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Estate planning concerns: Is your child irresponsible with money?

Imagine you have a $10 million investment account, but your child has never had more than a couple thousand dollars in his or her checking account, and every other week he or she is asking for a handout. You love your child until the end of the earth, but you're worried about whether he or she is fiscally responsible enough to manage such a large amount of investments.

If you find yourself in a circumstance like this, you might want to consider the creation of a spendthrift trust. A spendthrift trust essentially offers a way to protect your heirs from themselves and their poor money habits.

Why use a spendthrift trust?

You know that your child shouldn't spend all of his or her inheritance in one place, and your child knows this, too. However, coming into a sudden influx of money is difficult to manage when you're accustomed to never having any money at all. Friends will come forward asking you to loan them cash. Enticing vacations and luxury homes will also tempt you to spend the money quickly on frivolous things. Reading about the trials and tribulations of lottery winners who suddenly find themselves in possession of a large amount of money is a great example of how hard it is to manage lots of assets without prior experience.

How does a spendthrift trust work?

A spendthrift trust protects the assets in the trust from creditors. Let's say that your heir receives a $250,000 annual income generated by the managers of the funds inside a $10 million spendthrift trust. Next, imagine your heir takes out a $3,000,000 loan and defaults on the loan. The funds inside the trust will be immune from being taken by creditors, even if your heir files for bankruptcy. The only thing that creditors can attack is the income generated by the trust. Your heir also cannot access the funds in the trust. The trust will continue to generate income for years to come, regardless of your heir's actions.

Do you want to create a spendthrift trust?

A spendthrift trust is different from the typical "trust fund" in that it needs to contain a special legal provision to designate it as a spendthrift trust. If you're interested in this type of trust for your family, make sure you explore the potential advantages and disadvantages of this trust before you decide to create one.

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