When Are Staged Withdrawal Rights a Bad Idea?

Mary wanted her children to benefit from the comfortable net worth she had built. Fortunately for them, she consulted with an estate planning attorney. She considered setting up trust funds for her children but was unsure how to handle the payouts:  outright or through staged withdrawal rights?

First, What Does ‘Staged Withdrawal Rights’ Mean?

Trust assets are disbursed to beneficiaries at some point. When a trust is structured for ‘staged withdrawal rights,’ it means that the disbursements will be made at specified intervals or will be triggered by specific events (such as pre-set age of the beneficiary).

Sometimes staged withdrawals are set to protect the beneficiary from losing their entire inheritance through bad judgment. Other times, they are used to protect beneficiaries in a high-risk profession or a bad marriage.

Are They Sometimes a Bad Idea?

One heir may be responsible at an early age, while another spends money as soon as it hits his bank account. The first heir may be able to handle a large lump sum payment. The other definitely cannot.

Trusts with staged withdrawal rights do not always offer the best asset protection for the trust beneficiaries. If a beneficiary can withdraw from the trust, creditors can go after it, too. Setting up payouts based on age also may make those payouts vulnerable to claims from civil judgments and ex-spouses.

Another disadvantage to staged withdrawal rights? The grantor may expect the heir to learn from their mistakes. For example, grantor may suspect that an heir will squander the first disbursement, knowing there will be more disbursements. There is just no guarantee that the beneficiary will handle the next disbursement in a more responsible manner.

Alternatives or Variations of Staged Withdrawal Rights

A staged withdrawal or disbursement format does not take into account the beneficiary’s financial situation and maturity at the time of the disbursements. Using a discretionary trust may help. With this type of trust, the trustee has the discretion to make payments directly to the beneficiary – or not. Instead, the trustee could pay the beneficiary’s bills outright. Money that never reaches the beneficiary directly usually does not become vulnerable to creditors and other claims.

In Mary’s case, she established a trust, naming her children, Jackson and Bailey, as beneficiaries after her death, with their shares to be split into separate trusts. She structured the trusts so that the trustee had discretion on when to make distributions.  Upon reaching age 30, both Jackson and Bailey have the option to become a co-trustee of his or her own trust.  Then, upon reaching age 35, each has the option of becoming sole trustee of his or her own trust.  This format, using discretionary trustee distributions as opposed to staged withdrawal rights or staged distributions, provides Mary’s children with substantially greater levels of asset protection.