Well welcome back, everyone, to Aging… Well welcome back, everyone, to Aging Insight. This is Lisa Shoalmire. I’m here with John Ross and…
Who’s supposed to be pushing buttons to turn the mic on and it’s a little…
It’s a little late.
A little slow on that.
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Today we’re talking about what happens if you want to leave inheritance or a legacy to your children and they end up in the divorce situation? What happens to that property that John, you work so hard for.
That I mean…
That you wanted to go for the benefit of your child.
Your child, perhaps your grandchildren. But there’s a divorce situation in the mix here. We were talking before the break that essentially most people are aware or we’ve certainly let you know that inherited property is separate property, not community property. But then we… at the break we talked about how income that is generated from that separate property is community property.
That’s a little confusing but that’s the rule because basically the rules is any income that is earned during a marriage is community property.
No matter the source. We have to sit here and deal with and grapple with how do we make that work? How do we keep a divorcing spouse out of these assets?
Yeah. I had a guy, he was just telling… this was not why he was coming in. He was just telling me the story as because we were setting up a trust for him and we were going through all of the land and stuff. He was like, “Well, it’s kind of messed up here because I had my 80 acres. And then my son and daughter were going to… daughter-in-law were going to build on 20 acres. So I deeded them the 20 acres. Then they got divorced and she got half the 20 acres.”
“And then I bought her half back. So now my son only owns 10 acres and I own 70.”
“And I paid for it twice.”
“And I bought it twice because I had to buy her out because son couldn’t.”
Yeah, you don’t want family, the Hatfields and the Coys, all in the same land.
That’s right. And the thing is again, this was gifted property which again is separate property.
But this was one of those deals where although it was separate property, they had used a lot of their marital funds to make improvements to the property.
Right. It’s one thing to be given the dirt that a parent or a family member gives the dirt to another… to a recipient. But to make it a home, John, you got to…
You got to build a house on it.
You got to build something on there. If the marriage together, if both parties in that marriage are taking their assets and building that home on that property, a divorcing spouse is likely to get a substantial interest.
Right. They’re either going to get an interest or they’re going to get what they call a claim for economic contribution where although the land is still considered the separate property, the court is requiring that the separate property owner to buy the other one out…
Of the bill… of the value of the improvements.
Of the value, that’s right. So anyway, I guess the whole point is you cannot just assume that the property that you leave behind for a child is going to be protected because… from a divorcing spouse because it’s their separate property. It’s just not. Maybe, maybe on the day it’s received.
Right. But you know, what happens is that put forward, things happen. First of all, John. Often people will comingle their separate property with their community property.
Especially when it comes to things like cash money, cash equivalence. Before you know it, there is withdrawals made from the parent’s gift or inheritance that’s placed into a joint bank account. Before you know it, you can’t tell what’s what.
You always have the comingling aspect that pretty much erases the position that it’s separate property.
I always tell folks, you know, if you receive an inheritance, keep it in a separate account or—
Yeah. You can at least start by just making sure it doesn’t get blended with the other stuff. But once again you run into the problem of the income off of that separate property, especially when you’re talking about financial assets. Because take an inherited IRA. You receive an inherited IRA, you’re going to roll that over and do your own IRA, right? Or you’re going to take your parent’s IRA, roll it over into an inherited IRA. So it’s yours. It’s your separate property. But if it’s earning interest or dividends, the interest in dividends are community property. And unless you take those out of the inherited IRA, and consequently pay taxes on them, then you’re going to have to roll them back into.
15 years down the road, what is what you inherited initially from a parent and what is the growth that has been added to the asset over the years through income.
That’s right. And so you got to understand. The assumption from a court’s perspective in a family law case, the assumption is always start out with the assumption that it’s community property or marital property. Then it’s up to the person that wants it to be separate to prove otherwise.
