What to do about an irresponsible heir

• Setting up a spendthrift trust can be a smart solution for heirs who have addiction problems—or are just plain bad with money.
• Another option: an annuity. Your heir gets a monthly check instead of one lump sum. 

The prodigal son. The irresponsible heir. Every family’s got one. You love them, you worry about them, but you fear what might happen should you ever leave them a pile of cash. They’re more likely to blow an inheritance on some cockamamie real estate scheme or a boozy trip to Vegas than ask a wealth advisor to suggest a well-managed mutual fund.

The good news is that estate planners have solutions. The most common: a spendthrift trust. As the name implies, spendthrift trusts limit or regulate the beneficiary’s access to assets. They are especially well-suited to those with large or complex estates. For more modest estates, annuities can regularly dispense money in a way that avoids handing over a lump sum to someone who may not spend it wisely. 

Each option has advantages and disadvantages. The first step is discussing the irresponsible-heir situation with your wealth advisor. “It’s a sensitive subject, and clients are often hesitant to bring it up,” said Theresa Malmstrom, a TIAA wealth planning strategist. “But they’re usually relieved when they do. They find out they’re not the only families taking necessary steps.”

A trust to encourage healthy spending

Spendthrift trusts are designed to provide financial support while limiting an heir’s control over the assets. The beneficiary does receive the assets, but how much and when is governed by the terms of the trust and by the trustee appointed to oversee it. The beneficiary does not own the assets—the trust does—and that can help shield assets from creditors should the heir be sued or chased by debt collectors.

Here’s how it works. Say you want to leave your 50-year-old adult son, Tom, a $500,000 inheritance, but you worry about his gambling problem. You and your attorney can structure a spendthrift trust so Tom will get monthly income from the trust—maybe $2,500 a month—along with oversight from a trustee who can ensure the money is being used appropriately. (If you don’t have trust-and-estate lawyer, your TIAA wealth advisor can connect you with one.) You can grant the trustee power to distribute principal as well, in case of extenuating circumstances such as a large medical bill.

Depending on your family situation, it’s probably best if the trustee is independent rather than another family member. If Tom’s sister, Nia, were the trustee, it could strain their relationship. And whereas Nia might be swayed by Tom’s “c’mon, just this once” plea for extra cash, a corporate trust officer working for a trust company will not, assuming the terms of the trust do not allow it.Most trust companies, including TIAA TrustOpens in a new window, include independent trustees as part of their services.

The downside of spendthrift trusts is cost. The legal fees associated with setting up a trust can range from $750 to $2,000 depending upon complexity, according to Malmstrom. Spendthrift trusts require preparing separate tax returns too, which is another expense. On top of that, there are annual maintenance fees and asset management fees. TIAA Trust, for instance, has an all-inclusive fee structure (covering both trust and asset management services) that’s less than what many competitors charge but still costly for relatively small accounts. TIAA Trust’s annual fees range from 0.5% to 1% of assets depending upon the size of the trust, with a minimum of $9,000 a year¹.  For a trust with $100,000 in assets, the $9,000 minimum would erode principal fast.

The gift of lifetime income

If the cost of setting up a small spendthrift trust is too high, another option could be to purchase an after-tax annuity for your irresponsible heir, providing them with a monthly income stream for life. (Your TIAA wealth advisor can walk you through the process and help sort through your options for after-tax annuities.) Based on current rates, a $100,000 fixed annuity with a 20-year guarantee for a 50-year-old male would pay out approximately $500 a month, according to Benny Goodman, a veteran actuary and vice president with the TIAA Institute.

Goodman said this approach is a simple, low-cost way to spread out an inheritance and avoid the risk associated with leaving a lump sum to someone who is not good with money. The annuity might even prove more meaningful to your heir. Every time the monthly check arrives in their bank account, they’ll be reminded that you gave them a gift of lifelong financial security.

That said, there are drawbacks to the annuity strategy. For starters, due to new tax rules, it generally requires the use of after-tax annuities, which cannot be purchased with IRA, 403(b) or 401(k) money.

Another disadvantage of annuities—as opposed to spendthrift trusts—is loss of flexibility. Said Malmstrom, “It can’t be customized.” In other words, the monthly annuity payment cannot be altered should your prodigal son have a financial emergency—or, more optimistically, should he get his life in order.