Mom and Dad, a lovely couple in their early 50s, meet with me to discuss their estate planning. Mom shares, “our two children—ages 23 and 25—are special and productive. One just graduated law school and the other finishes medical school next spring.” Dad jumps in, “when we die, split all of our asset equally among our kids.”
And so, I ask, “would you like them to receive their inheritance outright or in trust?” Mom answers nicely, but firmly, “like I said, our children are fantastic. We want to give them full access to their inheritance. No interest in tying it up in trusts.” To which I respond, “got it. But just to confirm—are you aware trusts can protect assets from taxes, divorce, and creditors?” Their interest piques. Dad says, “we hadn’t thought of that. Please tell us more.”
This conversation happens in my office on a regular basis. Parents, naturally, want their children to have control over the assets they will inherit, until learning that full control presents several negative ramifications:
- Outright bequests will be subject to estate tax at the child’s subsequent death, while assets in a trust that is structured appropriately are not subject to estate tax;
- Outright bequests may be divided in divorce and can increase spousal and child support obligations, while assets in a trust fare far better in divorce; and
- Outright bequests are subject to claims of the beneficiary’s creditors, while assets in a trust that is structured appropriately can be protected from creditors.
Let’s briefly explore each of these.
When the survivor of Mom and Dad dies, their assets may be subject to estate taxes reducing the amount distributed to their children. If a beneficiary receives their inheritance outright, additional estate taxes will be owed on these same assets at the beneficiary’s death. If Mom and Dad instead bequeathed assets to a properly structured trust for their children, no additional estate taxes will be owed on these assets at the beneficiary’s death. Additionally, with proper planning, the generation-skipping transfer tax can also be minimized or eliminated through use of trusts.
In certain states, all property owned by either spouse is subject to division in divorce without any carve outs to treat an inheritance as the separate property of the person who received it. Specifically, many New England states follow this “all property” approach to division of assets on divorce. Thus, an inheritance received outright in such a state would be subject to division. However, if that same inheritance is placed in a properly structured trust, those assets would not be subject to division and the non-beneficiary spouse should not be entitled to any interest in the trust.
However, even in states that have a dual-classification equitable distribution regime (such as New York) and treat inheritances as separate property not subject to division in a divorce, trusts can still be helpful. First, trusts provide a safeguard against a beneficiary commingling or transmuting their separate property inheritance into a marital asset by transferring it to an account jointly titled with a spouse. Additionally, even the most cautious beneficiaries would still fare better in divorce with assets in trust because income earned on separate property assets titled in a beneficiary’s own name (as opposed to a trust) are more likely to be used to determine child support or spousal support obligations.
If a financial judgment is entered against an individual, assets inherited and titled in that individual’s own name are reachable by the creditor in the same manner as any other asset. However, if inheritance is instead bequeathed to a trust for the benefit of the individual, the assets should not be reachable, provided the trust is structured to be protected against creditors.
Back to Mom and Dad, who now say, “Wow, I never thought of all these issues. The trust sounds like a good option. But is there any way to ensure a trustee will actually distribute to my children if requested?” Although not foolproof, the trust agreement can provide the beneficiary with the power to remove and replace trustees. That way, if a trustee is not abiding by the beneficiary’s wishes, a more friendly trustee can be appointed to serve in that trustee’s stead. Mom and Dad left the meeting with a new outlook on trusts and ready to schedule their next meeting to discuss the many complexities of how their trusts must be drafted to provide the above-discussed protections. Back at home, they continue to think, “To trust, or not to trust?” Understanding the many benefits of trusts, their answer: “Let’s trust.”
 Mom and Dad may be subject to federal and state estate taxes. Federal estate tax at effectively 40 percent is imposed on assets transferred above $12.92 million in 2023. However, provided Mom and Dad are both U.S. citizens or residents, they effectively can combine their federal exemptions (with proper estate planning), giving them nearly $26 million that can be distributed free of federal estate tax to their children in 2023. This number is scheduled to be reduced in approximately half on January 1, 2026. With certain exceptions, generally, any gifts made during life above the “annual exclusion” (currently $17,000) reduces the amount that can be distributed free of federal estate tax at death. State estate taxes, where imposed, may operate differently. For example, New York provides an estate tax exemption of $6.58 million; the tax regime operates differently than the federal system; and the top rate of New York estate tax is 16 percent.
 If a beneficiary is given the power to remove and replace trustees, any replacement trustee could not be related or subordinate to the beneficiary within the meaning of the tax law.