May 5, 2023
Grandchildren Trusts and Education Trusts
During our meetings with grandparents, a common topic is leaving assets to their grandchildren. While direct gifting, paying for tuition or medical bills, or funding 529 educational savings accounts are all effective techniques, this article focuses on another popular technique: establishing trusts for grandchildren. We will explore the different types of trusts, incentivizing them, and several other important considerations.
Types of Grandchildren Trusts
A Family Pot Trust For All Your Grandchildren
A Family Pot Trust lets grandparents list multiple grandchildren, who all have access to the same pool or pot of money. Hence the name, a Family Pot Trust. The trustee of a Family Pot Trust has a fiduciary obligation to manage the assets of the trust for the benefit of all the grandchildren named as beneficiaries of the trust. The trustee shall distribute the assets of the Family Pot Trust pursuant to the provisions of the trust. Family Pot Trusts may include various different types of distributive paragraphs that will be discussed later in this article. The establishment of a Family Pot Trust has several advantages and disadvantages.
Advantages. The advantages of a Family Pot Trust include the fact that it gives grandparents the flexibility to treat all their grandchildren equally, or to make unequal distributions to their grandchildren based on their own individual needs. A Family Pot Trust may be advantageous when grandparents have grandchildren with different circumstances. Those differing circumstances include differences in age, financial needs, or financial means.
Disadvantages. Establishing a Family Pot Trust naming a large amount of grandchildren may place the trustee of the trust in a precarious position if unequal distributions are necessary to certain grandchildren. Due to the fact that the Family Pot Trust operates as a common fund for all the grandchildren, trust assets could be distributed to older grandchildren first instead of remaining in one large pot with the rest of the trust assets. This type of distribution would create an unequal distribution between older grandchildren and younger grandchildren. These types of unequal distributions become more prevalent as the number of grandchildren named as beneficiaries increases and as the gap between the ages of the grandchildren widens.
Individual Trusts For Each Grandchild
In situations where grandparents want to leave assets to one or a small number of grandchildren, individual grandchildren trusts are most likely the best type of trust to utilize. When grandparents have a smaller number of grandchildren, individual grandchildren trusts with an equal amount of assets funded into each trust probably makes the most sense. The trustee then has the ability to decide when and how much of the trust assets to distribute to each individual grandchild without affecting the amount of assets held in trust for the other grandchildren. The trustee is required to distribute the assets pursuant to the standards outlined in the trust. Just like Family Pot Trusts, the individual grandchildren trusts for each grandchild have their own advantages and disadvantages.
Advantages. Individual trusts for each grandchild ensures that all of the grandchildren are treated equally. Most grandparents choose to fund an equal amount of assets into each grandchild’s individual trust. Even though the grandchildren may use the assets in their individual trusts differently, each grandchild is treated equally because each individual grandchild trust is funded with the same amount of assets.
Disadvantages. If grandparents have a considerable amount of grandchildren, and they decide to establish individual trusts for all of their grandchildren, the cost to administer those trusts can become costly as accountant fees and attorney fees often increase depending on the number of individual grandchildren trusts created.
Incentivizing Grandchildren Trusts
Whether grandparents choose to establish a Family Pot Trust or individual grandchildren trusts, most grandchildren trusts allow for discretionary distributions of income and principal to the grandchildren from the trust for health, education, maintenance, and support. In other words, the trustee can make discretionary distributions to the grandchildren based on an ascertainable standard.
However, when most grandparents establish grandchildren trusts they also incentivize those trusts with certain milestones their grandchildren must achieve before their grandchildren may demand a distribution of some, or all, of the trust assets. Incentivizing a trust allows grandparents to instill a good work ethic in their grandchildren or to ensure that their grandchildren are set up for success. Grandparents often use incentives in a trust to:
- Encourage the grandchildren to attain a certain level of education.
- Ensure that the grandchildren have access to the trust assets when they reach certain ages.
- Encourage the grandchildren to work hard and have a productive career.
- Impose moral restrictions or incentives on the grandchildren.