Well, you know, in that situation, John, how often do we see where in a married couple like that where one spouse has received an inherited asset and they don’t want to touch it? So the family has bills or they’re doing something else and so the other spouse pulls from their resources. Maybe pulls out their retirement account or something and leaves that inherited IRA to grow, well… and then if they head to divorce court, the spouse that drew down their assets to meet the need of that married couple while the IRA just sat there growing and growing and growing, they’re going to have a claim that says hey look, if you have taken that out, then I wouldn’t have had to spend all this down. So I want an equitable division of property. We started talking about words like equitable. That’s really whatever the judge thinks at the time.
That’s right. Which you just don’t want somebody making that sort of decision. So the point here is what we would like to do is create a way to shield those assets so that not only are they separate property on day one, but they remain separate property on day two and day one and day 100, that the income from the separate property is separate property, that the growth on the separate property is separate property. We want to be able to structure all of them. Typically in this context we’re going to start talking about trust, because just like we use trust all the time in our practice to shield a beneficiary who is disabled.
Right. Very common.
Yeah. There are need-based benefits that they can’t afford to lose. Instead of leaving the assets to them directly, we will create a trust for their benefit but the terms of the trust would not allow the government agencies to consider those resources.
Right. That’s a very common use for a trust and in a situation like this. So when we’re talking about otherwise healthy children that we just have a concern that a divorce might be an issue, we can also use a trust to be the recipient, the receptacle if you will.
Or any inherited property.
Yeah. For example, if you’ve got three kids, instead of dividing your estate so that everything goes to your three kids, you can also divide your estate so that it goes into three separate trusts, one for each child. Or out write to two and in trust for one or however you want to do it. But trust are our weird little critter here because it’s for the benefit of that person but legally it’s not theirs.
Right. The trust itself is the legal entity that owns the asset.
Yeah. The trustee is the person who’s holding the assets but they’re hold them for the benefit of the beneficiary. So you’ve got this legal differentiation here between who’s hold the stuff and who’s receiving the benefit of it.
Once you get into the law, this stuff can make a pretty big difference. So I guess we’ll take one more break and then we’ll finish up this discussion in our fourth segment. So stick around, we’ll be right back. My mouth is dry.
Yeah. Well, and then in these divorce situations, no matter what you may think about your children and their marriages and what not, it’s just always appropriate to consider and plan that somebody is going to get divorced.
Sure. It’s going to happen. If you just assume that it’s going to happen and you plan for that contingency, then you don’t have to worry about if it doesn’t happen. That’s the whole thing, is that when you’re planning, if you plan for what you don’t want to happen, it’s a win-win at that point because if it doesn’t happen…
Who cares. If it does happen, then it was already planned for. That’s… I’m telling you this. The single biggest mistake that people make in their planning is not planning for what could happen but planning instead for what they want to happen and then it would be in a train wreck when what they didn’t want to happen happens, if any of that made any sense.
That’s right. That’s a good zone first routine right there.
Yes, seriously. But it’s so frustrating especially when we’re trying to explain this to people and then other parties out there are saying…
“Oh it’s no big deal.”
“Oh you just need to do it the easy way. Do it the easy way.” Well yeah, maybe it is easy and if everything goes marvelously in your life, then easy is going to be fine. But how often does it go marvelously? If you haven’t plan for those contingencies, then there’s a train wreck, it’s going to cause everybody a whole bunch of time and money. We’ll make money of it. I don’t care. I would rather not. I would rather have you have protected it on the front end and never have to clean up that mess.
He’s a little heated about this.
I do get a little heated about it. All right. We’re going back in two seconds.
Welcome back to Aging Insight, everybody. This is your host, John Ross here in the studio with Lisa Shoalmire. Today we’re talking the intersection of family law and the state planning and basically if you lead behind and inheritance and your kid gets divorced, are they going to lose some or all of that inheritance.
Right. Generally, I’ll have to say the answer is yes.
