A few weeks ago, I talked about Revocable Living Trusts (RLT), which are a core part of many estate plans. They’re designed to make the distribution of your assets to loved ones as smooth, cost-effective, and hassle-free as possible. If you missed that video, be sure to check it out! But while RLTs offer many benefits, they also have some often-overlooked downsides.
For example, they don’t provide asset protection while you’re alive and offer only limited estate tax benefits.
Without careful planning, your hard-earned wealth could end up in the wrong hands, get tangled up in legal battles, or shrink because of unnecessary taxes.
In this post, I’ll explore how RLT sub-trusts can fill these gaps to protect your legacy from creditors and lawsuits, while allowing it to grow safely for your loved ones. With the right structure, you can ensure that your wealth passes to heirs as intended and continues to benefit future generations.
What is a Living Trust Sub-Trust?
To better understand what a Sub-Trust is, imagine a family with a Revocable Living Trust. Mom and Dad have worked hard to ensure their kids and grandkids are well taken care of. When Dad passes away, Mom is left to manage the estate. Without sub-trusts, assets could get mixed up, making it hard to track of who gets what. Even worse, what if Mom remarries? Or what if she has a lot of debt and faces debt collectors? Or what if one child is bad with money or another has special needs? That’s where sub-trusts come in.
Think of them as mini-trusts created within the primary trust, each with its own specific rules, purposes, and beneficiaries – almost like a personalized playbook for handling assets based on each family member’s unique situation. When the main Revocable Living Trust becomes irrevocable - usually upon the grantor’s death - these sub-trusts are activated, ensuring assets are distributed and managed exactly as intended.
Essentially, sub-trusts serve as a safety net and protect the inheritance from being misused or lost to outside forces, like ex-spouses or creditors.
Why Do We Need Sub-trusts?
Asset Protection
One of the top priorities for many people who are looking to leave their legacy is asset protection from creditors and lawsuits. As I already mentioned, RLTs don’t offer much help here, but sub-trusts are ideals for this purpose and can safeguard assets from the creditors of your beneficiaries, children, or even your spouse. This protection kicks in because, upon your death, a revocable trust becomes irrevocable, shielding the assets from lawsuits and creditor claims. For example, if your child works in a high-risk profession like medicine, where malpractice suits are a possibility, you can set up a specific sub-trust to protect the inheritance from potential creditors.
Another strategy to protect your assets is to establish separate RLTs for each spouse instead of a joint RLT. While joint trusts are simpler to manage, they remain revocable after the first spouse’s death, leaving assets vulnerable to the surviving spouse’s creditors. With separate RLTs, the deceased spouse’s trust becomes an irrevocable sub-trust, offering better protection from creditor claims, even if the surviving spouse’s trust remains revocable.
You can also let the beneficiary act as the trustee of their own sub-trust. Although the beneficiary handles the distributions and investments, the trust remains irrevocable, which means creditors still can’t access those assets. This protection exists thanks to the HEMS standard which limits the use of the assets for the purpose of Health, Education, Maintenance, and Support. As long as these rules are followed, asset protection is maintained even with the beneficiary in control.
Alternatively, you can appoint an independent trustee - someone unrelated to you - to step in when needed. For example, if the surviving spouse is both trustee and beneficiary, and a distribution falls outside of the HEMS standard, they may worry about potential liability. In this case, they can appoint an independent trustee (if the trust documents permits so) to handle that specific distribution, reducing personal risk and maintaining asset protection.
Tax Planning
Sub-trusts can help minimizing estate tax, especially for married couples. For married couples, sub-trusts like AB Trusts or QTIP Trusts can strategically divide the estate to minimize taxes, allowing more to be passed on to the next generation.
Generational Wealth Management
Another big advantage of a sub-trust is its ability to help preserve wealth across multiple generations. Many people usually leave assets outright to their kids or spouse because they think it is the simplest and most efficient option, but it often results in losing control because the beneficiary can literally use the funds however they choose - often redirecting them outside the family.
Sub-trusts prevent this by offering more structure. You can specify when a beneficiary can serve as its own trustee or appoint a co-trustee, like a corporate trustee, to manage investments and ensure the safety of the assets for the future generations. This balances family involvement with professional oversight.
Another crucial yet often overlooked part of generational wealth planning is the power of appointment in a trust. Parents typically include this provision to give their children some flexibility to make outright distributions if unexpected needs or disabilities arise. However, depending on its type and how it’s written, the power of appointment can override your original intentions and let beneficiaries redirect asset distributions to others, including non-family members. If you want the wealth to stay in the family make sure the power is clearly defined to prevent unintended changes. This way, your legacy stays secure for future generations.
