Most Estate Planning attorneys recommend Revocable Living Trusts as the main vehicle for managing assets in the event of incapacity and transferring assets upon death. The most common reasons for utilizing Revocable Living Trusts are (1) probate avoidance and (2) the minimization or elimination of Estate Tax. While these are important objectives, most Estate Planning attorneys fail to fully utilize all beneficial aspects that a trust structure can provide, particularly for the Revocable Living Trust's beneficiaries.
If the attorney only thinks about (1) probate avoidance and (2) the minimization or elimination of Estate Tax as the reasons for creating a Revocable Living Trust, the attorney most likely will structure the trust to provide "outright distributions" to the beneficiaries upon the death of the trust makers. This means that the trust will distribute the inheritances out to the beneficiaries in their individual names and then the trust will terminate. The inheritances will be comingled with the beneficiaries' other property and subject to the total control of the beneficiaries. While this makes sense on the surface, a deeper understanding of the additional advantages trusts can provide for beneficiaries demonstrates why outright distributions – though extremely common – are less than ideal.
If a trust is properly structured, receiving an inheritance in trust rather than directly in the beneficiary's name can provide additional features such as (1) divorce protection; (2) creditor protection; and (3) additional Estate Tax protection.
Receiving an inheritance in trust rather than in one's own name creates a bright line distinction between property that has been inherited by a beneficiary and property that the beneficiary and his/her spouse have earned together. In a divorce, it will generally be much easier to distinguish between what property is separate (the inheritance) and what property is community and thus subject to division.
If the trust for the beneficiary has certain provisions, the inheritance can often be protected from the beneficiary's creditors. With the proliferation of lawsuits over the last several years, many people are concerned about frivolous lawsuits subjecting hard earned assets to plaintiffs and their attorneys. Receiving an inheritance in trust rather than outright provides significant creditor protection.
Finally, within certain limits, an in-trust inheritance can mean that some or all of the inheritance received by the beneficiary will not be considered part of the beneficiary's estate and thus will not use up the beneficiary's Estate Tax exemption.
If the trust makers feel that the beneficiary is capable of handling his/her inheritance, the trust for the beneficiary can be designed as a "beneficiary controlled trust," giving the beneficiary the protections of an "in-trust" inheritance while at the same time giving the beneficiary control over the inheritance. With all of these additional protections, "in-trust" inheritances are far more valuable than "outright inheritances," yet most attorneys are not aware of these additional benefits.