Generally speaking the answer is probably going to be yes. But that doesn’t mean that you can’t take some effort on your end that could prevent or at least lessen the impact of that.
Right. We were talking about using trust as a receptacle for inheritance for a child so that way if you have three children and you divide your estate in equal shares, then those shares then travel on down into a trust for each one of those children. And now the trust is the legal entity which is the owner essentially of that inheritance. John, we were talking before the break about there’s a trustee. One of the roles in a trustee who is the living, breathing typically who could…
Or a financial institution or as the case be.
Or entity, yes, who is directing that trust, who is making distributions from that trust, who is making investments on behalf of that trust. Then there’s a beneficiary. That’s another role. Who gets the benefit of those assets? John, what the beautiful part of something like this is that it is certainly possible, very common for the child who is the beneficiary to also serve as their own trustee.
They can. That is true.
That is a potential because a lot of folks ask about that. They don’t want their child to have to go ask a banker to make them give the distribution from the trust, but John, sometimes that’s the best thing to do.
Yeah, I know that’s right. You’ve got to make a decision on who’s going to be in charge. The more power the beneficiary has, the less protections they’re going have, potentially from outside sources as well as obviously from their own poor decision making. There is… you did a question like the income off of a separate property. So let’s say you die and you leave behind a house. But in this case you’ve done the planning in advance and so the house goes into trust for your child’s benefit. Now let’s say that they’re going to rent that house.
Okay. Again, now it’s still a separate property. It’s inherited property but we have income off of this separate property.
Sure. The property is owned by a trust.
The property is owned by the trust, not by the person. So the question is well, is that income? Normally that income would be community property.
It would be half-half, 50-50. But because the property is owned by the trust, do the same rules apply? Well there was actually a Texarkana count case by our local court of appeals.
That’s right. A lot of people don’t know that we have a sitting court of appeals for the state of Texas here in Texarkana. They cover about 19 counties I believe. So when the court of appeals’ decision is made by the Texarkana court, it certainly applies in all 19 counties that are covered by our district.
Yes, all the Texas side, Texarkana area. In this particular case, what happened is there was a trust that was set up for, again, for a minor. And the trust said that when the person turned 25, one half of the trust would be distributed to them. When they turned 30, the other half of the trust would be distributed to them. Now first of all, if you have something like that written in your trust, you need to go back and scratch that out and come in and see us because that’s stupid.
But it’s very common.
It’s very common but it’s dumb because you don’t have any idea what’s going on at that person’s 25 year old birthday when you’re planning and they’re one. It’s just dumb. So don’t do that. But regardless, that’s what this person said and yes, it is likely. As she said, it’s very common to see this sort of us. So if the trustee turns 25, half of the trust goes out. Well, when he turned 25, he said, “you know what,” in this case it was a bank that was in charge of it. And he calls the bank and he says, “You know what, I don’t want it. Just leave it in the trust for now.” Well, about 27, 28…
Years of age.
Years of age, he gets divorced. The spouse in this case was trying to make a claim that all of the income that had been generated by that trust was community property. They said no, look. We get it. The trust itself, when it was funded, when his parents died and it went into trust for him, we get it. That was separate property. But the ruling in Texas is income off of separate property is community property. It could have been distributed to him. That made it his. So we want half of all the income that that trust ever generated. The Texarkana court looked at this and they said, “You know what, if it was his, we would agree with you. But his wasn’t his income. This was the trust’s income. Now, any income that was distributed to him, yeah. But you already have that. So you’re talking about income that was included in the trust and still in the trust.”
Right, still contained within that trust.
The court said… so normally they said, “You know what, no. That’s not yours. But…”.
Yeah, it was a separate entity. That’s right. But remember that trust was supposed to distribute half the assets when he turned 25. The son just said, “You know what, no, I’m good. You just leave those assets in the trust.” Well the court did say, they said when he turned 25, one half of those assets were now his.
Right, even though he still left them in the trust.
