Is It Time For The Trust Conversation?

“Trust funds” aren’t just a toy for families with famous names and wealth that stretches back for generations. Even the working rich are incorporating trusts into their financial plans. When the moment is right, the benefits are simply too high to leave to chance.

The Financial World’s Best-Kept Secret

For generations, trusts have been the bedrock anchoring the lives of ultra-elite families with famous names: Rockefeller, Mellon, Astor, du Pont.

The “trust fund” determines the way their dynastic wealth circulates, liberating the heirs from day-to-day concerns while reducing drag from inheritance and income tax, creditors, premature distribution and even bad marriages.

Of course the appeal of this combination of structure and efficiency isn’t limited to the billionaire list. Drill down and more than half (60%) of all families with at least $250,000 to invest already have relationships with at least one trust — as beneficiaries, creators or both — so these instruments are far from exotic even among everyday people who want to make the most of the money they have.  

If anything, the logic gets clearer down the wealth scale. Someone like Jeff Bezos or the Walton family can generate $20 million a year in interest income on each $1 billion they leave behind, so their heirs don’t feel quite as much pressure to protect every dollar they can.

A fortune on that scale takes generations and even a little hard work to spend down. When you’re starting a little smaller, every incremental edge stretches the assets farther, turning what could have been a simple lump-sum bequest into an ongoing relationship with the future. 

You’re probably already familiar with the calculations.

Defer capital gains over time, and you tend to end up with more money when it’s time to distribute the returns. Structure that distribution carefully enough, and the principal gets more time to compound before the family fortune finally evaporates.

For multi-billionaires, the benefits still translate into real dollars, but there was never a lot of urgency: on an absolute scale, making the right choices simply don’t matter as much.

The rest of us need to be a little more prudent to achieve our long-term goals. That’s why trusts remain relevant to the working rich — arguably more relevant than ever.

Trust 101

At their most basic, a trust is a legal structure created to accept property from individuals who sacrifice direct control over the assets for the right to decide who will ultimately benefit from the wealth that accumulates. 

The trust documents define the creator’s wishes, naming specific individuals or a whole class of people (“all descendants”) as beneficiaries and setting the terms around which the assets will flow to them.

The trustee follows the directives, resolves ambiguities and ensures that the trust’s operations comply with all federal and state regulations. As the proxy for the trust creator, the trustee or directed trust officer often interacts with the beneficiaries to communicate the creator’s stated values, solve problems and in general acts as “concierge” supporting major life events.

The beneficiaries receive structured distributions as described in the trust documents.

These are often family members who will ultimately inherit the trust creator’s property, but can also be people (or even animals) with financial needs the creator would like to satisfy in the here and now.

The assets provide the financial fuel that drives the system. In theory, any form of property can be transferred to a trust, including the family home, working real estate, conventional market securities and shares in a family business or other closely held company.

With sufficient funding, trusts can operate for generations, even centuries after the creator is dead. 

Because the trust is a distinct legal entity from its creator, its lifespan is only bound by statute. While the structure will eventually dissolve when the assets are gone or the line of succession ends, immediate freedom from mortality ensures that a properly drafted trust will never pay inheritance tax or suffer through the grinding probate process. The assets simply pass on to the beneficiaries in a conventional financial transaction.

Many jurisdictions also give trusts additional beneficial tax treatment. In several states, trust assets can compound free from capital gains tax and distributions may see reduced income tax drag, extending the ultimate value the trust can provide the beneficiaries. 

For some trust creators, confidentiality is important. Adding a layer of trust ownership between creator and beneficiaries makes it more difficult for outsiders to discover exactly who owns a given property and how far their holdings extend.

This can become important in litigation and creditor disputes. Some states explicitly shield trust assets from personal liability, erecting a legal barrier against spousal division, compulsory inheritance and even nuisance lawsuits. In these scenarios, even if your heirs make unfortunate romantic choices, family property remains in the family.

Finally, a trust gives the creator the ability to make dynastic choices, guiding heirs beyond the point where human mortality makes face-to-face advice impossible.

The trust documents can, for example, reward certain educational or philanthropic decisions while providing only minimal support for descendants who fail to exert themselves.

With the right incentives, a trust can become the ethical backbone for generations as well as the financial wellspring that pays the bills. A lump sum inheritance creates a liquidity event. A trust ensures that the cash retains meaning.

