If you’re considering transferring wealth to your grandchildren, you could gift money outright or pay tuition or medical expenses directly on their behalf. That said, don’t overlook the option of establishing a trust. In many cases, trusts may provide you more alternatives for how and when your grandchildren receive funds, says Paul Sowell, Senior Wealth Planner for Wells Fargo Private Bank.
Establishing and funding a trust for your grandchild enables you to:
- Set guidelines on how you’d like the money to be used.
- Release funds at key milestones—like graduating college, getting married, or turning 35—over your grandchild’s lifetime, rather than all at once.
- Help protect the inheritance from potential depletion due to lack of financial literacy or other financial challenges.
- Help your grandchild meet specific goals, such as buying a home or starting a business.
Establishing a trust
Administratively, trusts can be fairly simple to set up, but they require careful thinking about what you’d like them to accomplish, says Sowell. Plus, gift trusts are typically created as irrevocable trusts – once you’ve established them, you typically can’t change your mind and reclaim your money.
Since grandchildren’s trusts are legal structures, you’ll work with an attorney to establish them. However, you may also want to discuss planning and investment options with your contacts at Wells Fargo Private Bank before you finalize your plans, Sowell says.
Selecting a trustee also requires thoughtful analysis. The trustee is the individual or entity that will be responsible for approving distributions from the trust. In addition, trusts also require a fair amount of administration and record keeping, and the trustee is responsible for those tasks as well. Although you can name a family member as trustee, it can sometimes be simpler to work with an objective third party, Sowell notes.
- Individual trustees may be the better choice if a particularly close relationship with the beneficiary is needed (when caring for a parent, for example) or if the trust asset requires specialized knowledge (like running a family business).
- Corporate trustees may be the better choice when there isn’t a trusted individual available who can both manage trust assets effectively and make the hard decisions about when (and when not) to make distributions.
Choose the right trust option
Once you decide that a trust is the right choice for your grandchild, you have two general options with advantages and disadvantages depending on the size of your family, Sowell explains:
1. A family pot trust for all of your descendants. If you have a large family and want to give discretion to your trustee for distribution of assets, a family pot trust may work for your needs. With a pot trust, you set up a single trust, and your trustee can decide when and how much money to distribute from that single pot of money to each of your grandchildren or other descendants based on a specific standard or desired objective written into the trust. The pot trust may specify that all of the beneficiaries be treated equally, or may allow the trustee to make unequal distributions among the beneficiaries based on their individual needs. You can also use a pot trust to leave a continuing financial legacy for multiple generations of your family. Depending on the size of your family, however, the trust may have many beneficiaries which may place the trustee in a difficult position when making unequal distribution decisions.
2. Individual trusts for each grandchild. If you’re leaving assets to just one or a few grandchildren, establishing individual trusts for each may be a good option. Most grandparents choose to put equal amounts of money into each grandchild’s individual trust. The trustee can then decide when and how much money to distribute to each grandchild from their individual trust based on the standards written into the trust. If you have many grandchildren, keep in mind that establishing individual trusts could increase the amount of trust administration and costs.
Give instructions and set stipulations
One of the advantages of establishing trusts for grandchildren is that you can work with your attorney to draft specific language in the trust. These provisions are helpful to the trustee in the administration of the trust for the benefit of the grandchildren.
For instance, you can set up your trust to distribute funds when the beneficiaries attain certain ages—such as 35, 45, 55— rather than all at once. You can also leave recommendations for your trustee, asking your trustee to consider approving distributions for paying college tuition, buying a first home, or addressing other goals such as starting a business. Alternately, you could ask the trustee to match your grandchild’s funds to buy a new car, rather than pay for the entire car, for example.
To help the trustee understand your intentions, a commonly used standard for discretionary distributions is health, education, maintenance, and support (also known as “HEMS”). The trust document may include a broader standard than HEMS or no standard at all. Sometimes the trustee is directed to make distributions by another party such as a distribution committee or trust advisor. Your estate planning attorney can help you understand the benefits of these different distribution standards.
Discuss with family
Just as important as coming up with all the stipulations for a trust? Frank family conversations about the concept. “In order to keep family harmony, I don’t believe you should ever set up financial gifts for grandchildren without linking in the parents,” says Sowell. For one thing, he says, the parents may have strong opinions about inherited wealth and how to prepare their children for it.
You may also want to discuss with the parents how much information to provide your grandchildren about the trusts you’re creating for them. Many experts now recommend talking openly to children about inheriting wealth rather than keeping it confidential until they’re older. Doing so can give your family time to educate your grandchildren about responsible money management.
However, Sowell says each family needs to decide for themselves the best time to speak to grandchildren about trust funds and the best way to communicate the information so that awareness of the trust does not remove the incentive for a grandchild to become financially independent or financially responsible.
For more information about establishing trusts for your grandchildren, talk to your contacts at Wells Fargo Private Bank and your estate planning attorney.