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Orange County Business Journal: Living Trusts: How Special Distribution Provisions Can Help You Achieve Your Objectives

Living Trusts: How Special Distribution Provisions Can Help You Achieve Your Objectives

By Gordon A. Schaller and Scott Harshman

Special Distribution Provisions in Living Trusts
The living trust is one of the most basic estate planning tools available, but some lawyers adopt a "one-form-fits-all" approach to drafting the trust. Many clients have special situations that demand that the estate planner take the time to understand their unique objectives to properly clarify and express the client’s intent.

Distribution provisions in a living trust commonly allow the trustee to distribute income and principal, in the trustee’s discretion, for the beneficiary’s health, education, support and maintenance. When distribution provisions are more narrowly focused than this general standard, great care should be used to ensure that the language is clear and that the client has thought through the practical application of the distribution scheme over time. Trusts may also contain language regarding the grantor’s intent that is only to provide further clarity, but is not binding on the trustee.

Finally, certain aspects of the living trust provide unique opportunities for the grantor to protect his children or heirs. Most clients prefer to hold assets in trust for their beneficiaries after their death. If the trust is drafted properly, assets held in trust may be protected from creditors of the beneficiary. This raises the question of whether principal distributions should be made to beneficiaries at certain ages and in what amounts or for what purposes.

Pot Trust vs. Allocation into Shares
One of the first decisions is whether the trust assets should be held in "pot" trust after the client’s death or allocated to separate shares for each beneficiary. A "pot" trust allows unequal distributions to the trust beneficiaries. This is often utilized for smaller estates or if a beneficiary has some specific need such as health care. However, the pot trust could be depleted for a single beneficiary if the grantor does not place appropriate caps or limitations. Limitations can be in terms of dollars, percentages, particular uses or a combination of these.

Allocation to "Funds" Approach

Certain clients have specific priorities for how funds are distributed to their beneficiaries.
Following the client’s death, the trust could be allocated into separate funds or "baskets" for specific purposes such as education, health, career incentives, purchase of a residence, family needs, etc. These would operate like a series of pot trusts. The amount allocated to each fund would reflect the client’s objectives and the assets available to satisfy those goals. Allocation could be in dollar amounts (with some inflation adjustment) or percentages of the estate, or a combination. Percentage amounts are preferable since the total dollar value of the trust may change over time. It is also possible to fully fund one or more objectives, before allocating any assets to an objective of lower priority.

Drafting Education Provisions
Education distributions for beneficiaries can extend over a long period of time. Many children attend private school with substantial tuition. Education expenses can last for 20 years or more if beneficiaries pursue advanced degrees. Some clients may desire to focus the trust funds only on higher education, beginning with college. Incentives can be drafted so that the beneficiary receives a cash distribution after completion of milestones such as a bachelors degree and more advanced degrees.

The client and drafter must also define the scope of distributions for education. Does it include room and board? Does it include summers when school is out or travel and study abroad? What if the beneficiary is not a full time student? Should there be provisions that the beneficiary maintain a certain grade point average? How do you prevent a beneficiary from becoming a lifetime student? These are all important questions that must be addressed in the trust.

Drafting Provisions for Health Care
Health care needs and distributions are the most difficult to quantify into the future. This is a function of the rising cost of health care, the possible revision of health care delivery and management in the future, and the unknowns we all have concerning our health. The trust should authorize or direct the purchase of health insurance for beneficiaries who are not otherwise covered by a plan. This will help to minimize the cost of catastrophic health needs.

Specific provisions can also be drafted into a health care fund to incentivize a beneficiary to live a healthy lifestyle. For example, the fund could provide for health club memberships, clinics to help stop smoking or drug use, physical therapy, and other medical care to promote a physically healthy lifestyle.

Drafting Incentives for Career or Homemaking
A career fund may promote productive employment and reward an ambitious work ethic. The two most common provisions in this type of fund are distributions for starting or continuing a business or matching part or all of a beneficiary’s earned income. The trustee should evaluate an appropriate business plan from a beneficiary desiring distributions to start or maintain a business. Distributions for earned income are often on a dollar-for-dollar matching, subject to some maximum amount, to reward beneficiaries who work hard regardless of the amount of money they earn.
A beneficiary who earns $50,000 a year could increase his lifestyle to $100,000 a year while continuing to pursue the career path of his choice. This may incentivize a beneficiary to obtain employment that is socially worthwhile, but does not pay a significant salary. Distributions can also be made either outright or on a matching basis for beneficiaries who want to advance their career through additional training, classes, institutes, seminars, or research, subject to some maximum amount for each purpose and beneficiary.

Often beneficiaries may decide that homemaking and caring for children are more important than an outside career. The trust could provide distributions to reward such activities for a certain time period.

Drafting Provisions For Housing
Many clients are interested in helping beneficiaries acquire a residence. As with other provisions, there are many variables to consider. The first decision is whether the trust should own the residence or should it be owned by the beneficiary and possibly a spouse. Second, what form should the housing distribution take – an outright purchase, a down-payment, or a loan to be repaid? Third, what limits should be placed on the price of the residence? For example, this could be defined as the median priced residence in the city where the residence to be purchased is located – that is, a house located in California is much more expensive than a house located in Iowa.

The housing fund could provide for a rent subsidy while the beneficiary is developing his career path and while the beneficiary is locating to more permanent housing. The fund could also provide financial assistance for a beneficiary who is unable to work due to a prolonged mental or physical disability.

Asset Protection for Trust Beneficiaries
Most clients are interested in the idea of protecting the assets that they pass to their children and grandchildren. While it may add a layer of complexity to a beneficiary’s life, through careful drafting, the portion of a beneficiary’s inheritance that is held in continuing trust can remain secure from divorce and the beneficiary’s creditors for his entire life. Trust assets, which by definition are separate property, cannot be commingled with community property funds and thereafter later paid to a former spouse as part of a divorce. Assets can often be purchased by the trust and used by the beneficiary and his spouse, while the assets remain protected from creditors and retain their separate property character. If a beneficiary is sued and a judgment is obtained against the beneficiary, then the creditor may have limited or no access to the funds inside a properly drafted trust. While most trusts prevent anticipatory assignment or pledging of income or principal to a beneficiary’s creditor, this protection is lost with respect to distributions made to the beneficiary.

Preparation of living trusts is always a collaborative effort between clients and lawyers. A good estate planning lawyer will take the time to explore the client’s objectives and learn about their family situation to determine whether detailed distribution provisions are appropriate. The variations and levels of complexity are unlimited and the lawyer’s job is to help the client explore them with the practical insight gained from experience. As always, the goal is to determine the client’s intent and express it with clarity.

© Orange County Business Journal 2008.