When clients meet with an estate planning attorney, one of the biggest concerns they have is that they do not want their children to receive too much money too early.
Accordingly, they want to set up a trust for their children. This is true even if the children do not have special needs or drug and alcohol problems. Unfortunately, the answer to the question “What are the Most Common Types of Trusts for Children” is not a simple one.
After all, there are many different types of trusts for children.
Different Categories of Trusts
Let’s break down the different types of trusts for children into four categories:
- A one-shot trust. This means that money is held in trust until the child reaches a set age. For example, once the child reaches age 25, the child can have all the money.
- A tiered trust. This means that the child would receive the money in multiple stages. For example, once the child reaches age 25, the child could receive half the money, and then receive the balance of the trust at age 30. You can have as many tiers as you want, and it can be established in whatever percentages you want. For example, you can do 10% at age 25, 20% at age 30, 30% at age 35, and the balance at age 40.
- A lifetime trust (or a dynasty trust). A lifetime trust for a child means that the money stays in trust for your child’s entire lifetime. A dynasty trust lasts not just for the lifetime of your child, but also the lifetime of all your descendants. Typically we would recommend a lifetime trust if you have reasons not to fully trust your child with money (or you are concerned about your child’s marital situation), but you believe that your grandchildren will be alright handling the funds.
- A common pot trust. A common pot trust is where money is held in a trust for multiple children. The other three trusts described above are typically just for one child. A common pot trust is useful to pay for the health and education of multiple children, with the children splitting whatever is left over once the youngest reaches a certain age. (A good time to use this might be if you have paid for the college of one child, but not the others.)
Common Distribution Rules for Trusts
Now, for each of these four categories of trusts, you can establish a variety of ongoing distribution rules. Ongoing distribution rules allow the Trustee to make payments to your child until he or she is old enough to receive their inheritance or until your child’s death. The most common ongoing distribution rules when creating trusts for children include:
- A distribution of income. (Although we recommend that this start at age 21 or later.)
- A distribution based upon the value of the trust. (For example, you can require the trustee to distribute 4% of the trust’s value every year, and have that paid monthly.) This is known as a unitrust payment.
- A distribution of a set dollar amount every year. (For example, you can pay your child $60,000 per year, in monthly installments.) This is like an annuity.
- Allowing the Trustee to pay your child whatever they deem appropriate for your child’s health, education, maintenance, and support. Under this standard, the trustee can use an unlimited amount of money to pay for doctors’ bills and operations. The trustee can also use an unlimited amount of money to pay for college. With respect to maintenance and support, the best way to understand this standard is that the trustee can maintain your child’s lifestyle in a manner that they are accustomed to.
- Allowing your child, once they get to a certain age, the ability to withdraw a percentage of the trust every year. (This is almost always capped at the greater of $5,000 or 5% of the trust.)
- Restricting the distribution so that the trustee can only distribute money from the trust at the complete discretion of the trustee.
Common Customization Options for Trusts for Children
There are also many custom distribution provisions that you can add. Custom provisions might include distributions if the child graduates from college or giving money to a child who wants to buy a business or a house. Many of these ongoing provisions and custom provisions are often combined within a single trust.
Typical Trusts for Children Based Upon the Value of the Trust
So now that you are probably overwhelmed with options, you can understand why people frequently ask their friendly estate planning attorney, “What are the typical trusts that most people create for their children?” Even in cases where there are no known problems with the children, the type of trust that we typically recommend depends upon the level of a person’s wealth.
Broadly speaking, if you are leaving your child less than $250,000, we often recommend a one-shot trust. Here we would usually allow the trustee to distribute funds for the benefit of your child for their health, education, maintenance, and support. Then, when your child reaches age 25, we would have the trust terminate. The trustee would distribute whatever is left to your child outright.
If you are leaving approximately $250,000 to $1,000,000 to your child, we often recommend a two-tier approach. Usually, we allow the trustee to distribute funds for the benefit of your child for their health, education, maintenance, and support. Then, when your child reaches age 25, we would have the trustee distribute 25% of the trust. Finally, when your child reaches age 30, the trust would terminate. The trustee would distribute whatever is left to your child outright.
If you are leaving approximately $1,000,000 to $3,000,000 to your child, we often recommend a three-tier approach. Usually, we allow the trustee to distribute funds for the benefit of your child for their health, education, maintenance, and support. Then, when your child reaches age 25, we would have the trustee distribute one-third of the trust. When your child reaches age thirty, we would have the trustee distribute another one-third of the trust. Finally, when you child reaches age 35, the trust would terminate. The trustee would distribute whatever is left to your child outright.
If you are leaving your child over $3,000,000, we often recommend a lifetime trust or dynasty trust approach. In this situation, we typically allow the trustee to distribute funds for the benefit of your child for their health, education, maintenance, and support. Then, when your child reaches age 21, we could also have the trustee distribute an income stream from the trust to your child. When your child reaches age 35, we would grant them the authority to take out up to 5% of the trust annually. This is in addition to the income stream. Finally, many people have their child take over as trustee at age 35 as well. The child in this situation would never receive the bulk of the principal outright. However, as you can see, they still have broad access to the money while still protecting it from creditors.
Conclusion – Common Trusts for Children
You will notice that the more money that is involved, the longer that people typically leave money in trust for their child. The reason for this is that it can produce an income stream for your child, but also protect it from creditors and divorce. Even with a lifetime trust, you don’t have to worry about your child not having control of the money, because you can name them as trustee of their own trust. (Note – there will be more asset protection if someone else serves as trustee though.)
Keep in mind, that a good estate planning lawyer can customize trusts for children however you wish. However, the purpose of this article is to help you understand what are the most common types of trusts for children.