Avoid The Pitfalls

While trusts have obvious advantages, these instruments are still only as good as the people who draft the documents and direct their operations. When the people make mistakes, trusts can diverge from their creators’ wishes. And when the people simply aren’t performing at peak levels, trusts fail to achieve their real potential.

It starts with you and the documents, and the failure is generally one of omission.

This is your golden opportunity to spell out the rules your trust will follow once it becomes an independent legal entity. The attorneys can provide guidance on what’s practical, but without your direct and detailed input, the trust risks becoming a generic way to delay the ultimate distribution of your assets a generation or two. That’s not a bad thing in itself, but it falls more than a little short of the intricate dynastic support that your “dead hand” could bestow on heirs who may not even be born in your lifetime.

The choice of trustee is also critical. Many trust creators believe that bestowing this role on a favored relative, colleague or family friend is an honor, more symbolic than structural.

In reality, running a trust well enough to satisfy the IRS and other regulators takes a lot of work and more than a little specialized expertise. The existence of an entire industry of corporate trustees — companies that can assign personnel to administer a trust — reveals that there’s a better way. 

Even the best individuals wrestle with conflicts, make mistakes, grow old and eventually die, leaving a void in the way your trust operates.

Naming an institution also eliminates interpersonal resentments and accusations of favoritism that we see again and again in families when one relative holds the keys to the collective fortune.

The institution can remain an impartial arbiter in disputes, serving the trust without creating even the shadow of picking sides.

On the other side of the coin, a trust company can get too big and institutional to carry out your directives. If you’re going the corporate trustee route, it’s critical to find an administrator that invests resources to make sure the account gets the human insight and personal attention it deserves. And since every corporate culture is a work in progress, make sure your trust lays out protocols for changing trustees if something goes wrong. 

Once again, the attorneys will instruct you on the details, but the objective here is simple: choose the company that provides the best fit in the h ere and now, while leaving the door open for future generations to challenge a relationship that’s gotten constrictive. (Along these lines, if you’re the beneficiary of an existing trust, there may be ways to reassign the trustee role if you aren’t happy. It’s always important to know your options.)

Finally, many trusts run to the letter of the rules but remain stunted because the trustees fail to manage the investments adroitly enough to weather market shifts, take advantage of strategic opportunities or simply stay ahead of inflation.

Too many trusts deteriorate faster than necessary because the person responsible for keeping the capital working isn’t familiar with modern portfolio theory or has a vested interest in parking the assets in expensive proprietary products that don’t deliver added performance to match their fees. 

It’s actually a little shocking that professional wealth managers only direct the assets in 42% of all trusts, leaving the majority to bankers, accountants and attorneys to invest.

After all, these families generally have relationships with investment experts they respect enough to handle their non-trust portfolios, so there’s no intrinsic reason to settle for less just because the assets shift into a trust’s control. The trust documents can allow the trustee to delegate investment management or even direct the trustee to follow the advice of a third party of the trust creator’s choice.

Families that don’t take advantage of this option force future generations to settle for less than the best outcomes.

Structuring The Conversation

When you’re ready to review existing trust relationships or create new ones, don’t be afraid to reach out to your current advisors for help refining your family’s dynastic plan.

Nearly half of all trusts are born when the creator — someone like you — takes the initiative and gets the process started.

The advisors were waiting for their clients to make the first move.

The conversation starts with you laying out your hopes and fears about what will happen to your money when you’re gone. It can happen any time, but generally there’s a trigger that serves as an occasion: retirement, a business sale or inheritance that unlocks a lot of liquidity as well as an unusual taxable event.

Sometimes the birth of a child or grandchild is what it takes to plant the seed of mortality and dynastic ambition.

Only you know how big of a financial impact you’d like to have on your heirs and what shape you’d like that influence to take.

Many people have reservations about making life too easy for their descendants. Others have a relative with special medical needs or character traits that make him or her a poor fit for having direct responsibility over inherited wealth.

Broad philanthropic interests may also play a role in the future you’d like to create.

Once your goals are on the table, your financial advisors will be able to determine the best route to achieving them.

In general, the people who manage your money now tend to have the most comprehensive insight into your current financial framework and how far it can stretch into the future.

They probably won’t draft the legal documents, but they’ll know how hard available assets will need to work for your dynastic plan to succeed.

They’ll also be able to weigh all the factors that decide if and when a given hypothetical trust arrangement makes sense.

Odds are good they’ve been wondering when you’d make the first move.

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