Estate Planning for Children: The Best Gift a Parent Can Give to a Child

Reprinted with permission from The Legal Intelligencer, July 16, 2024. © 2024 ALM Global, LLC. All rights reserved.

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By Justin H. Brown and George M. Riter Jr.

One of the greatest gifts that parents can give their children at death is an effective estate plan that takes into consideration the needs and desires of their children. Whether it is a child receiving public benefits who requires a special needs trust, a child facing a divorce who requires creditor protection, or a wealthy family that is aiming to prevent estate or inheritance tax upon the death of each successive generation, with proper planning, parents can assure that assets pass to their children in the best manner possible for each specific child.

Outright vs. Trust

In considering how to leave assets to children, parents must first determine whether assets should be distributed outright to their children or placed in trust. In making this decision, parents should consider the specific needs of their children as there should be no one-size-fits-all approach to planning a child’s inheritance.

Outright distributions to children are frequently the easiest and most cost effective approach to passing assets down to children. Outright distributions permit children to access funds immediately and have full control over the assets inherited. In simple and straightforward situations where children are able to manage their own assets, outright distributions may be the best solution for children. If there is any complexity in a child’s situation, however, trusts should be considered.

If an individual has minor children, it will always be beneficial to leave the minor’s assets in trust in order to avoid the need to appoint a guardian of the minor’s property and the subsequent court intervention in the administration of the minor’s funds. Such a process can be time consuming and costly as a guardian must often receive court approval before making significant distributions to a minor. A trust, on the other hand, does not usually require court intervention for distributions and is often significantly less expensive to administer.

A child, although not a minor, may not have the maturity to receive an outright distribution. By placing assets in trust, parents may delay outright distributions until such time as the child has the requisite maturity to manage his or her inheritance.

Parents should also consider whether a child has special needs or is receiving public benefits. If a child receiving public benefits receives assets outright, it is possible that the child’s benefits could stop, be reduced, or be suspended upon receiving an inheritance. The child may not be able to resume public benefits until all of the inherited assets are spent down. This could have catastrophic effects on a child and be entirely inconsistent with the intentions of a parent. By placing assets in a special needs trust for the child, the parent will be able to maintain the child’s public benefits and set aside a fund to supplement the needs of the child.

A child may also require creditor protection, either immediately or over the lifetime of the child, which would necessitate the use of a trust. Although distributions out of a trust to a child would not be protected from creditors, a child’s trust could be structured to protect the assets inside the trust from the reach of creditors. Creditor claims may arise in many contexts—a creditor may arise as a result of a child’s professional liability, business liabilities, divorce, or other personal issues. Placing assets in trust for a child with creditors or future creditors could prove to be a significant benefit to a child.

If a child’s estate could be subject to federal estate tax upon the receipt of an inheritance, then placing assets in a trust to avoid estate tax in subsequent generations may prove beneficial for future generations. Trusts may sometimes be structured to avoid federal estate and generation skipping transfer tax in all future generations. Using a parent’s federal estate tax and generation skipping transfer tax exemptions could allow trust assets to grow each generation without the encumbrance of estate and generation skipping transfer taxes.

Individual Trusts vs. Pot Trust

If a parent decides to utilize trusts for their children, a parent should consider whether each child should have a separate trust or whether all of the assets should be held in a “pot” for the collective benefit of all of the parents’ children and descendants.

Pot trusts are commonly used to facilitate family harmony because they promote the collective and collaborative investment and use of family assets. Pooling assets together enables greater investment opportunities for the family, and it provides a shared sense of responsibility in the use of family assets rather than viewing the pot as an individual’s assets. If one family member requires more resources, the family as a whole will support the family member. Pot trusts can therefore work very well in harmonious families to promote equity, but they can be difficult when family members are treated unequally or disagree as to the investment and administration decisions of the family pot of assets.

On the other hand, separate trusts are best used to create a separation among children so that each child may invest and utilize his or her inheritance in a manner best suited for each child. Sometimes, separate trusts create and facilitate family harmony because they avoid the potential issues that arise with pot trusts and enable each child to utilize his or her trust in a private and independent manner.

Trust Terms

If a parent chooses to utilize a trust for a child, the parent must next decide upon the terms of the child’s trust. The trust terms should be consistent with the parent’s purpose for the trust. If the trust is being created to preserve the child’s public benefits, assets should not be forced out of the trust to the child in a manner that would otherwise jeopardize the child’s eligibility to receive benefits. Providing the child with mandatory income, for example, could disqualify the child from receiving benefits and would be contrary to the goal of the trust. Terminating a special needs trust during the lifetime of the child could also have adverse consequences to the child, so such a trust is usually designed to remain in existence throughout the child’s lifetime when he or she is receiving public benefits.

If a trust is being created for asset protection purposes, the trustee should have discretion to make (or not make) distributions to the child rather than forcing assets out to a child and placing them within a creditor’s reach. Parents may believe that because a child does not have current creditors, an asset protection trust is unnecessary or termination of the trust at some point in the future is appropriate. Asset protection trusts will protect a child’s inheritance from both current and future creditors, and they will only offer protection so long as the assets are held in trust. Trusts created for asset protection purposes should therefore remain in effect until the creditor risk disappears—which often times, is impossible to predict.

If a trust is being created because the child is a minor or incapable of managing his or her inheritance, parents sometimes choose to distribute all of the trust assets to the child either upon the child reaching the age of majority or upon attaining a “magic” age when the parent anticipates (and hopes) that the child will be mature enough to handle the inheritance. Parents sometimes choose to spread large distributions to a child over time. For instance, the trust could distribute one-third of the principal around the age when a child could get married, one-half of the remaining principal when the child buys a house or buys into a business, and the remaining principal when the child has a child of his or her own. Spreading out distributions also permits children to further mature over the time period when they receive distributions so that they will be better prepared to manage later distributions. Parents could also choose to keep assets in trust in perpetuity for successive generations if they believe that there will never be the “magic” age of maturity.

If a trust is being created to protect the child’s inheritance from estate tax or generation skipping transfer tax at the child’s death, a trust should be designed to last for the lifetime of the child so as to prevent a mandatory distribution of assets to the child that would serve to only increase the child’s taxable estate at death.

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Structuring an inheritance for children requires an understanding of the specific needs of the child. Parents have many options for leaving assets to their children, and there should never be a one-size-fits-all approach to planning for children. A properly crafted estate plan can provide immeasurable benefits to a parent’s children and future generations.

Justin H. Brown, a partner at Ballard Spahr, develops creative strategies for wealth transfer, asset protection, and business succession. He also counsels fiduciaries on their duties and obligations in connection with the administration of estates and trusts.

George M. Riter Jr. is an associate in the private client services group at the firm. He focuses his practice on estate planning for high-net-worth individuals, along with estate and trust administration.

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