Wealth advisors and their clients spend significant time and resources engaging in lifetime wealth transfer planning, often using irrevocable trusts that will defer beneficiary distributions. This planning typically focuses on minimizing estate taxes and protecting the assets from financial and legal risks such as mismanagement, imprudent spending, creditors and divorce.
Often lost in the plan’s technical, tax and legal construct, however, is one basic question: When do you want the trust beneficiaries to begin receiving information about the trust and its assets? Note, this is a completely different question from the one about when the beneficiaries should start receiving trust distributions.
Clients may not understand that under state trust law, trustees generally have a legal duty to provide this information to qualified beneficiaries. The clients may assume that beneficiaries would not get the information before trust distributions actually begin, which could be several years after the trust is written. Or clients may assume that they can simply instruct the trustee not to tell the beneficiaries until they are “ready.”
These clients may get an unhappy surprise, then, when they first learn that the beneficiaries have rights and learn it after the planning has been completed. For example, assume a client creates an irrevocable trust for his two children (ages 18 and 20) and funds the trust with $5 million in marketable securities. The client may not want his children to know about the trust or to receive their trust distributions until they graduate from college and establish themselves in a career (say, when they are age 35 or so.) There are practical reasons for this. (A child might say, “Why study or work? This trust statement says I’m rich!”) But even if the children have limited or no current trust distribution rights, the trustee nonetheless may be required under state law to send them annual statements detailing the trust holdings and values, which could end up inhibiting the children’s career ambitions anyway and frustrating the client’s intentions.
Attempting to fix this problem after the trust is funded may not work either and could cause significant aggravation and rack up fees. If the children receive their first trust statement before the client is aware of the problem, then it is too late. If the client learns of the problem before that point, it could require significant time and attorney’s fees for him or her to amend the trust so that the beneficiaries don’t receive statements (which could be done by decanting a trust to a different one, through a private settlement agreement or through a judicial modification).
For advisors, the lesson is clear: The time to discuss the client’s trust disclosure preferences is early in the planning process.
Beneficiary Information Rights
Under the Uniform Trust Code (UTC), adopted in 31 states, as well as common law, a trustee has the duty to keep beneficiaries reasonably informed about the trust administration and the facts necessary to protect their interests. This includes providing the beneficiary with an annual trust accounting statement and, if requested, a copy of the trust. While the trust document can restrict the beneficiary’s information rights in some respects, beneficiaries generally must be given the required information when they reach age 25. The specific disclosure requirements of the state law must be checked, however, since many states have diverged from the UTC provisions. In most states, advance planning will be required to meet the client’s disclosure preferences.
Why Restrict Information Rights?
A client may have well-founded reasons for not giving the beneficiary information about the trust. The beneficiary may be young or immature about finances. The client might also be afraid of hampering the beneficiary’s career drive and self-motivation. Or the client might worry that the beneficiary will have developmental problems or substance abuse issues or worry about his or her privacy and safety.
The advisor and client should have a candid conversation about the specific reasons for non-disclosure. If the reason is the beneficiary’s current age and inexperience, that will become less important as the heir matures. The advisor can then design a trust that would cause the disclosure to apply once the beneficiary reaches a defined age or station in life. Conversely, if the beneficiary has developmental or behavior issues (such as substance abuse problems) that can’t be cured with time, then a more permanent non-disclosure structure may be needed. Because beneficiary rights differ by state, the choice of state law governing the trust may be an important trust design consideration. For example, Delaware and South Dakota provide significant flexibility in restricting beneficiary information rights.
‘Silent Trusts’: Restricting Information Rights
Many states’ trust laws allow some version of a “silent trust,” which gives the beneficiary no right to trust information. The client’s applicable state trust law must be reviewed to determine his or her options. In certain states, the trust document may specifically waive the trustee’s duty to keep beneficiaries informed or the trust settlor may provide a separate written notice to the trustee indicating the same. Other states opt for an approach in which the trustee gives the required information to a third party named by the settlor or trust protector instead of the heir—to a surrogate or designated representative.
