Many older Americans have a secret when it comes to estate planning—they intend to leave their life’s savings to their children…just as long as their sons- and/or daughters-in-law don’t get a penny!
It’s an uncomfortable and delicate issue, but in many cases you’re right to worry about your child’s spouse. Perhaps he has a gambling or drug problem…or she is a spendthrift who would fritter away your hard-earned wealth. Maybe your child has a contentious marriage, and you fear she could lose half her inheritance in a divorce.
Even if you think the world of your child’s spouse, you still want your family money to eventually go to your grandchildren. What happens if your daughter dies and she leaves everything to her husband? It’s unsettling to think he could remarry and your estate could wind up in the hands of his new blended family including his second spouse and her kids.
Bottom Line Personal asked estate-planning attorney Jeffrey L. Condon, JD, how to make sure the inheritance you leave stays in your bloodline…
Inheritance-Proof Your Estate
I always tell clients that it’s their money, and they can leave it to whomever they please. But cutting out a son- or daughter-in-law from your estate planning is tricky because it often involves more than just financial considerations. You may be passing on family businesses, real estate and other assets with high emotional value…and you don’t want to ruin your relationship with your child and family or create divisiveness if your child’s marriage is solid.
What you shouldn’t do: Create an inheritance plan…usually a living trust… that leaves all your assets to your daughter outright with nothing to your son-in-law. This does little to actually ensure that your wishes actually will be met.
First, your daughter may insist on sharing the assets with her spouse because she doesn’t want to hurt his feelings or imply that she doesn’t trust him. Children who inherit family money often are heavily pressured by their spouses to put it in joint accounts.
Second, in the event of a divorce, some states consider everything acquired during a marriage to be community property unless your child can prove that it’s separate property. That means there cannot be any “commingling” of the inheritance. Your daughter needs to maintain the inherited assets in a separate bank and/or brokerage account titled only in her name. If she invests the inheritance money in purchasing or renovating a jointly owned family home or deposits any of the funds in a joint account, that money could be considered marital property.
Finally, if your daughter passes away and leaves all her money to her children, the husband still may acquire some of her inheritance. In California, for example, spouses may have a right to a portion of their deceased spouse’s estate, regardless of what the will states.
Better strategies to protect your family’s financial legacy and provide you with peace of mind…
Encourage your child to draft a prenuptial or postnuptial agreement—especially if the inheritance of family wealth is substantial. These agreements, which have less stigma than in the past, can include wording that specifies the inheritance your child receives is separate property and not divisible in any divorce proceeding. These agreements can explicitly outline which assets are considered separate and which are marital property in case of a divorce…protect the inheritance rights of children and grandchildren from previous marriages…and address what happens in the event of one party’s death.
Use a bloodline trust. Also known as a protection trust, a bloodline trust allows you to bestow your child an inheritance while still controlling how she uses, manages, disburses and safeguards those assets.
You create a bloodline trust as part of the inheritance instructions in your living trust while you are alive. You transfer ownership of your assets to your living trust, including your home, personal property, bank accounts and brokerage accounts. Your trust also can be named as beneficiary of your retirement accounts and life insurance policies. Upon your death, the assets in your living trust are distributed to the bloodline trust for your child’s sole benefit.
A trustee whom you appoint manages your child’s bloodline trust as outlined in the trust document.
Bloodline trusts are considered separate property and are less likely to be divided in a divorce settlement or contested if your child dies.
Your child’s bloodline trust provides that when your child dies, any assets remaining will be distributed to your child’s children. If there are no grandchildren, assets go to whomever you want to name as the “back-up beneficiaries.”
There are two types of bloodline trusts—one for more minimal protection of assets and one for maximum protection…
Low-protection bloodline trust. How it works: Once you die, your living trust assets are “deposited” into the bloodline trust for your daughter’s benefit. Your daughter is trustee of her bloodline trust. As trustee, her function is to manage the trust assets and distribute all the income and principal to its sole beneficiary… herself.
Advantages: This minimizes family strife and resentment. Making your daughter both trustee and beneficiary shows you have great confidence in her and are respectfully asking her to follow your wishes. It also gives your daughter the power and rationale to say “No” to her spouse. As trustee, she can tell her spouse she has a responsibility to manage the trust responsibly in accordance with the conditions you put forth in the trust.
Drawbacks: A low-protection bloodline trust doesn’t guarantee your wishes will be observed or that family money will stay in the family. Since your daughter controls the trust as the trustee, no one will stop her if she interprets your wishes in ways you disagree with or even removes all of the assets from the trust and does what she wants with them.
High-protection bloodline trust. How it works: You leave instructions that on your death, the assets in your living trust will “pour into” an irrevocable trust. You appoint an independent third-party trustee, typically a bank that specializes in trust management or a private professional person who is in the business of being a trustee. You detail specific provisions that the trustee must follow in giving your child access to the assets after your death. Example: You can direct how much income or principal should be distributed to your daughter for specific reasons such as medical bills or education. Or say your daughter needs a new vehicle—you can direct the trustee to pay expenses directly from the trust to the car dealership. For larger purchases such as a home, the trustee could loan the money to your daughter. The house would be used as collateral to secure the debt to the trust.
Advantages: If your daughter has always done things her way to your dismay and disappointment, the trust guarantees your wishes will be observed. It is also useful if you believe your son-in-law’s sway with your daughter is too strong.
Drawbacks: Your child is likely to view this bloodline trust as a way to control her from the grave. But remember—you have great flexibility in crafting the terms of the trust. Example: You can stipulate how long the trustee controls the child’s inheritance. You can stipulate that if your daughter’s marriage lasts 20 years or your son-in-law dies, the trust can be dissolved and their child would gain full access to and control of the inheritance. Or you can allow the trustee to distribute assets at the trustee’s discretion.
Other drawbacks of bloodline trusts that you should address with your estate-planning attorney…
Inflexibility—bloodline trusts may not adapt well to changing family dynamics or unforeseen circumstances. They even may exclude beloved grandchildren who are adopted, simply because they are not literally part of the bloodline.
Potential loss of government benefits—for beneficiaries with special needs, inheriting through this type of trust could jeopardize their eligibility for government assistance.
