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How to protect your financial legacy from reckless heirs

In a recent interview with the British newspaper Daily Mail, 62-year-old rock icon Sting announced that he won't be leaving his $300 million fortune to his six children. This decision about his financial legacy continues to make global headlines—and to be picked apart by those quick to judge.

The announcement came as a shock to many, but his decision seems to reflect his stance on ethics as a parent rather than any spite on his part.

Sting's approach to "parenting from the grave" is a great example of the decisions that need to be made during the estate-planning process. In his case, it was a choice to encourage his kids' self-sufficiency by maintaining their strong work ethic. Others, however, make similar decisions out of fear of their children's spending habits.

Sting at the 25th Anniversary Rainforest Fund Benefit Concert at Carnegie Hall on April 17, 2014, in New York City
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Sting at the 25th Anniversary Rainforest Fund Benefit Concert at Carnegie Hall on April 17, 2014, in New York City

As a financial advisor, you might spend decades working for certain clients—only to eventually see their wealth recklessly spent by their heirs. Conversations with clients on this subject can sometimes be delicate, so use caution when broaching it.

Be careful not to offend your clients by implying that their kids or family members are irresponsible; in fact, you might want to approach this differently with each client. I recommend a separate meeting solely on the topic of legacy planning.

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In this meeting, you can review beneficiary designations, tax implications, recommendations on the transfer of wealth and suggestions for disbursing assets. They're likely to open up more in this setting and give you their honest opinion on the spending habits of their heirs. If this is something of concern to them, they will lean on you for advice.

The most productive way to assist in overseeing the distribution of your clients' wealth is to ask for a professional introduction to their children. This provides an opportunity to not only possibly gain these heirs as new clients but to also educate them on financial planning—in the hope they'll preserve the assets left to them after your clients' deaths.

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However, this can be a delicate situation, and you can sometimes find yourself in the middle of a difficult situation between family members; I suggest using discretion when deciding which family members to work with.

Like Sting, any parent does have the option of leaving nothing to a child. If it comes to this, the parent should make a statement to that effect within his or her will. If the inheritance is to go to a child and there's a concern he or she will make bad decisions on spending it, then it might make sense to direct those decisions to someone else by setting up a trust.

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The most difficult part of ensuring the enforcement of the trust is selecting the right trustee. This person, or persons, will be responsible for making decisions about spending the assets as stated in the trust. This person will have final say on the demands of the beneficiary, so the selection process shouldn't be taken lightly.

Many clients choose a family member or friend who won't be influenced by the beneficiary and his or her bad habits; others will hire a professional trustee to enforce the disbursement of assets.

A "spendthrift trust" is common in these types of situations. This kind of trust puts restrictions on withdrawals by giving the beneficiary a monthly allowance and/or lump-sum payments over a specific amount of time. Spendthrift trusts can also contain provisions allowing the trustee to distribute money earlier for specific purposes such as education or medical expenses.

An "incentive trust" is similar to a spendthrift trust but is designed to reward good behavior, such as going to college or getting a job. On the other hand, it can also be designed to make payments contingent on certain behavioral requirements, such as staying drug-free or completing a rehabilitation program. This type of trust may require more effort from trustees, as they may need to monitor the behavior of beneficiaries as opposed to simply following general instructions set forth by the trust.

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"An 'incentive trust' is similar to a spendthrift trust but is designed to reward good behavior, such as going to college or getting a job."

Not to advocate any particular product, but a less elaborate and less expensive alternative to setting up a trust may be to buy an annuity from an insurance provider. Annuities are often purchased to provide a source of future income, typically in retirement. Annuity contracts can also be set up to direct payments to a beneficiary upon death.

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The payments from the contract can be arranged over a certain time and can inhibit the beneficiary from accessing the lump sum cash value from the contract.

Regardless of the purpose for setting up a trust, it's recommended you consult an experienced attorney on applicable language to include in the trust to ensure the assets are actually disbursed as you intended.

—By Andy Roberts, special to CNBC.com. Roberts is a financial advisor and portfolio manager at Charleton Financial.

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