Investor Education – Tax & Estate Planning: Restricting a Beneficiary’s Access to Principal

By Wayne Cooper

There are two ways a beneficiary can access principal of a trust. A beneficiary may be entitled to an automatic distribution or an allowable withdrawal from the trust or a trustee could have discretion in making distributions to the beneficiary.

 In the past, many estate planning lawyers would provide a beneficiary access to trust principal on attaining certain ages. For example, possibly receiving 1/3 of the trust at age twenty-five, another 1/3 at age thirty, and the balance at age thirty-five. Or perhaps one half at age forty and one half at age fifty. We do not recommend this type of automatic distribution because the beneficiary loses the creditor protection that trusts can provide. Also, we do not believe that attaining a certain age is evidence in any way of the beneficiary’s maturity. Instead, we recommend using factors that evidence a beneficiary’s maturity level such as attaining a college degree or an advance degree, continuous full time employment with a single employer for a certain period of time, or possibly finishing service in the clergy or in the military.

Discretionary distributions usually use a standard that the trustee applies in determining whether a distribution is appropriate. The two standards most commonly seen are the ascertainable standard (usually health, education, support, and maintenance) and the best interest standard which allows distributions which are in a beneficiary’s best interest. The decision at which standard to use is driven not only by a desire to restrict the beneficiary’s access to principal, but also to avoid inclusion in the beneficiary’s estate. This is an issue if the beneficiary is also the trustee of the trust. In that case, an ascertainable standard must be used otherwise the assets could be in the estate of the beneficiary when the beneficiary dies. In addition to allowing distributions for health education, support, and maintenance, many clients want to allow distributions for other important matters such as principle to provide a down payment to purchase a primary residence. Normally we require that the residence be of a cost that the beneficiary could otherwise afford. Also we would allow distributions to allow beneficiary to enter a profession or start a business for which the trustee believes that the beneficiary has a reasonable chance of success.

Many individuals now use discretionary distributions from a trust to encourage certain types of behaviors that they want in their beneficiaries. For example, a trustee may be allowed to make distributions to encourage a beneficiary to engage in socially responsible work rather than just engaging in a profession that will provide the greatest amount of income. This is use for possibly providing a subsidy to a teacher or social worker or a beneficiary that is doing charitable work, serving in the clergy or the military, to encourage that behavior and allow them to have greater access to principal because they may be earning less from these endeavors that they otherwise would.

Other discretionary distributions may be to encourage stay at home parenting, maybe distributions upon the marriage of a beneficiary, or upon the birth of a beneficiary’s children. These types of provisions encourage the type of behavior that a granter of a trust would want to see in their children. We could also like negative restrictions to discourage certain behavior. This will allow a trustee to withhold distributions based on certain behavior of the beneficiary. For example, if a beneficiary is chemically dependent or has been convicted of certain crimes of reasonable seriousness, the trustee would be allowed to restrict distributions, to discourage that behavior, and not reinforce the behavior or allow further activity of this kind.

Whatever type of provisions you put in your trust, you want to be sure you have enough clarity to allow the trustee to effectively follow your wishes and understand exactly what your goals are.