Our ex-daughter-in-law, the mother of our only grandchild, has student loans and other debts. Can our grandchild's inheritance be protected from her creditors? Are 401(k)s or IRAs protected from beneficiaries' creditors? What about "pay-on-death" accounts and regular bank and investment accounts? Should we set up trusts in our grandchild's name? We live in New York, and they live in Arizona.
The surest way to protect your grandchild's inheritance from his mother's creditors is to leave it to one or more trusts for his benefit. (An IRA needs its own trust because it's governed by special rules, which I'll explain in next week's column.)
The trusts can be created in your wills and left unfunded until your deaths.
You should discuss your situation with an attorney; but here are some basic guidelines:
Nonretirement accounts have no creditor protection. Federal law protects 401(k) accounts from their owners' creditors and New York law protects IRAs from their owners' creditors. But neither law protects these accounts from beneficiaries' creditors. Current Arizona law does protect inherited IRAs from beneficiaries’ creditors; but laws can change. It's prudent to assume that your daughter-in-law’s assets will be vulnerable both to her creditors and to the legal claims of a future husband, should she remarry.
It's unwise to leave money outright to a minor child, however. Indeed, New York and Arizona laws both require a minor child's direct inheritance to be administered by a court-appointed trustee; and the child gets control of that money at age 18. When you create your own trust, you can choose the trustee, leave legally binding instructions for how the money is to be used, and stipulate the age at which your grandchild gets full control of his inheritance.
The bottom line
A trust is a good way to protect a child's inheritance.