extent,many issues should be taken into consideration such as your wealth structure, your family structure, present or future tax consequences, property ownership and your succession wishes. For those reasons, there is no "Templates" for this type of trusts each one is different.

Then, the beneficiaries of your will, revocable trust or any other of your assets would be changed and replaced to make the IEPT the beneficiary instead. However, in a few circumstances, this may not be the best choice because of unique tax issues.

After you pass away, the IEPT receives and owns your assets instead of your children. The children will be qualified beneficiaries of the trust assets instead of the owner of the assets. But be careful, very careful, because if you name your children as direct beneficiaries, this gives them a "beneficial interest" in the trust assets. This beneficial interest is something of value, just like any property. As such, it can be taken. In fact, the beneficial interest in the trust can be taken before a beneficiary receives your assets. A creditor can garnish and collect a beneficial interest in property or a trust asset as they could with any actual property. So, what can be done? The answer is simple, avoid establishing defined beneficial interests. And this is where the "discretionary" provision of the IEPT comes into play.

The IEPT is a discretionary trust; this means that the trustee chooses when and who receives a distribution from the trust and in what way, which could be in cash or in-kind, such as the use of trust properties. Your beneficiaries do not have ownership or "specific" beneficial interest in any assets owned by the IEPT. As such, your children’s creditors cannot take from them something that is nottangible such as "the use of trust’s car" or something that they don’t own such as the trust asset not explicitly assigned to them. So, how do your children get the use of those assets?

Property ownership: Even though the trustee holds the discretion of distributing the trust assets, the distributions must be made according to the trust’s provisions. The trustee is legally required to observe those provisions and act in the best interest of the beneficiaries. This is called "fiduciary obligations." Those obligations not only could be used to preserve trust’s assets only for the beneficiaries, but they are also enforced by law. No creditor can request a court order the trustee to breach his fiduciary obligation to the beneficiary, invade the trust assets to embezzle it and give it to the creditor. Which by being a "creditor"they also become a member of the excluded recipients stipulated in the trust. The trustee is required by law to comply with those trust’s provisions. Those provisions specifically stipulate that 1) distribution of assets or benefits from trust property should ONLY be made to qualified beneficiaries and 2) May not to be made to "excluded recipients."A creditor of a qualified beneficiary is specifically defined as "excluded recipient," as such, they cannot receive trust’s assets in the direct or indirect way. An indirect transfer to excluded recipients is prohibited and may be punishable by law. In other words, although there some exceptions, the trustee cannot distribute assets to your children with the intention of passing it to his ex-wife. Remember, the rust assets were your assets, the trust is established by you to distribute your assets as you chose. The beneficiaries creditors such as children’s ex-spouse and other creditors, DO NOT have any legal right to your assets even after you pass away, so the trust simply keeps it this way. Passing your assets directly to your children by a will, for example, turn the asset ownership from you to your children and to this extent, their creditor can collect what became their asset.

The Trustees and protectors: In large estates, the trustee is a committee made up of a group of attorneys usually three. The formation of this committee, removing and replacing members of this committee, and filling vacancies are specifically structured in the trust language and usually under the control of trust protector(s). The protector(s) only oversee the trustee(s) make sure they act as they should as trustees. The protector holds the powers to terminate or appoint trustees or limit their authorities. Obviously, this is a very complex structure, but in a multi-billion dollar estate, this structure is not overkill. In fact, this is what is expected and what we see frequently. Of course, we don’t see a structure like this in trusts holding $100,000 estate because the cost of structure like this will defeat the benefits, as it becomes cost-prohibitive. In the smaller estate, a reliable friend or a family member is usually sufficient to act as trustee. Remember a beneficiary may NEVER serve as trustee, as this will breach the trust’s protective function. So, NO, your children cannot be trustees if they are going to be beneficiaries.

