If you have children, there is a good chance that you have left them their inheritance in a trust, under which someone will act as trustee. If you have set up a trust for someone other than a child, the following discussion will apply as well.
There are many reasons you might set up a trust for a child.
- The child may be a minor, i.e., under the age of 18.
- The child may not be financially responsible to handle money.
- The child may be in an occupation that has liability (e.g., doctor or lawyer) and you are trying to protect the child's inheritance from liability.
- The child may be in a lawsuit and you do not want the child to lose the inheritance.
- You may be concerned the child may get divorced and you do not want the assets subject to a claim by the child's spouse.
Regardless of why you set up the trust, you have named a person to be the trustee who will invest the assets, file tax returns and make distributions to your child in accordance with the provisions of the trust.
There are two types of distributions which are made from trusts: discretionary distributions, in which the trustee will decide how much to distribute to the child, and mandatory distributions, which require the trustee to make distributions to the child at certain times, e.g., as the child reaches certain ages. For example, a child may receive 1/3 of his or her assets in the trust upon attaining age 30, another 1/3 at age 35 and the remainder at age 40.
The reason for breaking up the mandatory distributions to a child at specified ages is so that if the child is irresponsible with the first distribution, he or she will have a chance to learn from those mistakes and make better decisions with the next distributions. For example, assume you have $1.5 million in a trust for a child and the child receives 1/3 at age 30. Without having had experience in handling money, it is possible the child will not know what to do with the distribution, or how to invest it, wasting $500,000 of the trust.
A better strategy may be to allow the child to learn about the money before giving him or her full control over any portion of the trust by making him or her a co-trustee with your named trustee before the first required distribution. For example, if the 1st distribution is to be made at age 30, your child could become a co-trustee at age 25. This would allow the child to learn how the money is invested and what he or she should know before the child gets a distribution of 1/3 of his or her trust. While the child is a co-trustee, the child and the regular trustee would have to make decisions together as to investments and other matters relating to the trust. Obviously, the requirements for a child to become co-trustee depend on how you structure the trust. You may decide that he or she should only be a co-trustee for two years before getting the first distribution, for example.
In our experience, time spent as a co-trustee greatly helps a child learn responsibility with money, especially in cases where the child has very little prior knowledge. In these cases, it is much more likely that the child will keep assets invested once they take over full control, rather than cashing everything out and using the funds irresponsibly. Whatever age you select, making your child a co-trustee should enhance his or her knowledge of how to properly handle the inheritance, and will help to ensure a long-lasting benefit to your children and grandchildren.
