Making sure your kids would be taken care of if something happened to you is one of the most important responsibilities of being a parent. While we’d all like to think we’re invincible, the truth is that misfortune is seldom expected, so putting a plan in place to protect your kids is critical to keeping them safe.
While estate planning begins with preparing a will, there’s far more involved in making sure your kids are protected. Estate planning can seem like a simple matter, but plenty of mistakes are made that can have devastating effects on your family. Below are five mistakes that parents with young children often make in preparing their estate documents.
1. Leaving Assets to Your Children Directly
It’s natural to think that you should leave all your assets to your children if you pass away. However, leaving assets to children directly in your will or in a beneficiary designation can be disastrous.
Children under the age of 18 aren’t legally capable of managing assets, so the court will appoint someone to administer their inheritance. The appointed person is required to file annual reports with the court detailing how much money is being held for the child, how the funds are invested, and how the money is being spent. These reports are approved by the court and become a matter of public record. In an age where identity theft is rampant, having details of your children’s finances and expenses open to the public can make them prime targets for predators.
Leaving your assets directly to your children also provides them with unfettered access to their inheritance at the age of 18 – generally far younger than the age at which a child has the maturity to handle large sums of money. Having access to a large inheritance at an early age can result in a poor work ethic and imprudent spending habits. Your children are far more likely to make smart decisions about money when they are 25 or 30.
A trust is the best way to protect the privacy of your kids and to prevent them from having complete access to their inheritance at a young age. Administration of the trust is kept private and the assets are administered by a person you choose as trustee. You can specify in the trust document the age at which your child would have access to the money.
2. Leaving Assets to a Relative for Purposes of Taking Care of Your Children
In order to avoid court supervision of a child’s inheritance, some parents leave assets to a relative, with the expectation that the relative will use the money to raise their children. Because the relative would have no legal obligation to use the money for the benefit of your children, you’d be leaving the assets vulnerable, not only for the relative’s own use, but to the relative’s creditors or spouse.
If your family member were to be sued, fell into financial difficulty, or sustained large medical bills, assets you left to take care of your children could end up in the hands of creditors. If the relative is a grandparent, an illness or injury could land them in a nursing home, which would have a lien on the grandparent’s assets. If the family member died, your children may not be included in the will – and even if they were – the family member’s estate would be subject to claims by his or her spouse.
For these reasons, leaving assets to a family member with the expectation that they will use it to take care of your kids is a risky way to arrange your estate. It’s far better to leave the assets in a trust, naming your relative as the trustee. That way, the assets legally can be used only for the benefit of your children and are not available to your relative’s creditors. Alternatively, you can leave the assets to a custodianship, naming your family member as custodian. While a custodianship provides your child with access to their inheritance at an earlier age (generally 18 or 21) than a trust, it is cheaper than a trust and it has the benefit of preventing invasive, and often-costly, court supervision of the assets.
3. Leaving Assets to Your Children in Phases
Many parents, often under the guidance of a lawyer, create a trust that distributes a percentage of the trust assets to their child in phases, for example, 25% of the trust assets are distributed when the child reaches age 25; 25% when the child reaches age 30; and the remainder when the child turns 35, at which time the trust terminates.
While it makes sense in theory to provide children with greater access to their inheritance as they get older and (hopefully!) become more mature, such distributions are accessible not only to your child, but also your child’s creditors and future spouses. The better way to set up the trust is to allow the child to become the trustee of his or her own trust at a certain age. The assets in the trust remain protected, but your child has substantial control over the assets and can withdraw money from the trust for a broad range of purposes.
Your child will thank you if he or she becomes a doctor or enters another profession with a high rate of lawsuits because money in the trust will be protected from any legal claims against them. The trust can also protect your child’s inheritance in the event of a divorce. Because assets in the trust do not become marital property, they are not subject to claims by a divorcing spouse.
Finally, if your child becomes disabled – which can happen at any age – assets in the trust can be excluded for purposes of determining whether your child is eligible for government benefits.
4. Failing to Consider the Potential for Differing Needs Among Your Children
If you have more than one child, another drawback of leaving assets to your children outright is that it allows for no flexibility in allocating assets among your children according to their individual circumstances. If your will leaves your assets to your children equally, assets allocated to one child cannot be used for the benefit of the child’s siblings. While this arrangement results in a fair outcome in many cases, it can pose a problem if the children have or develop differing needs.
Suppose one of your children developed a serious illness or was injured in an accident, incurring substantial medical expenses. You may wish that more assets be allocated to the child with the greater financial need. Differing needs can also arise where one child is significantly older than the others. It might be unfair to leave your older child the same amount as your younger children. Suppose you passed away when one child had already finished college and your other child was only 12. You would expect that your younger child would require more financial resources than your older child, who may be entering the workforce.
In order to provide flexibility for your children’s differing circumstances, it is necessary to leave your assets to a trust that holds the assets for the benefit of all your children. In the trust document, you would appoint a trustee who would be responsible for make decisions about your children’s needs. This trust would hold all of the assets until your children reach a certain age, at which time the trust can either distribute the assets to each of your children outright, or split into separate trusts for each child.
5. Failing to Update Beneficiary Designations
When it comes to estate planning, you may not realize that your will covers only part of your assets. Many assets, such as life insurance and retirement accounts, are distributed outside of your will pursuant to beneficiary designations, and failure to keep those designations current can have shocking consequences.
When you started your retirement account, you may have been single with no kids and named your stoner boyfriend-at-the-time as your beneficiary. Ten years later, you’re married with two children, and your ex-boyfriend is still listed as your beneficiary. If you passed away, the whole account would end up with the ex-boyfriend – much to the chagrin of your husband and children. While this result seems inconceivable, stories like this happen all the time, and it’s almost impossible to correct once the account owner passes away.
In order to make sure all your assets would go to the people you actually want to receive them, review your beneficiary designations regularly, and make sure they’re incorporated into your overall estate plan. Naming your kids as beneficiaries is generally a bad idea for the same reasons that your will shouldn’t leave assets to your children directly (explained above). Talk to your estate planning lawyer about how to incorporate your beneficiary designations into your overall plan so that all of your assets will be protected for your kids.
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Shannon McNulty is the founder of Savvy-Parents.com and an estate planning lawyer in New York City who focuses on legal planning for parents with young children. Shannon received her J.D. from Georgetown University Law Center and her LL.M. in Taxation from NYU School of Law. She has also earned her CERTIFIED FINANCIAL PLANNER(TM) designation. You can learn more about Shannon and her firm at www.familylegalplanning.nyc.
The views and opinions expressed on this blog are purely the blog contributor’s. Any product claim, statistic, quote or other representation about a product or service should be verified with the manufacturer or provider. Writers may have conflicts of interest, and their opinions are their own.