How to Protect Your Children From Themselves and Those that Surround Them Through Lifetime Trusts - Trusts & Estates and Elder Law Newsletter
By: Alec R. Borenstein
We hear increasingly from clients that their number one estate planning concern is making sure that their legacy is preserved for future generations and is not diverted to non-family members (such as descendants’ spouses, whether former or current). The last thing our clients want is an in-law (or an out-law, as the case may be) inheriting everything our clients worked so many years to build. Even the most carefully planned inheritance can be lost if a client’s child gets divorced, is sued, or runs into financial trouble. Even where a child’s marriage is spectacular, if the client’s child dies and the child’s assets pass to her spouse, it then is up to the child’s spouse decide how the assets they inherited from you are distributed on their own death.
The good news is that in both New Jersey and New York, inherited assets are generally considered separate property for matrimonial purposes. However, that protection can disappear quickly if the inheritance is handled the wrong way.
Here’s what you need to know to protect your children’s inheritance from divorce, creditors, and in many ways, from themselves!
Inheritances Are Separate Property — Until They’re Not
Under both New Jersey and New York law, inherited assets are generally considered separate property — meaning they’re not subject to division in a divorce.
But there’s a catch: once those inherited assets are commingled with marital property, they can lose that protection. For example, if your daughter inherits $500,000 and keeps it in an account in her name only, that money may be safe from her ex-spouse in a divorce. However, if she uses the inheritance to pay off a joint mortgage or buys a home with her spouse, the protection may be lost. Similarly, if your daughter is pressured by her spouse to use the inherited funds for family expenses, a judge might rule that those assets, i.e., your legacy, is fair game for her spouse in the case of a divorce.
Sometimes parents choose to leave a child’s inheritance in a trust not because they are worried about the child, but because life can take unexpected turns. If a child were to pass away unexpectedly, anything they owned outright—including the inheritance—would typically go to their spouse under default estate laws, or pursuant to the terms of a Will which usually benefits a spouse first, which may not be what the parent intended. And if that surviving spouse later remarries, the assets could become commingled or eventually pass to a new spouse or step-family, drifting even further from the parent’s original plan. A trust helps prevent those unintended outcomes by allowing the parent to set clear instructions about where the assets should go if something happens to the child, keeping the inheritance available for grandchildren or within the family rather than inadvertently benefiting an in-law or future spouse.
A Properly Designed Trust Will Protect Your Legacy
When we explain the benefits of using estate planning to protect an inheritance, we describe divorce and asset protection as a spectrum, ranging from no protection at all to higher levels of protection. For instance, the estate plan that affords the least asset protection is when you leave a bequest to your child outright, and not in trust. On the other hand, leaving your assets in a trust provides a much greater level of protection. As you consider your estate plan, consider leaving your assets to your children in a “lifetime trust” instead of leaving their inheritance to them outright. A “lifetime trust” is a fully discretionary trust that holds inherited assets and prevents those assets from being comingled with your child’s individually owned assets or asset that a child and her spouse hold as marital property.
A properly designed trust can:
- Keep assets separate from marital property;
- Clearly identify the beneficiaries of those assets in the event that your child is no longer living;
- Protect funds from lawsuits or creditors;
- Provide ongoing management and financial oversight; and
- Still allow the beneficiary to receive income and principal for health, education, or other needs.
By using a trust, the inheritance is legally owned by the trust — not the beneficiary — which means it’s much harder for outsiders to reach, and the goals you established in the trust are more likely to be achieved.
Choose the Right Trustee
As mentioned, divorce protection is a spectrum, with the least protection when leaving assets outright and the most protection when leaving assets in a trust. However, even within the level of trust creation, there is still a further range of how protected trust assets will be, and the determining factor is the trustee.
At one end with the least asset protection, you name your child to be the sole trustee of his or her own trust. At a minimum, it’s going to be especially important for your child to follow the rules of the trust, i.e., your child-trustee needs to be sure to strictly follow the standards for distributions in the trust (usually known as HEMS: Health, Education, Maintenance and Support), and not make distributions to himself or herself outside of the HEMS standard. Similarly, if your child serves as both trustee and beneficiary, a divorce court could decide your child has too much control, making the assets vulnerable. Lastly, if your child is his or her own Trustee, the child might be pressured by a spouse to commingle distributions from the Trust, which could undo the trust planning.
At the other end of the spectrum with the highest level of protection, you appoint an independent trustee (such as a trusted relative, friend, or professional fiduciary) to oversee the trust. In this way, your child does not exercise the same level of control, but the assets in the trust are sure to be protected. Your child can still have influence — for example, by serving as a co-trustee with limited powers, or by having the right to replace the trustee under certain conditions, but he or she is not the sole trustee.
There is no correct answer when it comes to trustee selection. Some clients want their children to serve as trustee to give them protection but not make it too difficult to manage their parents’ legacy. Other clients want more protection and appoint an independent trustee. You usually know your child’s strengths and weaknesses, and you get to decide where on the spectrum you would like your trust planning to fall. However, flexibility is key, so including provisions in the lifetime trust that would allow for the appointment of an independent trustee if needed in the future is imperative, especially if one is not acting from the outset.
What If It’s Too Late?
Even if someone has already received an inheritance outright, there are still steps that can help preserve its separate nature:
- Keep inherited funds in a separate, individually titled account;
- Avoid mixing the inheritance with joint accounts or marital assets;
- Use inherited funds only for personal expenses, not joint ones;
- Consider a postnuptial or prenuptial agreement confirming that the inheritance will remain separate property;
- Discuss with your child the possibility of creating their own estate planning documents that would treat inherited assets differently than those they accumulated with their spouse; and
- Explore asset protection trusts in favorable jurisdictions (New Jersey and New York do not allow self-settled asset protection trusts, but other states do).
Conclusion
Protecting an inheritance isn’t just about taxes or paperwork — it’s about preserving your family’s legacy. By using thoughtful trust planning and keeping inherited assets separate, you can make sure your hard-earned wealth stays protected from divorce, creditors, and life’s unexpected turns. In essence, you are protecting your children not only from themselves but from unintended outcomes.
If you live in New Jersey or New York and want to review your estate plan to ensure your loved ones’ inheritances are fully protected, our team at Pashman Stein Walder Hayden P.C. can help. Please reach out to us to learn more.
Learn more about our Trust & Estates and Elder Law & Special Needs Planning Practices.
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The information contained herein is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to these materials do not create an attorney-client relationship between Pashman Stein Walder Hayden P.C. and/or its attorneys, and the reader of the materials.