How to be Fair in Your Estate Plan | Pot Trusts

When clients come in to discuss their estate plans, they often only know they should have a trust, but don’t realize or even know there are many different types of trusts out there. Below, we’ll discuss how to be fair and equitable in your distribution plan and pot trusts.

The Delicate Balance Designing Distributions

When our clients are in a situation where they are not looking to make a standard distribution equally among their children, there is often a bit of a struggle to figure out how to be fair yet also acknowledge the realities of life. What if a child is irresponsible with money or what if you want to earmark money for children or grandchildren, but you don’t know how much they might need? The question really comes down to this: where I want to hold money in trust for the benefit of my heirs, do I pool the money together, so everyone works from the same larger pot of funds, or do I have everything separated out so that each beneficiary’s share is not mixed together, but each receives only a set amount?

Separate Trust Funds

Let’s start with separate trust funds. The idea is you give different children or beneficiaries either a set amount or a percentage of your estate, and have those funds separated and used for that specific beneficiary’s needs. Everyone’s funds start on equal footing and that child only has their own funds to draw from. You can have one person manage all the funds, or have each fund managed separately. The manager being the trustee.

Pot Trusts or Pooling Trust Funds

Alternatively, you could keep all the assets together in one pot and have a larger pooled fund to draw from for all the beneficiaries you set, rather than individual small pools. Now there is only one manager of a single fund, the trustee, and they have the authority to manage all the funds and make distributions where needed.

Pot vs. Separate Trusts – How to Choose

Now the question of which structure to pick? Of course, it’s going to be situation dependent. The first question I ask my clients is what are the conditions for full disbursement? That is, are the funds to stay in the trust throughout the beneficiary’s life or are they to be distributed at some point in time. If they are to be distributed at some point in time, then what is the trigger point? Most pick age of the beneficiary as being the point of distribution, but some direct money to be distributed at certain intervals until its gone. For example, $1,000 per month or $10,000 per quarter until gone.

When Separate Trusts Make Sense

The main consideration telling me my clients need to do separate trusts is time. Is the intent to hold the money in trust for an extended period of time and or, is there a large age difference between the various beneficiaries? If the time for final distribution is many decades in the future or after the death of the primary beneficiary, then I have found it is often more beneficial to divide the money into separate funds given the idea is for the money to stay in trust for a long time, meaning an increase likelihood of one beneficiary’s needs being substantially different than the others’ (as in, chances are, someone is going to need more money overtime when compared to the others).

The other case is age. If one beneficiary is 10 and other is 20 for example, with the time of distribution being at the beneficiary’s 25th birthday, this is a case where it may make more sense to separate the funds at the outset. One will need their funds much sooner than the other, and from a tax standpoint, the 10-year-old beneficiary will pay more tax over 15 years (while their money is growing), when compared to the beneficiary who will receive their money in only 5 years. Because of the difference in age, it doesn’t make sense to link their potential tax burdens together, only for them to be separated later anyway.

Additionally, if one needs more money during that time than the other, for example, the 20-year-old has a medical emergency, then it oftentimes doesn’t seem fair for the younger beneficiary to receive less due to the 50/50 split occurring after paying one beneficiary’s medical bills. Finally, the beneficiary with the longer time horizon for distribution will have an investment profile better suited to longer term holdings (like later maturing bonds for example) and is less vulnerable to short-term volatility in the market. The beneficiary with the shorter time horizon will likely be better suited to short-term investments like T-bills or bonds maturing soon, as well as dividend earning shares and those subject to less volatility.

The Case for Pot Trusts

Conversely, a pot trust is often better suited for cases where the money won’t be held for an extended period of time, where there is not a significant age difference among the beneficiaries, or where there is some nuance or complexity among the beneficiaries’ circumstances. If you think about it as a parent with multiple children, you probably run your household like a pot trust. Each child’s expenses are paid as needed and with thus you are likely prioritizing important expenses like tuition and medical bills. Thus, there is something to the idea of having the same approach with one’s estate plan. You don’t want children or beneficiaries to be irresponsible with money so the money is held in trust, but you also know you can’t predict everything, so you want your trustee to have the flexibility to pay bills in priority of importance.

To counterbalance the responsibility of managing a pot of funds, the background administration will likely be a little easier for the trustee. They only file one tax return each year for the trust and the trust pays the taxes (rather than distributing it out among the beneficiaries based on how much each has in the fund); they can have one trust account rather than one for each beneficiary; and generally managing one pot of assets is easier and provides more access to investment opportunities when compared to managing many saucers of assets. In addition, if the beneficiaries are close in age or the time to disbursement is short, then it will likely be easier to pool the funds rather than always worrying about separating them, especially when it comes to trying to separate invested assets – something the trustee is required to engage in (that being, investing the money).

All this requires you have a great deal of trust in your chosen trustee as you are, in essence, entrusting them to be your surrogate and know your goals and priorities for your children. You trust them to pay tuition and required bills, not to just dole out money whenever someone asks.

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