Many parents assume that once they leave assets to their children, those assets will remain in the family and trickle down through the generations. Unfortunately, that is not always the case. An inheritance left outright and free of trust to a beneficiary may become exposed to divorcing spouses, creditor claims, lawsuits, bankruptcy proceedings, and financial mismanagement. In many cases, wealth that took decades to build can disappear quickly due to unforeseen circumstances if not properly protected. A well thought out estate plan can help preserve inherited assets for future generations and reduce the risk that family wealth will be lost to outside claims.
Our first big takeaway here is that inherited assets are not automatically protected from a variety of circumstances. Under South Carolina law, inherited property is generally considered nonmarital property in a divorce proceeding. However, inherited assets can lose that protected status if they are commingled with marital assets or otherwise treated as marital property over time. This commonly occurs when a beneficiary deposits inherited funds into a joint account, uses inherited assets to purchase jointly titled property, allows inherited funds to be mixed with marital assets, or treats the inheritance as part of the couple’s shared finances. Once inherited assets become difficult to trace, they may become subject to equitable division during divorce proceedings.
Outside of divorce, another risk to a beneficiary’s inheritance could lie in their creditors or lawsuits filed against them. A beneficiary who receives assets outright may later face business liability, personal injury claims, bankruptcy, professional malpractice claims, creditor judgments, and/or collection actions. Once assets are distributed directly to the beneficiary, those assets generally become legally owned by the beneficiary and may become reachable by creditors. This issue is particularly important for beneficiaries who are physicians, business owners, real estate investors, executives, or individuals working in professions with elevated liability exposure. It is of course important for them to do their own estate planning to limit their liability exposure, but you can do so in your estate planning by leaving their share in trust for their benefit.
One of the most effective tools for protecting inherited assets is a properly drafted trust containing spendthrift provisions and discretionary distribution standards. South Carolina recognizes the validity of spendthrift trusts under the South Carolina Trust Code. S.C. Code Section 62-7-502 provides that a valid spendthrift provision restricts both voluntary and involuntary transfers of a beneficiary’s interest and generally prevents a creditor from reaching trust assets before distribution to the beneficiary. In practical terms, this means assets remaining inside the trust may receive substantially greater protection than assets distributed outright to the beneficiary.
A properly structured inheritance trust can reduce exposure to divorcing spouses, help shield trust assets from creditors, protect beneficiaries from financial mismanagement, preserve assets for future generations, provide professional management of inherited wealth, and allow the beneficiary continued access to trust benefits under appropriate standards. In many cases, parents can design trusts that allow children to benefit from inherited assets throughout their lifetimes while still preserving significant protection against outside claims.
Discretionary trusts can provide another layer of protection. This works because beneficiaries generally do not have an automatic right to compel distributions from the trust. Under S.C. Code Section 62-7-504, certain discretionary trust interests receive additional protection from creditor claims. This distinction can become extremely important in situations involving lawsuits, divorces, or bankruptcy proceedings.
Rather than distributing assets outright at a certain age, many high net worth families instead prefer long-term trusts that allow a trustee to make distributions for health, education, maintenance, and support while keeping assets protected inside the trust structure.
As for long term protection, outright distributions often unintentionally undermine the goal of asset protection because they distribute assets outright once a child reaches a certain age. A distribution at age 25 or 30 may sound reasonable when children are young. However, once assets are distributed outright, creditor protection may disappear, divorce exposure may increase, the beneficiary may transfer or spend assets freely, and future generations may lose the benefit of long-term trust protection. In many situations, continuing trusts for adult beneficiaries provide substantially better long-term protection and flexibility.
As far as creditors go, clients are sometimes surprised to learn that revocable living trusts generally do not provide asset protection for the person creating the trust during that person’s lifetime. Under S.C. Code Section 62-7-505, assets held in a revocable trust generally remain subject to the settlor’s creditors during the settlor’s lifetime. However, revocable trusts can still serve an important role in protecting beneficiaries after the settlor’s death if the trust is drafted to continue in protected trusts for children or other beneficiaries rather than distributing assets outright.
Finally, the moral of the story here is that an element of planning considerations should involve preservation, not just distribution. Many estate plans focus only on how assets pass at death. Sophisticated estate planning should also address how inherited wealth will be preserved after it is received. For families who have spent decades or even generations building wealth, protecting inherited assets from divorce, creditors, lawsuits, and financial mismanagement is often just as important as minimizing probate. Carefully drafted trusts can help preserve family wealth for children, grandchildren, and future generations while reducing the risk that inherited assets will be lost to circumstances outside the family’s control. If your current estate plan leaves assets outright to beneficiaries, it may be time to review whether your plan provides the level of long-term protection your family actually needs.
If you are in need of assistance, the attorneys at Collins Family & Elder Law Group can help.
