Give Your Kids a Gift They Can't Give Themselves, Part II
Last week, I explained how using a spendthrift trust can protect the inheritance you leave to your children from divorces, lawsuits, and creditors that your children may encounter in the future.
However, even in those states that do recognize the validity of a spendthrift trust, there is nothing that you can do to prevent a creditor from attaching (getting their hands on) those assets once they've been distributed to the beneficiary (your child). In order to protect such distributions from the reach of creditors, the creation of a discretionary trust is very effective.
With a discretionary trust, an independent trustee (for example, a trusted friend, an accountant, an attorney, or a banker, etc.) can make completely discretionary distributions for the benefit of the beneficiary. For instance, rather than writing a check out of the trust checking account to your child to use to pay for tuition, the trustee can write a check out to the school to pay for the tuition. This way, the creditor cannot legally force your child to turn over the check written to him to pay the debt owed on the lawsuit judgment.
The key is that the discretion of when, how much, and even if a distribution is made is left to this independent discretionary trustee. The law cannot force this 3rd party trustee to make distributions to a creditor on behalf of the beneficiary. Nor can the beneficiary force the trustee to make distributions that are not authorized in the trust. And you, as the parent or creator of the trust, get to leave instructions with the trustee stating when, how much and whether a distribution is appropriate. Bottom line: you remain in control of how your money is used because the trustee is under a legal obligation to follow the instructions left by you.
Furthermore, the law simply does not provide any other vehicle that allows the same level of asset protection that a discretionary trust can.
Remember, though, in order to provide this type of creditor protection, the trust must be created with great attention to detail and it must be maintained and administered with care. Otherwise, there are traps for the unwary that could quickly unravel the trust's potential for protection. Obtaining solid legal, tax, and financial advice is essential when doing this type of planning.