An estate plan creates a plan for assets after the death of their owner. A good estate plan should not only include information about who should receive these assets but also outlines how the assets should be delivered. An Inheritance Segregating Trust (IST) is a vehicle to deliver assets to beneficiaries with an added layer of protection.
An IST is a living trust that is designed to keep inherited assets separate from the beneficiary’s other assets (including marital or jointly held property). It is structured similarly to a standard individual Revocable Living Trust but has some distinct characteristics. For instance, in a typical IST, the spouse of your beneficiary can never become the trustee or beneficiary of the IST (the trustee is the individual who manages the trust’s assets, and the beneficiary receives the benefit of the trust’s assets). The reason for these restrictions is to prevent a spouse from gaining control of the assets in the IST, which could make the assets subject to division in the event of divorce.
In order to make an inheritance subject to an IST, the estate planning documents should specify that, prior to receiving an inheritance, the beneficiary must establish an IST, and that the trustee must distribute the inheritance to the beneficiary’s IST, not to the beneficiary directly. Because the beneficiary receives the inheritance through their IST, they will have complete control over the assets, but will have a layer of protection against the commingling of assets.
Why Use an IST?
Many times, clients who wish to use this delivery vehicle want to make sure that their wealth stays in “the family line” and to pass more directly to their child and then grandchildren rather than to their child’s spouse or in-laws. Additionally, if a parent is concerned about their child’s assets being subject to division due to divorce, using an IST can help mitigate the risk of the inheritance being considered marital property. Because an IST has strict restrictions on who can be the trustee and beneficiary, there is a much better case for that asset to be considered separate property provided that the IST is managed correctly. Furthermore, an IST can serve as a helpful “beginner” living trust for a child, who is able to use the IST as their own personal estate plan, helping the child avoid probate on assets held in the name of their IST.
Keeping an IST Effective
In order for an IST to be effective, it must be properly managed. For example, an IST’s assets must be titled in the name of the IST, whether it be a bank account or real estate. If the IST’s funds are removed or commingled in a joint account with a spouse, the IST may lose its ability to protect the inheritance from division. For example, if a beneficiary withdraws a large amount from an IST for a downpayment on a home titled jointly with a spouse, and the couple proceed to live in the house together and make mortgage payments from a joint account, the home would likely be considered a marital asset even though the IST funds helped to pay for it. This is because the IST funds were used to acquire the joint property. An IST works best when funds are clearly kept separate from any jointly owned assets or property.
If you think that an IST might be suitable to deliver inheritance to one or more of your beneficiaries, you should work with an experienced estate planning attorney to revise or create your Revocable Living Trust. They will draw up the necessary documents outlining that your wealth must be delivered to your beneficiary through an IST. They do not have to set up their IST during your lifetime but can wait until after you have passed away if they would prefer. As you are thoughtfully considering whether an IST might be the best option to carry out your wishes, please reach out to us if you have any questions. We’d love to speak with you and help you as you continue on your estate planning journey.