By using a third party to receive the trust information (perhaps an older family member or professional advisor), the client can prevent the heir from learning about the trust’s existence until the appropriate time. There may be a time limitation on the nondisclosure period—it may last only through the settlor’s lifetime or after so many years. In more flexible states, the nondisclosure may continue for as long as allowed by the settlor or a third party, such as a trust protector.
Disadvantages To Silent Trusts
Although silent trusts may accomplish client objectives, there are drawbacks. Beneficiaries unaware of a trust’s existence or without access to trust statements would be unable to monitor the trustee’s activities and protect their interests. Furthermore, the beneficiary and trustee would be unable to communicate about the beneficiary’s financial needs, risk tolerance or changes in circumstances.
Also, if the beneficiaries are not provided an annual statement or accounting, the trustee could face an open-ended statute of limitations for fiduciary liability claims. The time period in which to bring such claims typically starts after the beneficiary is aware of the trust and the trustee’s activities. Some states attempt to alleviate this concern by having the trust information delivered to a beneficiary surrogate or designated representative (who may in turn have fiduciary liability for failing to monitor the trustee’s activities.)
Advisors representing both the settlor and the beneficiary may have conflicting ethical duties or at least be placed in a difficult situation when the beneficiary eventually learns about the trust. For example, the same attorney may represent both the parent and children in the $5 million irrevocable trust example. Suppose one child faces foreclosure at age 30, something that could be resolved with assistance from the trust, but his father (the settlor) wants him to learn a lesson the hard way. Can the attorney adequately represent both parties in that situation? How would the child’s relationship with the attorney change when he eventually learns about the trust?
Finally, a silent trust is obviously no longer silent after the beneficiary begins receiving distributions. Could the trust keep information away from him or her after that? If it does, it could create an unhealthy relationship between the beneficiary and trustee, and potentially lead to litigation.
Critical Next Step: Preparing The Beneficiaries
The client may or may not have faith that beneficiaries will naturally gain the financial skills and discipline to manage the trust distributions as they mature.
Even for modest size trusts, the settlor and advisor should develop a communication plan when it is time to disclose. Expectations should be set about the purpose of the trust funds. Are they intended to pay for education and learning experiences, provide funds to purchase a home or start a business, supplement the beneficiary’s lifestyle or aid long-term wealth accumulation? The proverbial “walk around the block” between the settlor (or trustee or advisor if the settlor is unable) and the beneficiary to discuss these expectations can go a long way in avoiding problems.
If the trust is larger and the client reveals its existence to beneficiaries without adequately preparing them, they could suffer “lottery winner syndrome”—go on unhinged spending sprees, be exploited by hangers-on and be sold questionable “investments” by unscrupulous advisors. Financially immature and unprepared beneficiaries may end up in worse condition than if they had never inherited any money.
It will take more than a good communication plan to prepare the beneficiaries of large trusts. They will also need financial, investment and trust education to understand what they own and they will have to ask good questions to protect their interests. Wealthy families should also think from a broader perspective and develop a written mission statement for the wealth in their family. What is the purpose of the wealth? What are the family’s values and priorities with respect to it? Families carefully thinking through these issues soon realize that the wealth is about more than just consumption. They are often motivated by the values of entrepreneurship, philanthropy and legacy and they want to protect future generations.
The client can help the beneficiaries be prepared by using a consistent process implemented over time by an experienced advisor team. Preparing Heirs by Roy Williams and Vic Preisser is an excellent book to help families work through these important issues.
Final Thoughts
There are many perils facing those transitioning wealth within families. Professional advisors often do an excellent job on the legal and tax aspects of this planning. Through higher estate and gift tax exemptions and sophisticated planning, huge amounts have been transitioned into irrevocable trusts in recent years. The practical side of these wealth transfers, however, is often not adequately planned. Addressing the client’s trust disclosure expectations in the trust document and developing a plan to fully prepare the beneficiaries to receive the wealth will help balance the scales and avoid these many perils.
Scott Mahon is the managing director of wealth strategy at Ascent Private Capital Management of U.S. Bank.
