1. What is an Inheritance Protection Trust?
An Inheritance Protection Trust is an irrevocable trust established through a deceased person’s estate plan typically for benefit of a surviving child. Although the term “Inheritance Protection Trust” could generally describe many types of beneficiary trusts, it usually refers to a trust established for a responsible adult beneficiary who is willing and able to manage an inheritance. This type of trust is usually drafted to continue for the lifetime of the beneficiary (or until all assets have been spent), rather than end at a predetermined time or age of the beneficiary.
The beneficiary is usually named as sole trustee of the trust and is given the right to name an independent trustee, if desired; thus, an Inheritance Protection Trust is commonly described as a “beneficiary-controlled trust.”
An Inheritance Protection Trust is used as an alternative to outright distribution when the amount of inheritance is expected to be substantial (generally more than $100,000 per non-spouse beneficiary). Its protective features are promoted as benefits to the beneficiary, not the trustor, because the trust is usually established after the trustor's death. But it is possible to establish and fund an Inheritance Protection Trust during the trustor's lifetime by having the trustor make irrevocable lifetime gifts into the trust. This is relatively uncommon because the usual incentive for gifting is to reduce estate taxes and very few people are wealthy enough to be concerned about it.
2. What are the benefits of an Inheritance Protection Trust?
By receiving inheritance in a trust, rather than receiving inheritance outright, the beneficiary can protect assets from various threats:
3. How is the Inheritance Protection Trust established?
The trustor's personal representative or successor trustee, depending on whether the trust provisions are drafted into a Will or living trust, establishes an inheritance trust by giving the separate trust a name and applying for its Taxpayer ID number. The provisions in the Will or living trust document govern the new trust, although it may be permissible for the trustee to restate the terms of the separate trust with a new document. This process is called trust decanting in Arizona.
4. Who should serve as Trustee?
In most cases the beneficiary will serve as the initial trustee. However, if creditor protection is a paramount concern, the beneficiary should not serve as trustee. Rather an independent trustee – such as a bank, trust company, or accountant – should be appointed. This enhances the level of creditor protection by eliminating the conflict of interest held by a beneficiary who also serves as trustee. If an independent trustee is appointed, the beneficiary may be given a right to remove and replace the independent trustee.
A common drafting option is to name the beneficiary as initial trustee and grant the beneficiary a power to resign and appoint an independent trustee. This gives the beneficiary the discretion to choose the level of creditor protection desired.
5. How much does an Inheritance Protection Trust cost?
Typically the addition of one or more Inheritance Protection Trusts to a Will or living trust will substantially raise the fee for preparation of the estate plan. When compared to outright distribution of inheritance, the benefits of the Inheritance Protection Trust offer a clear and present value to both the trustor and beneficiary.