What is a pot trust and how could it benefit your clients?

Do your clients struggle to structure their estate plan in a way that aligns with their wishes while providing for their heirs in times of need? They may want to consider an estate planning strategy that offers flexibility in distributing assets based on individual needs.

This approach allows the trustee to manage the assets as a single pool, with the discretion to distribute them to beneficiaries as needed. It’s particularly useful for clients who want to ensure that each beneficiary receives support based on their unique circumstances, rather than an equal share.

While many advisors recommend this strategy for its ability to provide equitable distribution, it can also raise concerns. The flexibility it offers might create ambiguity, potentially leading to disagreements among family members.

So, when is this strategy a good fit for your clients? Keep reading to learn how this approach works, its benefits and drawbacks, and the scenarios where it could be the most effective way to pass on wealth.

What is a pot trust?

A pot trust is a type of trust that offers flexible estate planning, where assets are pooled into a single “pot” and distributed among multiple beneficiaries based on their needs. Instead of allocating fixed percentages or amounts to individual beneficiaries, a pot trust allows the trustee to decide how and when to distribute the assets based on the beneficiaries’ changing needs.

The beneficiaries are often family members, such as children or grandchildren, and the trustee is given the discretion to determine how much each beneficiary will receive at any given time. This flexibility ensures that each person’s financial needs are met fairly, particularly when there are significant age or financial disparities among the beneficiaries.

While the HEMS standard (Health, Education, Maintenance, and Support) governs many trusts, pot trusts go further by granting the trustee broader discretion to distribute funds, going beyond these basic categories to cover any unforeseen needs that might arise for the beneficiaries.

When should your clients consider a pot trust?

A pot trust can be a great solution for clients with two or more children or grandchildren. Especially when they’re far apart in age or have different levels of financial need.

A pot trust works well when clients want to distribute assets in an equitable manner to ensure each person’s needs are met fairly. This, however, brings up an important question that even advisors can’t answer for clients: Is it fair to distribute assets in a way that’s not necessarily equal? How will each beneficiary feel or react when they learn that others got less or more money?

As an advisor, you may commonly hear from clients that they want to use their assets to help kids or grandkids if unforeseen challenges arise. You may also have clients who have one or more children who are already well-off financially as well as children who are either much younger or still trying to get a stable financial footing. That’s where a pot trust can come in, addressing concerns such as:

•     What if one of my minor children has large unexpected needs after I pass away?
•     How can I distribute my assets equitably if one of my children is already well-off financially?
•     How do I make sure that the children who truly need financial help will receive it – even if it entails leaving differing amounts to each child?

A pot trust is not only a great tool for parents, but also for grandparents. Let’s look at how grandparents might use a pot trust to support grandchildren of varying ages and levels of financial responsibility.

Example of a pot trust

Consider a client with three grandchildren, all at different stages of their lives. The oldest grandchild just sold his first tech startup, becoming a self-made millionaire. The middle grandchild recently graduated college. The youngest just started high school.

Your client has already contributed $100,000 towards college expenses for the middle grandchild. They also want to help the youngest grandchild finish college debt-free.

If the client were to pass away today, the two elder grandchildren are likely going to be ok financially as compared to the youngest grandchild. If the assets are divided evenly, the two elder grandchildren might benefit at the expense of the youngest grandchild who may still have to pay for college.

But what about the oldest grandchild? Should your client leave an equal amount to all three grandchildren, even though the oldest might not need the money?

Having a discussion that involves these questions can be tough. But it opens the opportunity for advisors to add value as they help clients work through their preferences to find an estate planning solution most aligned with their wishes.

How does a pot trust work?

Like establishing any other trust, creating a pot trust involves drafting the official trust document with an estate planning attorney. The client acts as the settlor, designating a trustee to oversee and distribute the assets.

If the client chooses to set up a pot trust as part of a revocable trust, they can modify the trust down the road. The pot trust can be funded either when it’s established or at death, becoming an offshoot of another trust. 

Once the trust is funded, assets either remain in the trust until disbursed or until the youngest child reaches a certain age to be specified in the trust document (e.g., 18, 21, 25, or another age). At that time, any remaining assets within the trust can be distributed directly to the beneficiaries or divided into separate trusts for each beneficiary.