The Beneficiaries of the IEPT are usually a class of people, not a specific person. This class could be something like "my blood descendants, adopted children, parents and siblings" or any other combination you may choose. You may even add further specification such as the maximum amount each may receive (the word "MAY"is critical). In general, the more specific you are, the less discretion you give the trustee, thereby giving your children’s creditor the opportunity to argue there is a "beneficial interest" to be taken from your children. Another nice feature of the trust is it could allow the beneficiary the use of trust property "Not owning it" so it can be taken from them. For example, they may drive trust’s car, live in trust’s house or have the trust pay for their kid's tuition. An experienced estate planning attorney can advise you how far is too far.

The Excluded Recipients: Just like there is a class of people or entities making up the "qualified beneficiaries", there is also a class of people or entities making up the "EXCLUDED" recipients. These are the ones that may not directly or indirectly receive assets from you’re the IEPT. This list usually includes "Any creditor or potential creditor of any qualified beneficiary." The trust also specifies "Unauthorized Transaction" those are a distribution that will indirectly or ultimately would end-up to an excluded recipients. An example of this is making a distribution to your children to pay legal settlements. Remember, you are not required to pay the divorce settlement or child support on behalf of your children. But you can still help your grandchildren by making them qualified beneficiaries. To this extent, the trustee is prohibited from making distributions to your children if he/she believes it will indirectly be confiscated by the IRS or collected by creditors. When you make minors, such as grandchildren qualified beneficiaries, you also stipulate who receive assets on behalf of the minors you may even stipulate in what way it should be spent. For example, you can stipulate something like "my son receive distribution made to my grandson until he is 21 years old, which should only be used for health care and education of my grandson." In this way, the assets intended for the minor grandson is not passed to your son ex-wife to buy a new car with it and justify it that she uses the car to drive the grandson to school.

It is important to ensure that the IEPT has full legal ownership of your estate assets. Therefore, the IEPT must be irrevocable so that it passes the property ownership transfer test.

Other things to consider

Trust Jurisdictions: Creditor rights against trust assets are different from State to State. Some creditors may try to pierce the trust under one theory or another. Some creditor uses the "drive up the legal fees tactic" by initiating complex litigation even knowing they will not win, just to force the trust to an unfair settlement to avoid legal expenses. Some jurisdiction finds this practice to perfectly fine, others find it extremely reprehensible and punish it severely. To add another layer of protection, one should use jurisdictions that offer greater protection to trusts. Some states or countries offer more protection than others. For example, Alaska and Nevada trust laws are better than most States in protecting trust assets from creditors’ claims. On the opposite side, California and New York are among the worst in the USA. If your trust assets are large enough (over $3M), a foreign country such as the Cook Islands or Neves could offer even superior asset protection laws. Those jurisdictions have laws that deter frivolous litigation against trusts with very severe sanctions against frivolous litigations. In some jurisdictions, the attorney and the plaintiff engaged in frivolous litigation could be held liable to the defendant trust for damages including, direct, consequential, and punitive damages. Obviously not too many plaintiffs’ attorneys will be motivated to carry the cost of initiate frivolous litigation in forging countries, incur travel expense, and make themselves liable to the defendant for massive damages if they lost, which is likely to happen. Some jurisdictions require plaintive to post a bond or pledge liquid assets as collateral to pay the legal fees and damages to the defendant trust if they lost.

The "When" factor: Like with any asset protection structures, trust or otherwise, The IEPT must be established without litigation in progress or likely expected as this will constitute committing fraudulent connivance which is illegal and could render the trust invalid. Therefore, those trusts must be established in advance while the sea is calm. Further, You don’t have to wait till you pass away to fund your IEPT for your children and grandchildren. Many would like to be part of the joy of having their loved one enjoying the assets intended for them while they are alive. Another use of the IEPT is to gradually transfer the assets of a large estate which is subject to inheritance tax to take advantage unified tax credit and gift exclusion during your lifetime. One other tax planning use is to have the trust purchase a life insurance policy on the life of the parents. When you pass the trust, receive the face amount of the policy tax-free. In doing the trust pay the relatively "small" premium and your children receive the "Large" face amount, a large tax-free exchange as you gift the seed; they get the tree.

An IEPT is a robust protective tool that has been used by high net worth families for a very long time. Today, many middle-class families are implementing those trust in their estate plans.