Graduation From An Accredited University, College Or Trade School
There are any number of provisions that can be added to a grandchildren trust to incentive grandchildren to further their education after high school. Some grandparents include a provision stating that their grandchildren may receive the remaining assets in the trust once they obtain a four-year degree from an accredited college or university. Many grandparents recognize that secondary education is not for everyone, and they state that the grandchildren may receive the remaining assets from the trust after they obtain a four-year degree from an accredited college or university, or when they complete skilled training at a vocational school. A number of grandparents want to make sure that the grandchildren trusts do not linger on for many years. Those grandparents will include a provision in the grandchildren trust stating that if the grandchildren have not obtained a four-year degree or completed skilled training at a vocational school by a certain age, the grandchildren may request an outright distribution of the remaining assets in the trust at that age.
Advantages. These types of provisions in a grandchildren trust are beneficial because they provide an incentive for grandchildren to seek higher education and receive a degree from either a college, university or vocational school. Most grandparents like the idea of their grandchildren obtaining a degree or specialized training in a trade, and providing them with the means to be able to achieve those goals.
Disadvantages. Grandparents need to be cautious when including education-based incentive provisions in the grandchildren trusts. If these provisions are too restrictive or narrow, the trustee may have a difficult time administering the trust when unanticipated circumstances arise related to the grandchildren’s education. For example, if the grandchild is in an automobile accident and is unable to attend an institute of higher education, the trustee may be restricted to using the trust assets to pay for education, or the grandchild may only get a distribution from the trust once secondary education is completed. If the grandchild is unable to attend an institute of higher education, the trustee will be unable to use the assets in the grandchildren trust to benefit the grandchild.
Some grandparents establish pure Education Trusts for their grandchildren. Education Trusts are specifically designed to pay for education only. An Education Trust eliminates the ascertainable standard outlined above (health, education, maintenance, and support) and states that the assets in the grandchildren trust must be used for education only. The benefits of an Education Trust are:
- Grandparents know their grandchildren’s inheritance is being used for a useful purpose.
- Grandparents are giving their grandchildren the gift of education.
- Grandparents are allowing their grandchildren to leave college or a vocational school without student debt.
The primary disadvantage of an Education Trust is that it is limited to only education expenses. The grandchildren are not allowed to use the assets in the trust for medical expenses, living expenses, or any other expenses related to health, support or maintenance.
Release Funds At Certain Age Milestones
Linking age milestones to distributions from a grandchildren trust is a common way for grandparents to incentivize their grandchildren trusts. Most grandparents agree that giving all of the assets in the trust to grandchildren when they reach the age of majority (18) is not a great idea. Most adults at the age of 18 are not financially responsible, and they lack the discipline to appropriately manage wealth at that young age. Therefore, grandparents will base the distributions from the grandchildren trusts on certain age milestones. For example, the terms of grandchildren trusts may state that the assets in the trust may be used, at the discretion of the trustee, for health, education, maintenance and support. However, the terms of the grandchildren trusts may also state that the grandchildren may, upon request to the trustee, receive one-third of the trust assets at the age of 25, one-half of the trust assets at the age of 35, and the remainder of the trust assets at 45. The grandparents incentivized their grandchildren trusts to make sure they could control when their grandchildren received their inheritance.
Advantages. Age milestone provisions allow grandparents to control when their grandchildren may receive distributions from the grandchildren trusts. These provisions give the grandparents great flexibility to determine when they believe their grandchildren will be financially responsible enough to receive distributions from the grandchildren trusts. The grandparents can choose whatever ages and amounts of distributions are appropriate for their specific grandchildren.
Disadvantages. Although age milestone provisions allow grandparents to control when their grandchildren receive distributions from the grandchildren trusts, it is impossible for any grandparents to know when their grandchildren will be ready to receive the assets in the trust at the ages selected by the grandparents. If grandparents had a crystal ball and could foresee what their grandchildren will be like as they hit their milestone ages it would make the estate planning process for grandchildren much easier. However, grandparents cannot tell the future, and therefore, age milestone provisions include a certain amount of risk regarding the conduct of grandchildren as they hit those milestone ages.
