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Would you like to provide your children or loved ones with an inheritance but protect them from the risks that may accompany a large windfall? If so, you can create a beneficiary-controlled trust in which the person you name as the trust’s primary beneficiary has rights, benefits, and control over the property held by the trust, but with important protections. In a beneficiary-controlled trust, you can name the primary beneficiary as the sole trustee, or if you name a co-trustee, the beneficiary can be given the authority to remove the co-trustee and select a successor co-trustee if they choose. In addition, a beneficiary-controlled trust may include a broad, nongeneral power of appointment that enables a beneficiary who is also trustee to limit the ability of other more remote beneficiaries to enjoy the property held by the trust.

Maryland law permits you as the trust settlor to create trusts for beneficiaries (both known and future, but currently unknown/unborn, beneficiaries) where the beneficiary can also serve as their own trustee. Duvall Law Firm designs these “Beneficiary-Controlled Trusts” (BCT) to give the child and successive generations the opportunity to be mentored in how to handle the trust responsibilities before being given the reins to control the trust. You can add any contingencies which are important to you as a prerequisite to them becoming trustee. Those contingencies could include a certain age, a certain educational attainment, or other achievement. It is another wonderful way where your family can be benefited through careful estate planning.

What Are the Pros?

If you want to provide an inheritance to a mature child or loved one that you trust to make prudent financial decisions, a beneficiary-controlled controlled trust is a strategy that you should consider. Even beneficiaries who handle money wisely could encounter situations in which their money and property are vulnerable to creditors’ claims, divorce, lawsuits, or estate taxes: a beneficiary-controlled trust can protect the property held in the trust against those claims. Although you can include terms in the trust document that limit the degree of involvement and control you would like the beneficiary to have, a beneficiary-controlled trust can still enable the beneficiary to have a considerable amount of control over their inheritance and how it is used.

Beneficiary as sole trustee. Maryland law can be used to protect your beneficiaries so, even if a beneficiary is the sole trustee, most creditors may not reach the beneficiary’s interest. This feature in the law provides a modicum of asset protection for your beneficiaries. Using these features, most creditors cannot grab your beneficiary’s interest in the trust or compel them to make a distribution unless such distributions are mandated. Also, even where a beneficiary is the sole trustee, the trustee has a fiduciary duty to adhere to the trust’s requirement to make distributions only for the beneficiary’s health, education, maintenance and support (HEMS) and is not permitted to make distributions to the beneficiary’s creditors. The beneficiary as trustee can be given discretion over distributions and, therefore, is in a wonderful position to negotiate with creditors for pennies on the dollar. The However, once the trustee makes a distribution to themselves as a beneficiary, the creditor may then be able to reach the funds.

This type of provision provides two additional benefits. First, the HEMS standard provides a safe harbor under the Internal Revenue Code (I.R.C.), and its use will prevent the value of the money and property in the trust from being included in your beneficiary’s gross estate for estate tax purposes. Second, depending upon the unique circumstances of each beneficiary and if there is low risk of creditors’ claims or lawsuits, naming the primary beneficiary as the sole trustee, along with the HEMS standard for distributions, may reduce expenses during administration of the trust because the fees required for an independent co-trustee would not be incurred.

Beneficiary as co-trustee. Generally, we provide our BCTs with supervision through the use of adult co-trustees for young beneficiary-trustees. By having friendly, knowledgeable adults available for beneficiaries just beginning their duties as trustee, many errors can be avoided. We can also improve the authority of the adult co-trustee by permitting them to void and reverse/undo actions of the young beneficiary-trustee.

The beneficiary’s credit her protection can be further enhanced through the use of an independent trustee, so long as that trustee is actually independent—not a related party or a person subordinate to the beneficiary as defined by I.R.C. § 672(c). In addition, the beneficiary may replace the independent trustee if circumstances change. For instance, any time the beneficiary is facing a heightened risk of lawsuits, divorce, or creditors’ claims, they could resign as the trustee and appoint an independent trustee to serve in their place, providing additional protection for the trust’s assets.

What Are the Cons?

May not protect against all creditors. Some states’ laws provide exceptions that preclude BCTs from being used to protect trust assets from claims by certain creditors, for example, a former spouse’s claim for alimony or a claim for child support. In those states, the creditor may be able to reach the trust’s property to satisfy those claims or to compel a distribution that it can then use to satisfy the claims.

May provide too much control for some beneficiaries. For beneficiaries who are not skilled at managing money or have poor judgment, a beneficiary-controlled trust may not be the best estate planning strategy. The Duvall Law Firm mitigates this weakness by the use of adult co-trustees, as discussed above. Although the trust document will specify the beneficiary’s responsibilities as a fiduciary, a BCT provides the beneficiary with considerable control over their inheritance. Even if a beneficiary who is also the sole trustee may only make HEMS distributions to themselves, to a large extent, it is up to them to determine if a particular distribution meets that standard, permitting them substantial leeway in how the money or property held by the trust is expended. If you are concerned that a beneficiary will not be able to handle the responsibility of also being a trustee for a BCT, other estate planning solutions may provide you with more peace of mind.

If you would like to find out more about whether a BCT is a strategy that will work for you and your family, give us a call to set up an appointment. We can help you think through how to design your beneficiary-controlled trust in a way that achieves your goals and protects the inheritance you want to leave for family members and loved ones.