The Beneficiary Controlled Trust

Hello. My name is Kyle Krasa and I’m an estate planning attorney in Pacific Grove, California. I’m certified by the state bar of California, as a legal specialist in estate planning trust and probate law. The purpose of this video is to give you general information about an important aspect of estate planning law so that you can be prepared when working with your own attorney. Watching this video does not establish an attorney client relationship. The law is far more complex and nuanced than can be explained in a few short minutes. As a result, before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. With that understanding, I hope you enjoy my video and you find it informative. Thank you.

When designing an estate plan, there are three critical questions you should ask yourself. Number one, who, who should inherit from your estate. Number two, what, what should they inherit? And number three, and this is a question that most people don’t think about, but it is just as important as the first two, how, how should the beneficiaries inherit or receive their inheritance? And that third question, the how, is the subject of this video. Let’s assume that you have a trust and that upon your death you have designed the trust to divide your estate into three equal shares among three beneficiaries. So you’ve answered the first two questions. You’ve answered who, you have identified the three beneficiaries, and you’ve answered what they’re each getting: one third. But that third question of how is critical: “How should they take their inheritance”? Now we have all the beneficiaries are adults and if they are all responsible with managing money, then the traditional approach would be an outright distribution.

This simply means that upon your death, the trust will end and it will divide the trust into three equal shares to the three beneficiaries. Once the trust distributes. One third to each beneficiary. The trust will not have any property in it anymore and it will just dissolve. It will not be valid anymore. The analogy that I often use is a toothpaste in the tube. Imagine your trust as a tube of toothpaste and all of your assets are the toothpaste itself. With an outright distribution, you are simply squeezing one third of the toothpaste out to each beneficiary and once you’ve squeezed all shares out to each beneficiary, there is no toothpaste left in the tube and you just discard the tube of toothpaste. That’s the idea behind an outright distribution, which is the traditional approach. Now there are pros and cons to an outright distribution. First of all, a pro is that this is a very simple concept.

It’s very easy to understand. This is the logical conclusion. Someone passes away and their assets get divided into equal shares to the beneficiaries. A second benefit, a second pro to this approach is that the beneficiaries have complete control over their inheritance. They can do whatever they want, no strings attached. There are some downsides though that people don’t always think about. Number one, divorce. What if after receiving the inheritance the beneficiary gets a divorce, can the divorcing spouse claim half of the inheritance? Well, in a community property state like California inheritance does start off as separate property. However, if the beneficiary co-mingled that property with their surviving spouse, then they may have converted it or transmuted it into community property and when there’s a divorce years down the line, the divorcing spouse could claim half of the inheritance. A second problem is lawsuits or liability. So if a beneficiary gets into a car accident or has a health bill that exceeds their insurance or has other kinds of a liability, even if they were careful, even if they didn’t do anything wrong, the creditors could take all their inheritance, their assets could be just as vulnerable.

Their inheritance would be just as vulnerable as their other assets. Now in a traditional approach, if a beneficiary were under age or maybe had some trouble managing money, then the other approach would be to do an in-trust inheritance. And so instead of the trust being divided into three equal shares and to be given to the beneficiaries outright, instead trusts are retained for the beneficiaries. And in the traditional approach there is a third party trustee who’s in control of the trust. Now, whether this is by design or by accident, there are some benefits to this traditional approach. Number one, there is pretty good divorce protection because the in-trust inheritance forces the beneficiary to keep the inheritance separate from their spouse. So this creates a bright line division between the inherited separate property of the beneficiary and the joint community property of the beneficiary and the spouse.

And so this provides a very strong degree of divorce protection as far as the inheritance is concerned. A second benefit to an interest inheritance is a degree of asset protection. In California, as in most States, when you create your own trust, you cannot give yourself asset protection. You cannot create a trust for yourself with your own assets and give yourself asset protection. However, if you create a trust for somebody else and you’re the one putting the assets into that trust, you can give the a pretty significant degree of asset protection. So an in-trust inheritance can provide that level of security and protection. However, the traditional approach where you have a third party as a trustee, one big downside to that is there’s no control by the beneficiary. So the beneficiary says, well thanks a lot. You’re giving me protections from things that might happen like divorce and lawsuits.

But the cost of that, the trade off is I’m not in charge of my own inheritance and that’s not necessarily a happy situation. Now of course, uh, if it’s possible we want to be able to have it both ways, right? We want to give the beneficiary divorce protection and asset protection while at the same time giving the beneficiary control. So the way that we do that is a hybrid option. Um, where we combine the best of both worlds is where we create in-trust inheritances, but instead of having a third party as a trustee, instead the beneficiary will be his or her own trustee. So each beneficiary will be the trustee of his or her own trust. Sometimes we refer to this as a beneficiary controlled trust. And I think that’s a good description. The beneficiary is in charge of the trust. So each of these separate trusts are designed to give each beneficiary complete control over his or her own inheritance.

They can spend it all the very next day if they want. They can decide where any, any unspent assets go upon their death. They can name their own successor trustees but because you’re putting it into the wrapper of a trust, um, that you created for them, you’re giving them a significant degree of asset protection. So this third choice is a hybrid choice of a beneficiary controlled trust and in trust inheritance where the beneficiary is his or her own sole trustee is the idea of combining the protections of an interest inheritance with the control of an outright distribution. Anytime you’re creating an estate plan, you want to think about maximizing all estate planning opportunities. And my feeling in general is if you’re are ready going to use a trust as the primary vehicle for your state plan because you want to avoid probate and you want to make things as efficient as possible. Why not at least consider taking advantage of another estate planning opportunity by keeping the inheritance in trust in a way that gives the beneficiary control, but also protects their inheritance.

I hope you enjoyed watching my video. As I mentioned at the beginning, this is not intended to be a substitute for proper legal counsel. Before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. Thank you.