Encourage Hard Work And A Productive Career
Often grandparents want to encourage their grandchildren to be productive members of society. They want to promote hard work and a career that will allow their grandchildren to be financially stable without the help of their parents or grandparents. Grandparents with these goals in mind for their grandchildren may incentivize the grandchildren trusts by including provisions linked to their grandchildren’s employment. These types of provisions usually include one of the following:
- Distributions from the grandchildren trusts that match the grandchildren’s annual earned income.
- Deny distributions from the grandchildren trusts if the grandchildren are unemployed.
- Distributions from the grandchildren trusts if the grandchildren want to start their own business (these provisions normally require the grandchildren to present a viable business plan to the trustee).
Advantages. Provisions in the grandchildren trust linking distributions to employment can be beneficial because they encourage grandchildren to seek the highest paying employment they can find, or to be entrepreneurs and start their own businesses.
Disadvantages. These types of incentive provisions can also discourage grandchildren from pursuing socially beneficial employment that normally has lower compensation. Jobs like teachers, social workers, ministers, stay at home parents, etc., are all meaningful professions, but they pay very little and sometimes nothing. Sometimes hard work and a productive career do not always equate to high compensation.
Impose Moral Restrictions Or Incentives
Grandparents are sometimes interested in encouraging behavior from their grandchildren which is in line with their values. Also, some grandparents are interested in providing disincentives for grandchildren that behave irresponsibly. Grandparents with these goals in mind for their grandchildren may incentivize the grandchildren trusts in numerous ways. The most common ways for grandparents to incentivize the grandchildren trusts based on moral restrictions or incentives are as follows:
- Limit distributions from the grandchildren trusts if the grandchildren are abusing alcohol or drugs, or are gambling excessively.
- Allow distributions to grandchildren once they get married.
- Limit distributions to grandchildren if they get divorced.
Some grandchildren trusts include a provision that allows the trustees to override a mandatory distribution due to some of the immoral behaviors listed above. For example, a grandchildren trust might state that a grandchild may be allowed to receive one-third of the trust assets at the age of 30, but the grandchildren trust may also include a provision which states that the trustee can refuse to make that distribution if the grandchild is abusing alcohol or drugs, or gambling excessively. As you will see in the disadvantages section below, this is a great safety net for grandchildren trusts that have mandatory distributions, but it may also put an undue burden on the trustees of the grandchildren trusts to act as the “babysitter” for the grandchildren.
Advantages. The obvious advantage of these incentive provisions is that they encourage behavior that is in line with the family’s values. Many grandparents are interested in making sure their grandchildren adhere to the same moral principles that they have for many years. These types of provisions allow grandparents to encourage the moral behaviors they want to instill in their grandchildren whether the grandparents are living or deceased.
Disadvantages. The incentive provisions may cause certain issues related to the administration of the grandchildren trusts. They force the trustees of the grandchildren trusts to be “babysitters” for the grandchildren. For example, the trustee may have to make the determination whether a grandchild has a substance abuse problem.
Other Issues to Consider When Establishing Grandchildren Trusts
Revocable vs. Irrevocable
When grandparents establish grandchildren trusts, those trusts may be revocable or irrevocable. Revocable and irrevocable grandchildren trusts have their own advantages and disadvantages.
Revocable Grandchildren Trusts. The benefit of making grandchildren trusts revocable during the grandparents’ lifetimes is that the grandparents have more control over the provisions of the trusts while the grandparents are still living. For example, what if grandparents decide to put an incentive provision in their grandchildren trust which states that their grandchildren may get an outright distribution of all the trust assets when they obtain a degree from a four-year college or university, and one of the grandchildren is in a terrible accident. That accident limits the grandchild’s ability to attend a four-year college or university. If the grandchildren trust is revocable, and the grandparents are still living, they can amend the grandchildren trust to include provisions more suitable for their grandchild that has been in an accident. The disadvantage of making grandchildren trusts revocable is that grandparents cannot take advantage of the tax savings an irrevocable trust can provide.
