The Problem Heir

Let’s face it – there is always a family member who causes concern, disappointments or heartache.  Embarrassing, isn’t it?  But you are getting ready to do your estate planning or thought you had it done until something comes up that causes you to think about the situation. So, what do you do?  How do you best handle the situation? 

Well, the worst thing you can do is to hide these issues from your estate planner.  As I have mentioned before, a good estate planner will ask questions about situations within your family so that they can best create an estate plan to meet your desires and concerns.  There is nothing to be embarrassed about.  Chances are very likely that you are not the first clients they have that has had a similar situation. 

The following are some options which might be helpful for you to consider:

Make gifts indirectly.  You can make up to $15,000 of gifts tax free to each of any number of people in 2020. Spouses can give jointly up to $30,000 per recipient. These gifts don’t use your lifetime estate and gift tax exemption. Gifts greater than the annual exclusion reduce your lifetime estate and gift tax exemption.

Fortunately, you don’t have to give money or property directly to a person. Instead, you can pay bills for the problem child, purchase things for him or her, pay for family vacations or take similar actions.  Further, unlimited tax-free gifts when directly paying for qualified education or medical expenses are available. Make payments directly to a school or to a medical professional, and you can give an unlimited amount without worrying about gift taxes or how the child might spend cash.

Custodial accounts When the child is still a minor, you can put money or property into a custodial account, known as either a Uniform Gift to Minors Act (UGMA) or Uniform Trust to Minors Act (UTMA) account. The gift qualifies for the annual gift tax exclusion, but an adult has control of the account. The adult is in control only until the child reaches the age of majority, which is 18 in most states. After that, the child has legal control of the money which may or may not be what you wish.

Create family limited partnerships (FLP). The FLP primarily was popularized to remove assets from an estate at a reduced gift tax cost.  The FLP provides for dealing with a problem situation. Assets can be placed in the FLP and limited partnership shares can be issued. Because you and your spouse are the general partners, you control what is done with partnership assets. You manage them and also decide on distributions from the partnership. The problem child has an ownership share but can’t do much with it. In addition to avoiding misuse of the assets, the FLP might be a way to help the child learn to be more financially responsible by becoming somewhat involved in decisions.

Protective trusts Perhaps the most common and comprehensive way to plan when faced with an unfortunate situation is to put assets in a trust with protective provisions. There are a number of different provisions that can be put in trusts.

  • Spendthrift clause: This clause says creditors of the beneficiary can’t force payouts from the trust. If the beneficiary is bankrupt, the creditors cannot invade the trust. However, once distributions are paid from the trust to the beneficiary, the creditors can try to claim them.
  •  Discretionary clause: This clause gives the trustee discretion over when to make payments of income or principal to the beneficiary. The trustee determines both the amount and timing of all payments. This provision can work when the trustee knows your wishes well and especially when you provide written guidelines. The trustee also needs to monitor the beneficiary. The choice of trustee is a key to effective use of this clause.
  • Milestone or stepping stone trust: Trusts with this provision initially pay only income to the beneficiaries. The annual income payment might have a limit or might be restricted to payments for certain expenses, such as education and medical care. The beneficiary receives additional income or principal distributions when certain milestones are met, such as reaching a certain age, graduating from college, being employed for a certain number of years, or virtually any milestones you set. The entire trust might be distributed upon reaching one milestone or in stages as different milestones are reached.

There are no guarantees that the problem heir won’t waste money. But if you want an opportunity to help with protecting the wealth, these strategies may be helpful.

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Kay Sowa

About the Author

Kay Sowa is a paralegal in the Trusts and Estates Group at Capehart & Scatchard, P.A. She is an IRS Enrolled Agent, an Accredited Estate Planner®, and a Certified Trust and Financial Advisor. She oversees the trust and estate administration practice for the firm. She is an accomplished author and lecturer who has frequently spoken on behalf of a number of organizations including the National Business Institute and the Institute of Paralegal Education.

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