How Should I Leave Assets to My Children?
An important question faced by many parents is “How Should I Pass Assets to My Children” when I am gone?
Assets can pass in many creative ways to the next generation, so this overview is in no way a limitation on that, however, it outlines the three most common ways assets are passed to children. Generally upon the death of the surviving spouse, assets remaining in the estate or trust are divided into equal shares for each living child (or a deceased child’s share passes to that child’s children). Assets can generally pass outright or be held in trust for the child’s benefit (minor or adult children) as follows:
1. Outright to Children. As long as a child is over eighteen (18) in Colorado, there is no legal prohibition on an outright distribution. This can work well if there are not significant assets in the estate and you have a fiscally responsible child who can responsibly manage the assets. Obviously, this type of distribution to a child provides no creditor protection, nor are there any limits or structure to how and on what the child can spend the assets.
2. Trusts with Assets that Pass Outright to Children at Certain Ages. This plan holds assets in trust for the benefit of the child until the child is more mature. Typically there is a three or two tier distribution, when the child attains certain ages, such as 25, 30, 35, etc. If there is ever an outright distribution for a child during that child’s lifetime, it will lose the majority of asset protection against any creditor, and therefore is not recommended if you decide to use a trust for asset protection. For example, if a child divorces a spouse, the outright distribution of the trust is considered to be a known asset and can be adjusted for present day time/money value even if the asset will not be available to the child for many years to come. Additionally the assets could be spent down very quickly once they pass outright to a child and not provide a lifetime of financial security for basic needs.
3. Lifetime or Dynasty Trusts for Children. This plan provides that the individual trust for each child will last for his or her lifetime. The advantage to creating a lifetime trust for each child is that the amount passing to trust will not be taxable in your child’s estate and it should be beyond the reach of most creditors or a divorcing spouse of the child, as long as there are remainder beneficiaries (typically naming the descendants of the beneficiary). While the principal of a lifetime trust is unlikely to be included as a martial asset of your child, the appreciation on the assets of such a trust is marital property under Colorado law and may be taken into account in the division of other property upon a child’s divorce. It may also be necessary for the child to release certain rights, such as serving as trustee, or providing for a co-trustee to serve with the child in order to provide maximum protection against creditors. Trustees will be discussed in future blog.
Conventional trust terms generally provide that the trustee may make distributions of income and/or principal for your child’s health, education, maintenance, and support (a “HEMS” standard). These limitations are necessary in order for the trust not to be considered property in your child’s estate if the child is serving as trustee upon death or divorce. In Colorado, it is permissible for the beneficiary to also be the trustee as long as there is an “ascertainable” standard, such as the HEMS standard listed above.
To instill financial responsibility skills, a child may be given the power to serve as co-trustee (to learn the management and administration of the trust) and then sole trustee after attaining an age of maturity. In order to provide flexibility in a lifetime trust, your child may also be given a “special power of appointment” over the trust which allows the child to gift trust property, during life after a certain age if qualified to serve as sole trustee, or at death. This power may be broad, allowing your child to gift the trust property “to any person or entity” or narrow allowing your child to gift to a certain group of individuals, such as your descendants or relatives. This power is individual to each plan and can be tailored to your wishes.