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1520 6th Ave
San Diego, CA, 92103
United States

(619) 320.8780

San Diego law firm focusing on estate planning including preparation of trusts, wills, and powers of attorney, trust administration, probate, business formations including partnerships, limited liability companies, and corporations, business succession planning, bankruptcy, business litigation, employment law, and general civil litigation.

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How to Protect Your Beneficiaries' Inheritance After Your Death

Casey OConnell

What happens to a beneficiary's inheritance if at the time he or she is entitled to receive the inheritance, he or she is wrapped up in litigation, bankruptcy, divorce, or has outstanding judgments in favor of creditors? Or what if your beneficiary's spouse is being sued at the time of distribution? While most trusts include "Spendthrift" clauses to prevent a beneficiary's creditors from seeking payment from a particular beneficiary's share of the trust estate while the assets remain in the trust, once those assets are distributed to the beneficiary, third parties can take those assets. As a result, our firm offers our clients the option to include "Conditional Distribution Provisions" to their trusts. These provisions, what we call Protective Inheritance Trust provisions, create two conditions that must be satisfied before your beneficiary is entitled to receive his or her inheritance.

First, before any beneficiary may receive his or her inheritance, the first condition imposed upon them must be satisfied. The first condition requires the beneficiary to be free of legal proceedings that may reduce, negate, or jeopardize all or any portion of that beneficiary's inheritance. Once the beneficiary establishes, in the attorney's discretion, that he or she, or his or her spouse, is free of legal proceedings in this regard, this condition is satisfied. If satisfied, the beneficiary must then meet the second condition imposed upon him or her.

The second condition requires the beneficiary to establish a "Sole and Separate Property Trust" in which to receive his or her inheritance. Under California Community Property laws, inheritance is deemed to be an individual's separate property. In other words, in the event of death or divorce, the beneficiary's spouse has no claim to what was inherited. This becomes a murky issue, however, if a beneficiary deposits his or her inheritance in an account that is a community property account with his or her spouse. If such commingling of separate and community assets takes place, the deposit of separate property into the community account is deemed to be a gift to the community estate of the husband and wife. Consequently, even a separate property inheritance that is not kept separate from a marital estate can be lost in a subsequent divorce. Thus, the Sole and Separate Property Trust that the beneficiary must establish clearly defines the inheritance as separate property and keeps the inheritance separate and apart from community assets. The beneficiary may use these funds to benefit her spouse or in any way he or she sees fit. After all, it is their inheritance. However, by establishing a clear distinction between separate and community assets, there is little risk that the inheritance will be lost to a beneficiary's spouse. This adds a level of certainty and protection to your beneficiary's inheritance that would not otherwise be available to them and prevents avaricious spouses from conniving to grift your child's inheritance.

Lets analyze a short hypothetical factual scenario to better illustrate the advantages of including the Protective Inheritance Trust provisions in your family trust.

Hypo #1:  Burt and Jane establish a trust that benefits their three children, Sara, Ed, and Burt Jr. equally upon the death of the second spouse to die. Burt and Jane's trust does not include any Protective Inheritance Trust provisions. Burt then dies, followed by Jane two years later.Their estate is valued at $3,000,000 after payment of last debts, taxes, and expenses.  Six months before Jane dies, her son Ed is sued for breaching a contract he entered into for a business venture he was starting at the time. Additionally, Sara has defaulted on her significant sum of student loans and is being hounded by her lender seeking payments. Upon Jane's passing, the three children are set to receive their 1/3 share of their parents' estate, or $1,000,000 each. Because their respective shares are not made conditional as discussed above, the successor trustee of Burt and Jane's trust must distribute the beneficiaries' shares as called for by the terms of the trust. By this time, Ed has come to an agreement to settle the lawsuit against him by paying the opposing party $250,000. Sara, however, still owes nearly $200,000 for her graduate school student loans. Upon distribution of Ed's share of the estate, the opposing party would seek to attach the full amount of the settlement amount, or 1/4 of Ed's inheritance. The same applies to Sara for the defaulted student loan balance. Burt Jr. is the only beneficiary that will receive his full 1/3 share of the estate. As you can see from this simple example, failing to plan for your beneficiary's circumstances after you are gone may expose your hard-earned assets and children's inheritance to their or their spouse's creditors.

Now, lets say Burt and Jane include the Protective Inheritance Trust provisions in their trust. How does this change the analysis? First, Ed's share of the estate would be held in Burt and Jane's trust until his legal proceeding was resolved. As a result, Ed would be entitled to receive distributions for his health, education, maintenance, and support from his parents' trust, but would not receive his lump sum inheritance until he satisfied the settlement amount with the opposing party. Similarly, Sara's share would be held in trust until she resolved or settled the default on her student loans. Once resolved, the beneficiaries would then be required to set up their own Sole and Separate Property trusts in which to receive their $1,000,000 share. In this instance, all three beneficiaries receive an equal share of the estate as Burt and Jane intended and Burt and Jane's gift to their children is not jeopardized by the actions of their children.

These provisions protect your beneficiaries. Implementing these provisions only serve to further plan and protect what you have worked so hard to leave your loved ones. If you'd like to discuss how these provisions might apply to your particular circumstances, call our office to schedule a free one-hour initial consultation.