If you’re a parent, you likely want to provide for your children not only while you’re alive, but also after you die. Most parents want what is best for their children, and to the extent possible, they want to ensure their children’s well-being after they are gone. However, the way you leave your assets to your children is just as important as how much you leave them. In fact, if you don’t plan properly, it is possible that much of the inheritance you leave your children could be someday be lost to creditors or former spouses. In today’s litigious world and in a country where the divorce rate hovers around fifty percent, planning to protect your legacy for your children is more important than ever.
Many parents either do not have a will or leave everything outright to their children when they die. For certain assets, this might make sense, but for large amounts it usually does not make sense to leave an asset outright to a child. This is because once the child owns the asset, it will become subject to the child’s creditors if he or she is ever sued for any reason, such as an automobile accident or failure to pay off a debt. Alternatively, although inherited property is separate property under Texas community property laws, outright gifts of cash or securities often become commingled with community property, ultimately making it difficult to distinguish the inherited property from community property in a marriage situation. This means that if the child gets divorced in Texas, some or all of the property may be subject to division in a divorce decree unless some sort of tracing mechanism can be used to segregate the inherited property from the couple’s community property.
Instead of leaving assets outright to children or other beneficiaries, it often makes sense to leave assets to them in a testamentary trust, which is a trust that is created under the terms or your Texas will or revocable living trust. By creating a trust to hold your children’s inheritance, the assets are protected from creditors and failed marriages, while still allowing your child to enjoy the use of the assets during his or her lifetime. The child can also be trustee of the trust, meaning he or she will have control over the use and distribution of the assets.
Most types of assets can be left in a testamentary trust for your children as part of your Texas estate plan. However, assets in retirement plans, insurance policies, and annuities pass outside of the probate process and go directly to the beneficiaries named in the plan or policy. Additionally, how beneficiaries are named in retirement plans can affect the income tax treatment of the proceeds, so you should check with your Houston estate planning attorney to ensure that beneficiary designations are completed properly. For more information, see this previous post regarding the importance of updating beneficiary designations.