Hostak, Henzl & Bichler
840 Lake Avenue, Suite 300Racine, WI 53403
Phone: 262-632-7541

Why Some Clients are Using Loose Trusts in their Estate Plans

By Stephen J. Smith
The Family Vision Experience

Although not an actual case, it is inspired by many cases we have handled. Our clients put their daughter through college; she graduated debt free. She has a stable job with bright prospects, working for a fine employer. She is in good health and is careful with money: not living beyond her means and already beginning to learn about investing for her retirement. She is living with a wonderful young man who graduated with major educational debt, and he is thinking about going back for a Master’s degree in his chosen field, adding to his debt. They will probably get married sooner rather than later.

Our clients have asked what happens if they die, leaving the daughter’s share outright to her. They do not believe she needs protection from herself, so they would be inclined to leave her share outright to her.

  • What if their daughter’s relationship ends after they have died but before marriage?
  • What if they are married when she inherits her share and they are later divorced? Will part of it be divided in a divorce and pass to him?
  • What if they are married and later find themselves in a credit stew, perhaps flowing from the husband’s educational debt, perhaps from medical or similar expenses not fully covered by insurance?

We have a number of options to help protect the daughter which involve putting the inheritance in the hands of a third party and controlling access to the inherited wealth. However, in this case the goal is not so much to protect her from herself as to preserve the identity of these assets as her inheritance, at least so long as she wishes to do so. This is not a world of absolutes – but we can improve significantly on an outright bequest to her.

What we have come to call a Loose Trust refers to a plan which leaves the daughter’s inheritance to her as trustee of a trust for her own benefit. Typically it has the feel, in practice, of an IRA: that is, it is a separate account, not commingled with the daughter and her husband’s joint account or other assets. It has a separate status, and it was created by a third party (the parents), not the daughter. I like to say, “You (the parents) can legally do for her what she cannot do for herself: set aside money that will benefit her but not belong to her in a way that exposes it to a divorcing spouse or creditors the same as it would if she herself put it into a separate trust for her own benefit.

I call the idea a Loose Trust because the result is intended to produce a real benefit (non-absolute but real protection of the assets from creditors or a divorcing spouse) without making the daughter feel like she is unduly restricted and without incurring outside trustee fees, at least at the outset. The plan would be that if there were storm clouds on the horizon (financial or marital trouble), the daughter would step aside as trustee in favor of an independent third party trustee to strengthen the trust from attack.

Suppose the daughter received the inheritance outright and wanted to preserve it under Wisconsin law as her separate (not marital) property? She could do so. However, if she put the inheritance in a separate account, while the amount going in would be her separate property, the income from the account would under Wisconsin law be marital property. If she let the income accumulate, then eventually the entire account would be converted to marital property and subject to division in a divorce. A little known aspect of the Wisconsin Marital Property Law is that if her parents had left the property to a trust for her benefit (such as a Loose Trust), then the income from it would also be the daughter’s separate property. This is a significant advantage.

It’s not that assets will be fully protected in all situations, it’s that they are better protected than if the parents had left these hard-earned assets outright to the daughter. The trust would be flexible enough that there would be practical ways to end it later, if desired, but so long as the daughter controlled the trust as trustee, why would she?

This article is not meant to be legal advice in a specific situation, and it does not describe all the terms of a Loose Trust, but by reading it we hope you see there is a good case to be made for going beyond merely leaving an inheritance outright to an adult child.

© 2019 by Stephen J. Smith
creator, The Family Vision Experience