We have often discussed the options of how to leave assets to beneficiaries.  The often-selected method is outright and free of trust.   This merely means that the asset has no strings attached and belongs to the beneficiary.  Assets that pass by beneficiary designations (Pay on Death), surviving joint ownership, and by distributions directly to the beneficiary under a will or trust, are outright.

While outright may seem the natural choice, it is not usually the best choice.  Assets that are left to a beneficiary outright become part of the beneficiary’s estate and are at risk to the beneficiary’s creditors as well as to a divorcing spouse.  While inherited assets are sole and separate property, most beneficiaries co-mingle these assets with marital assets.  The marital assets are divided in a divorce.

A recent ninth circuit bankruptcy court case highlights the hidden perils of out right distribution.  Those wishing to pass real estate upon their deaths have the option of using a Beneficiary Deed. This allows a person to convey real estate on death without probate.  This bankruptcy case illustrates the risk of using such tools to distribute without protection.  In the case, Decedent executed a beneficiary deed and died approximately six months later.  The beneficiary, her grandson, and his wife filed a chapter 7 bankruptcy petition 3 days before the grandmother’s death.  The bankruptcy court ruled the inherited property was “property of the estate” and allowed the bankruptcy to sell the property to pay creditors.

The alternate to outright distribution is to leave assets to a beneficiary in a trust.  The trust, known as a spendthrift trust, allows the inherited assets to be used solely for the beneficiary and cannot be touched by the beneficiary’s creditors (even in bankruptcy) or a divorcing spouse.

The obvious benefit the various methods of outright distribution is to avoid probate, but the costs of probate are significantly less than the risk of your beneficiaries losing their assets.  Alternatively, a living trust allows an estate to be administered privately, without probate, and under the trust your beneficiaries’ may inherit in spendthrift trusts created for them.  That truly is a much better form of gifting your hard earned and valuable assets to your heirs.