It’s a more common dilemma than you might think: A successful person has a substantial estate to pass down, but a member of the family’s next generation has proven to be a poor money manager. In other words, a carefully accumulated inheritance might be quickly squandered by the owner’s own child or children.
But it’s still possible to design a trust that will benefit grandchildren, without letting their less-than financial savvy parent or parents misuse assets that are meant to benefit the next generation.
I recently heard about a not-so-young man who has either quit or been fired from a long sequence of jobs, and has taken huge sums of money from his parents that he mostly spent on fun and games.
Now divorced, he has been stingy with child support. His teenage children and their mother must rely on welfare just to get by. His own father, now elderly, has a sizeable estate. The older man’s challenge is whether he can find a way to help his needy grandchildren. Or will he take the easiest option and just leave his money to his son, who is sure to fritter it away, just as he’s done with all the other money his parents have given him over the years?
Unfortunately, I have run into this situation with a number of clients. And several factors can interfere with finding the best solution to the problem.
For one thing, most people sadly lack the ability to see their way past their children’s wiles and to recognize that they should pass them by and let their estate go directly to the next generation.
And even those who recognize the problem may run into the problem of the so-called “generation-skipping tax.” This is a little-known provision of federal tax law that requires you to pay a whopping 50 percent of your estate when you leave an inheritance that “skips” a generation and the heirs in that generation are still living. The provision applies only to estates over $1 million, and with larger inheritances that first million is exempted. But estates of this size are quite common these days, so it’s important to be aware of this provision.
On the other hand, if, for any reason, members of the next generation have died, then the grandchildren’s generation “steps up” and the tax doesn’t apply.
My advice to anyone concerned about that big potential tax bite: don’t let the tail wag the dog. If you have good reason to believe your money would be squandered if you did leave it to your immediate offspring, you might as well secure it for the next generation, tax or no tax.
Here’s one way we can help accomplish that goal, and minimize the tax impact. We set up what is called a GST: a “generation-skipping trust.” It contains no more than $1 million, so it’s not subject to the generation-skipping tax. And the sum is put in trust for the grandkids. If any funds are left over, then they can be put in trust for the unreliable child — the grandchildren’s parent. That trust is set up with very strict usage rules and governed by a trustee like Old North State Trust that will be sure to carry out the owner’s wishes.
One example of this is a client of mine who had two children, both of whom were drug addicts. As it happens, both children died prematurely, so the problem has taken care of itself in the most unfortunate way. But the client’s trust had been set up so her children had to pass a drug test before they could receive any money.
I have other family situations in which drugs aren’t the problem, but the kid (and I use the term “kid” loosely) just wouldn’t work. In these cases, the trust’s terms stipulated that the child must provide me with a W2 - proving he’s gainfully employed - before receiving any money from the trust. Even then, the funds may be used only for certain things, such as medical expenses.
When considering your own estate options, you certainly can cut out anyone and leave your assets to anyone else of your choosing. But in doing so, you should understand how best to accomplish your goals, and what the consequences will be.
Nevertheless, whatever those consequences, it’s always better to do the choosing yourself. The alternative is to let the state decide, which almost never matches up with what someone would have chosen for his or her family.
Old North State Trust, LLC (ONST) periodically produces publications as a service to clients and friends. The information contained in these publications is intended to provide general information about issues related to trust, investment and estate related topics. Readers should be aware that the facts may vary depending upon individual circumstances. The information contained in these publications is intended solely for informational purposes, is proprietary to ONST and is not guaranteed to be accurate, complete or timely.
Susan Willett is the director of trust services and oversees all aspects of trust administration for Old North State Trust, LLC. Old North State Trust, a North Carolina chartered trust company, provides: asset management services; income, estate and trust tax consulting; retirement planning and administration; and trustee and estate services to both individuals and businesses. Old North State Trust professionals have many years of experience and for over a decade have assisted clients in identifying and reaching their financial goals. For more information, visit www.oldnorthstatetrust.com or call 910-399-5470.
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