Irrevocable Grandchildren Trusts. The benefit of making grandchildren trusts irrevocable is that the grandparents can fund assets into those irrevocable trusts, and those assets may no longer be includable in the grandparents’ estates for estate tax purposes. These assets may be real estate, cash, or securities. Due to the fact that those assets have been removed from the grandparents’ estate and funded into the irrevocable grandchildren trusts, this reduces the grandparents’ estate tax liability. In 2023, grandparents may gift up to $17,000 a year into grandchildren trusts without reporting it to the IRS. In 2023, each grandparent may gift up to $12.92 million without paying gift taxes. However, it must be noted that if grandparents use all or a portion of their gift tax exemption by funding assets into grandchildren trusts, that will reduce the amount the grandparents may leave at death estate-tax-free. In other words, the gift tax exemption and estate tax exemption are linked. The disadvantage of making grandchildren trusts irrevocable is that grandparents lose the flexibility and control of the trust assets provided by revocable grandchildren trusts. Once irrevocable grandchildren trusts are established, the grandparents cannot change the terms of those trusts.
“Spendthrifts” are defined as people who, by excessive drinking, gaming, idleness, or debauchery of any kind, shall spend, waste, or lessen their estates as to expose themselves or their families to want or suffering. For purposes of this article, grandchildren are considered spendthrifts if it is anticipated that they will spend, waste, or lessen the assets in their grandchildren trusts as a result of poor financial decisions. Therefore, every grandchildren trust should include a spendthrift provision. A spendthrift provision prevents grandchildren from pledging or spending the assets in their trusts before they actually receive the benefits of their grandchildren trusts. The assets in the grandchildren trusts are protected by the spendthrift provision until the trust assets are distributed directly to the grandchildren.
Corporate Trustee v. Individual Trustee
When selecting a trustee to administer grandchildren trusts it is important to weigh the advantages and disadvantages of corporate trustees and individual trustees.
Corporate Trustees. Corporate trustees are beneficial because they have the time, expertise, and resources to fully administer grandchildren trusts properly. Also, corporate trustees are impartial. They are required to administer grandchildren trusts with an unbiased point of view. Corporate trustees remain neutral when family dynamics are strained. Often corporate trustees can prevent disagreements and angst among family members. The corporate trustee is in place to make difficult decisions regarding distributions from the grandchildren trusts. Decisions that may cause strife within a family if an individual family member is acting as trustee. However, some grandparents are not in favor of corporate trustees acting as the trustee of grandchildren trusts. Corporate trustees charge a fee, which some grandparents do not want to pay to administer the trusts. Also, some grandparents want to keep family decisions, like distributions from grandchildren trusts, in the hands of family members or close friends.
Individual Trustees. Individual trustees are typically family members or trusted friends who usually receive little to no compensation for their administration of the grandchildren trusts. The benefit of naming an individual trustee of the grandchildren trusts includes the relatively inexpensive administration of the trusts, but it also includes that individual trustee’s intimate knowledge of the family dynamic. Intimate knowledge about the family that a corporate trustee may not hold. Some grandparents want the trustees of grandchildren trusts to have a deep, intimate background regarding their grandchildren’s behavior so those trustees can make appropriate decisions regarding distributions from the grandchildren trusts to the grandchildren pursuant to the guidelines outlined in the trusts. However, with individual trustees you lose the time, expertise, and resources corporate trustees provide. Also, some individual trustees are not capable of making tough decisions regarding distributions from the grandchildren trusts. Individual trustees can sometimes be easily convinced or manipulated by the grandchildren to make unwarranted distributions from the grandchildren trusts. Corporate trustees do not have a difficult time making tough decisions regarding distributions from grandchildren trusts to the grandchildren because they are not connected to potential toxic family dynamics.
The establishment of grandchildren trusts is a great estate planning technique that grandparents can utilize to transfer wealth to their grandchildren. However, there are numerous decisions that grandparents need to make regarding the provisions of the grandchildren trusts to ensure that the assets are being transferred to their grandchildren pursuant to the grandparents’ goals.