Trusts: How to Protect a (Troubled) Child from Your Money

Parents: You are responsible for the financial education and well-being of your child. You have more life experience, you are the ones who brought your children into the world, and you are the one leaving your money to them. So take the extra step and make sure you give your children money in a responsible way.

We’ve all heard of it: The child who spent all of his inheritance before he received it, the gambler, the substance abuser, spendthrift, and so on.

In 2011, I had a 29 year old female client, whom I shall call “Janice” who didn’t have one penny to her name: Janice was living in a homeless shelter, on all types of public assistance, and almost thoroughly ignored by her family and childhood friends. That all changed upon the death of her father, who apparently felt bad, he was not involved in her life, and left everything to her (and excluded his other children from his estate). Janice received over $120,000 from her father’s life insurance and retirement plan through a state job. We planned to have her move out of New York to escape bad influences, buy a condo in Florida (which at the time had a good inventory of condos available), and have a nominal cash reserve to get her on her feet.

Of course, Janice wanted to have some fun first, and went on a shopping spree with her mother. Her half-siblings insisted that Dad meant for her to give them some of the money, and would not leave her presence until they were paid. Then, her otherwise uninterested family showed up expecting handouts (some quite literally grabbed cash out of her hands). Former friends demanded past debts be paid with usurious interest. A few nights spent with a new boyfriend at a hotel ended with Janice waking up to find said boyfriend and several thousand dollars no longer in the hotel room. And then there were the many out-of-hand parties that would have made Keith Moon and Amy Winehouse turn in their graves. I received crazed phone calls from her at very late and early hours, one night stranded at an Albany hotel, another night being confined at a Westchester police station. I thought she was going to die.

Remember that this was Janice’s money, in her name, and only she could control what to do with it. Within two months the entire $120,000 was gone, with nothing except a few shoes and purses to show for it; Janice was back in the homeless shelter, where the shoes and purses were soon stolen.

Instead of a fresh start, Janice was left with more of the same: Financial disempowerment, hopelessness, loneliness. And though at this point in  my career I am now a bit more hardened to the realities of people like Janice, at the time I was devastated. This happened despite weeks of planning with her as to what she wanted to do, meeting a financial planner she would be investing with, and despite my multiple-and-always-urgent pleas for her to “slow down now!” this was, obviously, a disaster for both her and her deceased father: The money should have been used for her betterment, but only lead to greater problems. The worst part is that this could have been avoided quite easily with a Trust.

Life insurance and retirement plans are transferred outside of a Will, and this property can either be transferred directly to a beneficiary (such as in the horror story above) or through a “Living Trust” for the benefit of a beneficiary. A Trust can also be created by a Will at the time of your death (a “Testamentary Trust”). IF I had known the father before his passing, for the price of a few thousand dollars, my client above could have been saved from herself. Unfortunately, for the spendthrift child, and particularly a child who has never had much money, this often doesn’t happen.

What protections does a Trust afford a beneficiary? First, it can provide a “spend thrift” provision, so that children deep in debt do not try to assign any future bequest for a loan now. In New York this is the default for people who have a Will. So what happens if you die and a child is approached by his creditors who know about this death? The Trustee will negotiate a settlement with the creditor (maybe 25 cents on the dollar, depending on the creditor) or else the Trustee will not transfer the funds (because funds are in the trust they are not truly the beneficiary’s money, unless the beneficiary is also the Trustee). This also protects the child from having trust funds attached to a marital dispute, such as spousal maintenance. Remember that you cannot easily protect your funds from your creditors by holding them in a Living Trust, but you can protect your children and sometimes your spouse from their creditors.

Next, if the beneficiary has a substance abuse issue, or likes to gamble to excess, special provisions can be inserted in the Trust allowing the Trustee to withhold distributions until these problems are cleared up. I have found this helpful on several occasions with children who are well-intentioned, but in the grasps of harmful addictive behavior.

Also, a Trustee may be given the power to have full discretion as to when to distribute funds. This allows the Trustee to have the beneficiary prove whether a distribution from the Trust is appropriate at that time. So whereas the beneficiary may have spent funds already distributed to him or her based on poor decisions, he or she will be put on notice that this behavior will not be tolerated again.

I have not heard from Janice since soon after the money ran out. There was one phone call she made regarding whether her father owned a car that she could sell, and then the calls stopped. I hold no grudge against Janice, and wish her well. She never had money or a substantial job, and never learned how to save or spend money: Considering her situation in life she probably did not stand much of a chance. But I do wish her father had not just done a “good thing” by leaving his daughter an inheritance, but had done the “right thing” by leaving it to a trust for her.

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