For clients concerned about lowering the value of their taxable estate because of the 2026 estate tax exemption sunset, consider an irrevocable pot trust. This removes the assets and appreciation from their estate. When setting up an irrevocable trust, however, it’s important to keep in mind that your client won’t be able to change the terms of the trust and will have relinquished ownership of the assets.

What are the benefits of a pot trust?

A family pot trust offers several advantages that make it a worthwhile consideration among advanced estate planning strategies. The benefits of a pot trust include:

Addresses unforeseen needs

The trustee’s authority to distribute trust assets on an as-needed basis allows for supporting children or grandchildren during emergencies, such as health crises or divorce, without encouraging reckless spending.

Flexibility in asset distribution

A pot trust allows clients to distribute a bucket of assets without a feeling of obligation that everything has to be split equally. If unexpected needs arise for any given beneficiary, there’s no need to adhere to strict equality.

Potential protection from creditors and spendthrifts

Assets held within a pot trust remain under the trustee’s authority until distribution. This could safeguard beneficiaries from creditors and former spouses. If spendthrift children or grandchildren are a concern, a further trust can be set up for their share of the assets once the pot trust is dissolved.

Cost-effective solution vs multiple trusts

Establishing multiple individual trusts can be complex and costly. Creating one pot trust can save clients money on setting up and maintaining multiple trusts for each beneficiary.

What are the disadvantages of a pot trust?

While a pot trust can be a great solution for some, there are drawbacks that warrant further discussion with clients:

Potential for family conflict

While the flexibility of pot trusts is a great benefit, it can also ignite familial tensions due to uneven asset distribution. Some beneficiaries may feel they’ve been treated unfairly or received a smaller share of inherited assets than others. This could cause conflict among family members and/or the trustee.

Skewed distribution of assets

Pot trusts, intended to cater to changing financial needs, may lead to an uneven allocation of assets, heavily favoring one beneficiary over others in unforeseen circumstances. If one beneficiary needs expensive emergency surgery, for example, but the others remain healthy, this beneficiary might use up a much larger portion of the assets than expected.

Delay in distributing assets

If there’s a wide age gap among the beneficiaries, it could be a while before the oldest beneficiary receives their inheritance (assuming no unexpected needs arise for them). For example, if the youngest and oldest child are 15 years apart and the trust specifies that all assets will be distributed when the youngest child reaches age 21, the oldest child will be 36 by the time they receive their final share of the assets.

Constraints on investment options

Unlike trusts that outline specific instructions for how and when the assets should be used, pot trusts leave much room for uncertainty. This makes it more challenging for advisors and/or trustees to invest the assets because the time horizon and liquidity needs are unknown. This limits the investment flexibility of the assets within the trust, potentially leading to lower returns than if the assets were invested in an individual trust with a specific time horizon.

Final considerations around using pot trusts

A pot trust is a great estate planning solution for clients who want flexibility in passing their assets while providing for heirs if and as they need financial help. On the other hand, a pot trust might not be the right solution for clients who don’t like ambiguity or want to ensure an equal split among beneficiaries no matter what.

Because a trustee plays such an important role in the proper use of a pot trust, be sure to have a conversation with your client about the importance of choosing the right trustee. If your firm offers successor trustee services, consider giving your client the option to look into those services if they don’t have anyone else they trust to serve in this role.

It can also be valuable to help clients visualize the impact that a pot trust would have on their estate plan. You can do this by using an estate planning software like Vanilla to illustrate the flow of assets upon death so they can see exactly how their wealth may be distributed.

Not sure how to start an estate planning conversation with clients to determine whether a pot trust is even something to discuss with them? Use our estate planning checklist to map out your clients’ estate planning needs. 

Integrating Vanilla into your estate planning discussions can enhance client trust, foster enduring client relationships across generations, and potentially lead to new business opportunities through introductions to clients’ family members and trusted advisors. Discover how Vanilla can help you do a better job for your clients and grow your business today!

The information provided here does not, and is not intended to, constitute legal advice or tax advice; it is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with your financial advisor or estate attorney who can advise as to whether the information contained herein is applicable or appropriate to your particular situation.