Posted On: MAY 2023
Should you use one trust or separate trusts?
One of the most effective ways to provide for your children in your estate plan is to set up trusts for them. Trusts offer many benefits, including, among other things, the flexibility over when and how to make distributions, protection of assets from beneficiaries’ creditors and protection of assets from being divided as part of a beneficiary’s divorce.
They can also help protect the funds from depletion by a beneficiary with a substance abuse problem, a gambling addiction or bad spending habits.
Many parents’ estate plans call for their assets to be split into equal shares and used to fund a separate trust for each child. But, depending on your circumstances, it may be preferable to pool your assets into a single “pot” trust.
Equal isn’t necessarily fair
Most parents want to avoid “playing favorites,” so separate trusts appeal to their sense of fairness. But “equal” and “fair” aren’t necessarily the same thing. Think about how you use your funds now. If one of your children has a specific need — whether it’s college tuition, medical care or something else — it’s likely that you’ll pay for it without feeling any pressure to spend the same amount on your other children.
View your estate plan in the same light: Fairness means providing for your children’s needs, regardless of whether you distribute your assets equally.
For example, suppose you have two children, Stella and Lucy, age 23 and 18, respectively. Stella recently graduated from college and Lucy is about to start. You’ve already spent more than $200,000 on Stella’s tuition and other college expenses. If you were to die tomorrow, and your estate plan divides your wealth equally between Stella and Lucy, Stella will come out ahead. That’s because she already received the benefit of $200,000 in college expenses. Lucy, on the other hand, will need to tap her trust fund to pay for college.
A pot trust to the rescue
A pot trust can be a great way to continue meeting your children’s individual needs and avoid giving one child a windfall, like Stella received in the example above. As the name suggests, you pool assets into a single trust and give the trustee full discretionary authority to distribute the funds among your children according to their needs.
Essentially, a pot trust allows the trustee to spend your money the way you would if you were alive. If one of your children has substantial educational expenses or medical bills, the trustee has the authority to cover them, even at the expense of your other children’s inheritances.
For many families, a pot trust makes sense when children are relatively young and are likely to have differing needs that can change dramatically over time. If appropriate, your plan can call for the pot trust to be divided into separate trusts for each child at some point in the future — for example, when the youngest child reaches 21, 25 or some other milestone.
Choose your trustee carefully
For a pot trust to be effective, it’s critical to choose your trustee — as well as a backup trustee — carefully. As with any type of trust, your trustee should be trustworthy and impartial and have the skills necessary to manage the trust assets. But for a pot trust, it’s particularly important for the trustee to have the ability to communicate effectively with the beneficiaries.
Because distributions depend on each beneficiary’s unique needs, the trustee must understand those needs, as well as your objectives for the trust, and be able to explain the reasoning behind his or her decisions to all the beneficiaries.