If you're in the process of making an estate plan and have more than one child, you may plan to split your assets into equal shares to fund separate trusts for each one. However, an alternative to consider is pooling your assets into a single "pot" trust. This pooled trust can help ensure fairness and enable you to meet the individual needs of your children.
One of the most effective ways to provide for your family in your estate plan is to set up trusts for them. The benefits of trusts include flexibility over when and how to make distributions, protection of assets from beneficiaries' creditors and protection of assets from being divided as part of a beneficiary's divorce.
Most parents want to avoid "playing favorites," so they may set up separate trusts for each child. But "equal" and "fair" aren't necessarily the same thing. If, for example, one of your children has a specific need — whether it's college tuition, medical care or something else — it's likely that you'll pay for it without feeling any pressure to spend the same amount on your other children. You should view your estate plan in the same light: Fairness means providing for your children's needs, regardless of whether you distribute assets equally.
Say, for instance, you have two children, Emily, age 22, and Ryan, age 18. Emily recently graduated from college and Ryan is about to start. You've already spent more than $200,000 on Emily's college education. If you were to die tomorrow and your estate plan divides your wealth equally between your two children, Emily will come out ahead. That's because she already received the benefit of $200,000 in college expenses. Ryan, on the other hand, will need to tap his trust fund to pay for college.
A pot trust can be a great way to continue meeting your children's individual needs and avoid giving one child a windfall, like Emily received in the example. As the name suggests, you pour assets into a single trust and give its trustee full discretionary authority to distribute the funds among your children according to their needs.
Essentially, a pot trust allows the trustee to spend your money the way you would if you were alive. If one of your children has substantial educational expenses, medical bills or other special needs, the trustee has the authority to cover them — even at the expense of your other children's inheritances.
For some families, a pot trust makes sense when children are relatively young and are likely to have differing needs that can change dramatically over time. If appropriate, your plan can call for the pot trust to be divided into separate trusts for each child at some point in the future, such as when the youngest child reaches 21, 25 or some other milestone.
As you might anticipate, a pot trust can only be as effective as its trustee. So it's critical to choose your trustee — as well as a backup trustee — carefully. Your trustee should be impartial and reliable and have the skills necessary to manage the trust assets. For a pot trust, it's particularly important that the trustee has the ability to clearly communicate with the beneficiaries.
Because distributions depend on each beneficiary's unique needs, the trustee must understand those needs. The trustee also must know your objectives for the trust and be able to explain to all beneficiaries the reasoning behind any distribution decision.
Although a pot trust can solve asset distribution issues for many families, others may still benefit from establishing separate — or even specialty — trusts. For example, if you have a child with disabilities, you may want to consider setting up a special needs trust. The important thing is to make sure your estate planning advisor understands your circumstances and goals.
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