Children’s Asset Protection Planning in North Carolina: Don’t Leave the Liability Window Open!
Whenever I draft wills for a young couple expecting their first baby, or for a couple who already have at least one child, I always set up a children’s asset protection trust for them within the will documents. In case the parents pass away before their children have finished their education, or in case the parents become incapacitated so that they can no longer financially care for their kids, the parents always want to plan for a responsible adult family member or friend to manage their children’s assets for them as trustee of the children’s asset protection trust, in a way where the assets of the children’s trust will be protected against any possible future liability, creditor, or financial problems encountered by one of their children.
All of my client parents agree that such asset protection for their kids is a good thing! But while parents definitely want asset protection for their children, my younger client parents frequently are a lot more cavalier (“it won’t happen to me”) about asset protection for themselves.
Many of my client parents initially ask me for the following will planning:
- Sweetheart Will. If either one of the parents pass away leaving a surviving parent, all of the deceased parent’s assets benefit the surviving parent. The surviving parent can then use this money to take care of the children.
- Surviving Parent Wants Benefits in Cash. Except for the deceased parent’s share of the home, his or her personal property, or retirement account proceeds, the surviving parent receives the deceased parent’s assets “outright,” or in cash. Any life insurance (important in financially protecting young families) owned by the deceased parent benefits the surviving parent directly, in cash.
- The Parent’s Assets, Retirement Accounts, and Life Insurance Proceeds Flow Directly Into the Children’s Asset Protection Trust When Both Parents Pass Away. When both parents pass away, all of their assets, and any life insurance (and any retirement account proceeds in inherited retirement accounts) flow into the children’s trust, where a trusted adult family member can manage trust assets for the children as they grow and complete their educations. Once assets are held within the family trust, if one of the 17 year old children later has a car accident creating financial liability, all of the children’s family trust assets within the family trust are protected from the liability claims brought by an opposing attorney.
This is a pretty good strategy, but it can be greatly improved! The parents’ desire to receive their deceased spouse’s assets unhindered in cash (in Step 2 above), and life insurance benefits unhindered in cash, may leave the liability window open! This open liability window could seriously chill the financial outlook of both the surviving parent, and the surviving children.
DON’T LEAVE THE LIABILITY WINDOW OPEN!
Most parents would want to guard against the following tragic scenario: The dad is works late one night, falls asleep at the wheel driving home, and has a car accident killing both himself and the driver of the other car.
As is typical, both the mom and the dad are the co-owners of the car that dad was driving. The opposing plaintiff’s attorney receives a large financial judgement for the family of the other deceased accident victim, greatly in excess of mom and dad’s automobile liability policy limits.
If the unlucky mom and dad had set up a sweetheart will, where many of the deceased dad’s assets flowed directly to the mom in cash, and the dad’s $500,000 life insurance policy benefitted mom directly, both mom and the surviving children may be in trouble! The dad’s individual assets may have to pay vehicle liability claims in probate, where valid creditor claims have to be paid before the deceased person’s assets can flow through the will to beneficiaries. Thus there may be none of dad’s own assets left for mom, and the kids, to live on!
What about the $500,000 life insurance policy? Well, since mom was a co-owner of the car, the opposing plaintiff’s attorney could sue her individually, even though she was not even in the car with her husband during the accident. Since mom receives the $500,000 from the life insurance policy directly, and in cash, all of the $500,000 insurance proceeds may now be available to the opposing plaintiff’s attorney. And if mom never gets the $500,000, the children will now never get it either, because the liability window was left wide open!
THE SURVIVING PARENT’S ASSET PROTECTION TRUST
North Carolina law would have allowed, however, the dad to have set up a testamentary asset protection trust (testamentary irrevocable 3rd party trust) in his will benefitting mom, which is a type of “vault” which could have protected assets that dad left for mom from any of mom’s future creditors. Even though North Carolina probate rules would not have protected dad’s individual assets from his own probate creditors (for example the auto accident claim holders), dad could have set up his $500,000 life insurance policy where mom’s testamentary asset protection trust was the direct beneficiary of dad’s life insurance benefits, not mom individually. Planning this way, where dad’s $500,000 life insurance benefits would flow directly into mom’s asset protection trust, could have saved the $500,000 life insurance proceeds for both mom, and the children.
Some younger parents worry that leaving assets from a deceased spouse in trust for them may be too restrictive. But in North Carolina, the surviving parent can be the full manager, or “trustee” of his or own asset protection trust, writing checks to himself or herself as needed for his or her health, education, maintenance, or support, or for his or her children’s same needs. A “right of withdrawal” may also be written into the surviving parent’s asset protection trust, where, as beneficiary of the trust, the surviving parent can decide to withdraw any portion, or all, of the trust funds out the trust at any time, for any purpose.
Fortunately, where the primary residence is sold and it was the principal residence for two of the last five years before the sale, individuals may typically exempt up to $250,000 in federal capital gains taxes. Couples may typically exempt up to $500,000 in capital gains taxes under these conditions.