It is not unusual to leave your young child's inheritance to a family member. This usually happens by way of a beneficiary form.
This is no inheritance, you nimwit!
This is sometimes called a "poor man's will." Rather than setting up trusts for your young kids to protect their inheritance, you instead direct your financial accounts and other assets to a "trusted" family member to oversee the funds for your child.
This type of plan is no doubt well-meaning. You trust your named family member to manage and dole out the funds to your child as needed.
Although this may seem like an easy fix, the potential ramifications are terrible. Let me explain.
In my 22 years of experience, it is more common than not for any inheritance you leave your family member to never make it into the hands of your child.
Hey, my job as a planning professional is to give my clients the worst case scenario and unfortunately, in this particular instance, it happens frequently.
There are too many unknown scenarios that can go wrong. Here are just a few:
1. Although probably the least likely to happen since you trust this family in the first place, your family member may change their mind and want to keep the money. In my 22 years of experience, this happens more often than not.
2. Your family member may run into money problems. Financial stress can create the temptation to use the funds for themselves, even if they have good intentions to repay the money.
3. Your family member may have creditor problems. Similar to the prior scenario but this time, your family member has creditors chasing them down. For example, perhaps your family member caused a car accident and the damages are catastrophic so insurance does not cover all of the damages. If the plaintiff's attorney obtains a judgment against your family member, they will start the collection process and the inheritance you entrusted them with for your child is fair game for repayment. Yikes!
4. Your family member files for bankruptcy. The bankruptcy court will require your inheritance funds to be used to repay your family member's creditors.
5. Your family member has a falling out with your child or whomever is raising your child. It's human nature to use the withholding of funds as punishment against your child, even if your family member is in the wrong.
6. Your family member has a drinking, drug, gambling, or other addiction. Addicts use whatever funds are available to them to support their addiction. Your entrusted inheritance is not off limits.
7. Your family member gets divorced. Although this varies by state, inherited funds in your family member's name may be subject to division between the divorcing spouses regardless of the source of the funds.
8. Your family member decides to use the funds for someone else. Wow, this happens a lot when the family member marries. Suppose you leave your child's inheritance to your spouse who is your child's stepparent. You assume your spouse will continue to financially care for your child but then your spouse remarries someone else after you die. Still think the "new spouse" won't benefit from your inheritance? Very unlikely.
9. You never know who is "talking in your family member's ear." You don't know who the family member is listening to and may be planting seeds of doubt about the purpose of the funds. "Oh, your sister really wanted YOU to have these funds. After all, if she really wanted her child to get it, why didn't she just give it to her child?" Tough argument to rebut, greed being an inherent part of human nature.
10. Your family member may be a poor financial planner. I'll assume your family member has good intentions and loves your child or else you wouldn't entrust them with your assets in the first place. However, they may be a poor money manager with your child's inheritance and it becomes depleted unnecessarily.
Although it will require an investment of time and money to establish, a much better option to protect your children and their inheritance is to establish a Minor's Inheritance Trust instead.
Your child will be the beneficiary of the trust which means that whomever you've named to manage the trust (the trustee) cannot use the funds for their own benefit.
You can still name your trusted family member as the trustee or manager of the trust. You can still grant the trustee the discretion to dole out the funds according to the standards and guidelines you've set in advance.
Leaving your child's inheritance to a trusted family member should only be an option of last resort, such as you are on your deathbed or have no money whatsoever to establish a minor's trust with a professional.
To learn more about creating minor's inheritance trusts for your children, you should read my book, "Wise Women Protect their Assets" which you can download by clicking the photo below.