Post-Death Management
This might sound dramatic, but sub-trusts let you “rule from the grave.” If you are worried your kids might waste the inheritance and quit working because of the windfall, you can set limits on how they access the funds – allowing distributions only for health, education, maintenance, and support. This way, you protect the rest of the assets so they can continue to grow and benefit future generations.
If your goal is to eventually distribute the assets and terminate the trust, you can set up the sub-trust to distribute funds gradually as your children get older, reducing the risk of a sudden windfall that could be harmful. For example, you could direct the trustee to give out one-third at age 30, another third at 40, and the rest at 45. This approach is ideal if your children aren’t financially mature yet and could potentially misuse a large inheritance.
For blended families, you can include a provision requiring the trustee to consider the beneficiary’s other resources first. This ensures a surviving spouse doesn’t deplete the funds, leaving nothing for your children. By structuring the trust thoughtfully, you protect your legacy and support your family’s long-term financial well-being.
Planning for Beneficiaries with Special Needs
Another major benefit of sub-trusts is how they can support beneficiaries with disabilities. Properly structured, these trusts provide financial assistance without disqualifying the beneficiary from government benefits like Medicaid or SSI. This can apply not only to children but also to spouses who may require long-term care in the future.
To be effective, this planning needs to happen early, before any long-term care needs arise, due to Medicaid’s look-back rules. A great option is to include a “standby” supplemental needs trust in the main document and allow the trustee to have the discretion to direct assets there if needed. Alternatively, you may include a provision that lets an independent trustee step in to set up a separate trust if a beneficiary’s circumstances change and they need government support.
To summarize, sub-trusts are incredibly versatile tools that help families balance tax efficiency, asset protection, and financial security for all beneficiaries, no matter their unique needs.
Types of Sub-trusts - Breaking Down the Options
Another great thing about sub-trusts is that they can be tailored to fit nearly any situation. In this post, I will highlight a few common types without delving too deeply into the specifics. But if there’s a specific sub-trust you’d like me to cover in more detail in the future, please let me know in a comment below!
Marital Trust
A Marital Trust is a “spouse-protection” sub-trust. It’s created to support a surviving spouse, giving them access to income or principal, but with a catch. It includes provisions to ensure that the remaining assets are distributed according to the grantor’s wishes after the surviving spouse’s death, preventing them from being diverted outside the family.
Family Trust
A Family Trust holds assets for the benefit of children and grandchildren, with rules for distribution - like only when they turn a certain age or meet a milestone, such as finishing college.
Disclaimer Trust
A Disclaimer Trust is usually set up when the surviving spouse decides they don’t need the entire inheritance. They can “disclaim” or pass some assets into this sub-trust, where it can be protected from taxes or preserved for future generations.
Special Needs Trust
A Special Needs Trust, also called a Supplemental Needs Trust is crucial for families with special needs children or dependents. Setting up a Special Needs Sub-trust allows to provide extra financial support for loved ones without jeopardizing their eligibility for government benefits. Instead of giving them money outright, the trust holds and distributes funds in a way that keeps them qualified for Medicaid, SSI, and other assistance programs.
Spendthrift Trust
A Spendthrift Trust is used when there is a beneficiary who’s not great at managing money. It restricts how much money they receive and under what conditions, protecting the funds from being wasted or seized by creditors.
These are just a few examples but as you can already see sub-trusts can be custom-built for almost any situation.
Common Mistakes to Avoid
Even with all these benefits, sub-trusts can backfire if not set up correctly. Common pitfalls include:
Vague Language: If your sub-trust instructions aren’t clear, it can lead to disputes and even court involvement.
Inappropriate Trustee Selection: Picking the wrong trustee can result in mismanagement or conflicts of interest.
Not Updating the Trust: As family circumstances change—new marriages, divorces, births, deaths—you need to update your sub-trusts accordingly. Many people forget to do that, and this can lead to serious issues in the future.
Final Thoughts
Creating a Revocable Living Trust is a great start, but without sub-trusts, you’re possibly missing out on some of the strongest tools for protecting your legacy. Whether it’s tax efficiency, asset protection, or simply making sure your wishes are followed, sub-trusts are the “guardrails” that keep your estate plan on track. If you want your plan to truly reflect your wishes and adapt to life’s complexities, sub-trusts are the way to go.
If you would like us to take a closer look at your estate planning goals and create a strategy for leaving a legacy, please feel free to book an Estate Clarity Meeting.