Asset Protection for your Children through Descendant’s Trusts

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I periodically get calls from potential clients regarding “asset protection.”  Generally speaking, asset protection is pre-claim planning for those who are concerned that someday they might become liable to unknown creditors for unknown claims.  Asset protection is not about protecting assets against known, pending claims.  Often, clients are worried about what they can to do protect their assets from exposure to their children’s mistakes.  Are my assets exposed if a child is involved in a car accident that exceeds automobile insurance policy limits?  Can my son-in-law reach my daughter’s inheritance if they divorce? 

Parental Assets and Custodial Accounts are Exposed to Tort Claims.  Where a child is under 18 at the time of the accident, parents may be liable for $3500 of property damage and $3500 for bodily injury, C.R.S. § 13-21-107.  More significantly, custodial property, e.g., bank accounts established under Colorado’s Uniform Transfers to Minors Act (CUTMA), is available to satisfy tort claims committed by the minor, C.R.S. § 11-50-118. Colorado’s Uniform Fraudulent Transfers Act (“CUFTA”) provides that transfers to present and future creditors are fraudulent if they are made “with actual intent to hinder, delay, or defraud any creditor of the debtor.” C.R.S. § 38-8-105. Factors relevant to actual intent include “before the transfer was made… the debtor had been sued or threatened with suit” and “debtor became insolvent shortly after the transfer was made.”As a remedy, CUFTA provides for 1.5 times the value of the fraudulent transfer or 1.5 the amount necessary to satisfy the claim, whichever is less, plus the creditor’s actual costs. CRS 38-8-108.

Inheritance Interests May Be Exposed in a Divorce.  Generally speaking, inheritance interests are “separate property” not subject to equitable division if your child divorces.  However, the increase in value of inheritance interests may become marital property subject to equitable division upon divorce.  The use of inherited property to purchase a joint asset (e.g., using inherited money as the down payment on a house), or trust distributions deposited into a joint bank account, for example, may recharacterize inheritance interests as marital property subject to equitable division upon divorce.  Even if your child marries in Colorado, divorce law is governed by the state where divorce is filed.  In some states, inheritance interests may be considered an “economic circumstance” in an award of maintenance (alimony) or property division.

Leaving Inheritance to Children in a Descendant’s Trust Rather Than Outright Provides Asset Protection.  One easy solution to protect a child’s inheritance from creditor claims is to leave assets to children in a descendant’s trust rather than outright.  Your child, and her descendants, may receive income and principal from her descendant’s trust as needed for health, education, maintenance, and support in her accustomed manner of living.  If your child dies before receiving all of the balance of the trust, you can even give your child a testamentary limited power of appointment, exercisable in favor of your descendants.  That is, the beneficiary may, in her Will, provide how the balance in his or her trust will be distributed, which adds flexibility to the estate plan by giving the beneficiary the power to modify the plan in light of changed circumstances, even after your death. 

Under current Colorado law, a descendant’s trust can give your children three main advantages: the beneficiary’s creditors cannot generally force a distribution from the trust to satisfy a claim, the trust assets should be excluded from “marital property” in the event of a divorce of the beneficiary, and under current federal law, the trust assets will not be subject to tax in the beneficiary’s estate to the extent of your applicable generation-skipping transfer tax exemption.

Please contact our Denver estate planning attorneys if you would like to discuss building a descendant’s trust into your plan.

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