This Blog was written by: Daniel Watts, Estate and Trust Consultant, Scotiatrust
I wrote in a previous post about determining an appropriate age for a beneficiary to receive an inheritance (Choosing an Appropriate Age for Young Beneficiaries to Inherit, February 7, 2019). Below, we take that idea a bit further by considering additional approaches rather than a simple, single distribution of all the funds when a beneficiary attains a certain age.
Interim Distributions of Capital
One common approach is having multiple distributions of capital from the trust at different ages. This may look like this: the beneficiary should receive 10% of the funds in trust at age 21, 30% at age 25 and receive the rest of their inheritance at age 30.
Now, if the beneficiary is mature enough to receive 10% or 30% prior to age 30, then why not give her everything? Or, if the beneficiary is not mature enough at age 21 (which is implied since most of the funds will be held until age 30), then why make an early distribution at all? There are a couple reasons:
- A Test Run – Often, a concern of the parent is that the child will squander their inheritance if they receive a large sum, especially when the child is younger, by living hard and fast, or spending on frivolous things. By giving the child a lump sum (e.g. 30% of the funds), the child is given the opportunity to manage their own money. The result may be that the child does indeed squander all of it.What is the silver living? The hope is that the child has learned the hard way that money disappears if used unwisely, and when it runs out, it’s gone. Parents like the idea that the child can learn that lesson with only a portion of the inheritance, and then when they receive the remaining share from the trust at a later age, they will be more careful and responsible.Of course, when choosing an age for the initial distribution, the parent is still trying to choose an age where they hope the child would be responsible, as they hope that even this initial money does not get squandered, but they can more optimistic with this age, knowing that at least the child will get a second (or third) crack at it even if they initially fail.
- Learning Experience – As well, a goal for an early distribution can provide a different type of learning experience for the child: the beneficiary learns how to manage funds or how to invest (or, how not to invest), or can use the funds to buy a house or start a business. It is like training wheels on the inheritance. The beneficiary may be already mature enough that there is no concern of him squandering the money on frivolous purchases, but if the beneficiary has not had an opportunity to manage any significant wealth, then his well-intentioned plan may be victim of his inexperience, through ill-conceived investments or otherwise.If things go well with how the child uses the funds, then giving them some funds early works well in that they to gain some experience and confidence. If things do not go well, then, as above, there is a lesson learned from the experience, which will not be repeated when the remaining inheritance arrives.
Distributions for Other Reasons
In addition to large lump sums given to the beneficiary, the trust can also have specific provisions for the trustee to use his or her discretion to provide funds to other specific purposes. For example:
- Motivation for Pursuing Education – A parent may want to encourage his or her child to pursue post-secondary education. To encourage this, the trustee can be instructed to pay for the child’s university tuition, books, rent, and even the costs of a car or other lifestyle expenses, if the child is enrolled in a full-time post-secondary education program. The idea is to provide an extra incentive for the child to pursue education, since not only are the education-related expenses paid, but also his or her living expenses will be paid.
- Resources for Starting a Business – A parent, often when they are entrepreneurs themselves, may want to build a provision into the trust that allows the trustee to either give funds or loan funds from the trust to the child if the child has a proposal for a new business and requires funding. Without this flexibility, a parent may be concerned that the child may miss out on the opportunity for the child to begin building a business. The trustee, of course, is given discretion as to whether to provide funding or not, since the concern would be: (1) is the proposed business reasonable (or this is youthful folly that the trust was created to avoid)?; and (2) is the child attempting to receive money from the trust early by way of this business, with the hopes of selling or liquidating shortly thereafter? (though this concern can be alleviated by the trust providing a loan rather than an outright distribution).
Specific Rules vs. Providing Guidance
It can be difficult in determining how much control you want to leave with the trustees and how much control you want to retain and restrict? For example, do you want to ensure that your child receives the lifestyle funding as long as they can simply provide the trustee evidence of enrollment in a post-secondary program? Or, would you rather provide your trustee with a wider degree of discretion, and provide guidance for the trustee to encourage him or her to provide the lifestyle funding for the child if he or she is a student. Some parents like the idea that the trustee must do as instructed, while other parents want the trustee to have a final say, especially to prevent the child from “gaming” the rules by enrolling in a school with no purpose or motivation other than having their living expenses covered, and barely receiving passing grades in a study of no interest to the child, and with little prospect of advancing them in their life.
While providing “guidance provisions” may not be binding on the trustee, they are still very valuable. If the trustee is given a lot of latitude, then the trustee, in his or her discretion, often tries to make decisions based on how the parent would have wanted this money to be used for their child. With no guidance, a trustee may be concerned that providing seed money for the child to start a business is outside of what they may be allowed even if it seems like a great opportunity. Some guidelines provide the trustee with some comfort that this is within the general intent, as well as having specific legal authorization to make such a distribution. Also, it can lessen arguments between a beneficiary and trustee, since there is some general guidance that both beneficiary and trustee can look to when discussing whether or not the trust should be making distributions to the beneficiary.
Often, trusts for a child or grandchild are drafted based a generic framework with little customization. As discussed above, there can be much more to be considered when establishing trusts if more attention is given to the parent’s unique desires for their child. A trust can be custom-built to provide enough flexibility for the trustee to bend with the changes of the beneficiary’s life, as well as allowing a parent to provide incentives to encourage and direct the child into what they hope is a successful and fulfilling life.