Right. Even though they hadn’t been officially transferred out of the trust by the trust’s owing terms, those assets were his. So they said that one half of the assets, the income off of one half of the assets following his 25th birthday was in fact community property. So they did have to write the spouse a check for that. Which goes back to my point of why it’s stupid, to arbitrarily terminate a trust at a particular day.
Yeah because I’m not looking at the moment, John, but I am betting that the terms of that trust said the trustee shall distribute one half of the principal and accumulated income to the beneficiary upon reaching his 25th birthday.
And shall, it mean shall.
It means shall. That’s exactly what it was. It was a mandatory one half distribution at 25 and a mandatory termination of the trust at 30. Again, these are very… these are actually very common provisions that you will see. People say, “Oh, you got to play in in case a minor gets it.” You’ll have a little provision in there that says oh well, if this is going to lay on the hands of somebody who is under the age of 25, then it will be held in trust for their benefit until their turned 25. That’s what they call a contingent trust for minors. Those are very common. They’re just dumb because there’s no absolutely no reason to arbitrarily terminate a trust on a specific day.
Or to make mandatory distributions.
Right, exactly. In fact it would be much better to say for example, “Well, we got a bank in charge of it as the trustee until that person turns age 25. But then once they turn age 25, they can elect to be their own trustee so they can make decisions related to distributions.”
Yeah. Then the trustee may distribute.
Right. You can even build in some other things in there to help even though the fact that that person has the ability to make their own decisions, you can limit the circumstances that they can make certain decisions. And then you do that in a way to kind of build continuing levels of asset protection for those beneficiaries.
John, we’ve been talking about this but one of the things that have been so common of late is that we see more and more families where their largest asset that they will likely pass to children are IRA type accounts.
That’s right. That is now your… historically you would see that most people’s largest asset was their home.
Yes, was their home and lands.
Yeah, was their home and land, but it’s flipping now and you’re seeing folks that have a relatively modest home but in many cases hundreds of thousands of dollars in their IRAs. Once companies started doing… stop do doing traditional pensions, then all of that money accumulated in 401Ks and then when they retire they roll them over. If you talk to financial advisers and CPAs and many of those folks, they’re very quick to talk about the importance of naming your kids as the beneficiaries of your IRA. And that’s because of the tax issues that within IRA, unless you have a qualified beneficiary, then if you don’t have a qualified beneficiary, then the entire IRA becomes taxable upon your death.
That’s right. The tax man is there at the funeral service.
That’s right. This is why you never ever, ever name your estate as a beneficiary on an IRA.
Or a charity. There’s taxable issues with that.
There can be. The main thing though is… but most people don’t realize that a properly structured trust can actually be the beneficiary of IRA and still qualify for a roll over.
Right. You can extend out their time but you have to pay those taxes.
That’s right, and so from a divorce context, from a family law context…
From a tax planning context and even from a creditor, bankruptcy, special needs, disability, all of these issues, all of these potential problems that could befall your kids or other loved ones that you are leaving assets to, you need to have protected them from those contingencies. And the way you do that is by individualized, separate trust established for those beneficiaries inside your overall plan. Your estate plan says when I die, leave everything to the three kids but held in trust for their benefit where it’s qualified under the tax rules, where they’re going to get the asset protection from that wife that’s run off with the pool boy or a husband that’s run off with the cocktail waitress or whatever the situation is.
Whatever the situation is.
You want to protect them out there and we want to protect you. Which is why we show up here and do this program and we hope you’ve enjoyed it.
Yeah. We hope you’ve learned a little bit today about protecting yourself and your future heirs and beneficiaries and check us out on Facebook and on channel 10, Aging Insight Television.
That’s right, so until next time. We will see you later. Bye-bye. All right. And that’s all for us. So we’ll see you later.
In this episode, John and Lisa discuss what happens if you want to leave an inheritance or a legacy to your children and they end up in the divorce situation… part 2.