Asset Transfer Strategies that Safeguard Your Legacy
As your family grows with marriage and children, it can change the way you think about the future of your assets. It can also bring into sharp focus any concerns you may have about the flow of your assets and how you can best protect your legacy.
It’s important to understand what terms you can write into a trust regarding the transfer of your assets to future generations, and the potential consequences of the terms you choose to include or exclude in your documents
When it Comes to the Language in Trusts, Less is Sometimes More
Whether you’re conferring assets during your lifetime or leaving them as an inheritance, drafting trusts with well-thought-out terms can ensure your assets end up in the right hands. You can write any terms or restrictions you wish into a trust, but it’s important to weigh the options between including a strict requirement versus leaving some flexibility for the trustee to exercise discretion. This is particularly true as the world changes, as what makes sense today may not make any sense 5 or 10 years from now, either due to changing tax law or changes in your objectives or the lives of your beneficiaries.
To reduce the chance of regret, it is often recommended that a trust be drafted with provisions that bestow trustees with discretion on distribution of income or capital to the beneficiaries. Sometimes referred to as discretionary trusts, these trusts tend to restrict the extent to which a beneficiary can make demands upon the trustee. They provide trustees with the freedom to make decisions on their merit and without any interference from the beneficiaries (and hopefully reduce the exposure to creditors of the beneficiaries).
If leaving full discretion to a trustee causes concern, there are some important items that can help with this, such as providing guidance to your trustee in a non-binding manner and ensuring that the right trustee provisions are included (language regarding successor trustees as well as who has the right to remove and replace a trustee).
Regarding the non-binding guidance, grantors can outline their general wishes with respect to the trust assets and how/when trust distributions should be made. Since the letters are non-binding, the trustee can use the letter to have a better idea of the values and objectives of the grantor while maintaining the right to ignore the guidance if that is in the best interest of the beneficiary. These types of circumstances could include:
- Holding back a distribution if a beneficiary develops an addiction
- Holding back a distribution if a beneficiary is being sued by a creditor
- Accounting for tax law changes and the impact of making a distribution or holding it back
In our view, a properly-drafted trust with a non-binding letter not only provides the trustee with freedom to make decisions, but also some guidance on what decisions to make.
Here are 3 topics a grantor may want to discuss with their attorney that could be included in their trust via non-binding letters:
- Prenuptial Agreements
Marriage is a business relationship almost as much as a romantic one. This dual nature and purpose has led to the increased acceptance of prenuptial agreements (prenups, for short) as a tool to protect a spouse’s financial interests. If you’re concerned about your assets remaining within your family (i.e. passing to your relatives, such as children, grandchildren and great-grandchildren), then a prenup can help with any possible divorce or separation.
You may choose to hardwire language into your trust that specifies a prenuptial agreement is in place for your married children before any distributions are made, or other requirements about how trust assets can be used with respect to your children’s lives and choices. Spelling out certain parameters can eliminate any ambiguity down the road, but be sure you work closely with your estate attorney and wealth advisor to understand the potential impact of these types of decisions. It is ultimately your choice how specific to make the language in your trust and whether it is binding or not binding on the trustee, but it is recommended that this decision be made with your attorney since it could have significant consequences if done incorrectly, such as unintended family resentment or financial/creditor exposure.
- Age-Specific Distributions
Grantors may also choose to hardwire language into a trust that requires distributions to the beneficiaries once they reach a certain age. Alternately, grantors could leave distributions to the full discretion of the trustee and outline their distribution wishes in a side letter. Assets that are placed in a trust for another party’s benefit are typically not considered to be property of the trust beneficiaries and therefore have a higher level of creditor protection in the event of a divorce. However, once a distribution is made to the beneficiary (or made available to the beneficiary if hardwired into the document), the assets are no longer protected and become part of the beneficiary’s personal property rather than part of the trust property.
- Business Investments
If your children are entrepreneurial, it might make sense to consider how trust assets are best used to support business ventures. One option may be to require your child to establish a business plan and provide funding to a certain point–whether through their own investments or with the help of an outside investor–before they can tap into their trust. This prerequisite, along with a cap on trust distributions, allows you to ensure the trust assets aren’t being used for incomplete ideas that may not last. The trustee could also choose for the trust to make the investment directly, rather than making a distribution to the beneficiary to make the investment, which would keep the assets under the control of the trust and potentially with a higher level of asset protection.
Regarding trustee powers, the key items to be mindful of include:
- Trustee succession
- Trustee removal
- Trustee appointment in the event of a vacancy, resignation or removal
These considerations are particularly true with discretionary trusts, since you’re leaving control to the trustee to use their judgment on how best to manage the assets and when to make distributions. A few items to consider are:
It’s all too common for a grantor to select a close friend or attorney to serve as successor trustee, but that friend or attorney is often the same age (or older) than the donor, so what happens when both the grantor and the successor age? Who should replace them on a trust that could last multiple generations? It may make sense for the beneficiaries to serve as co-trustees so they’re involved in the management of the assets. It may also be wise for a professional to serve with them to make sure the trust is being managed properly from a tax, legal and investment standpoint.
- Removal Power
Without removal power, a donor or beneficiary may be forced to work with an unreasonable trustee and may have no leverage to negotiate fees, asset management or distributions.
- Appointment Power
It’s typical for the donor to be able to appoint a trustee in the event of a vacancy or to plan for succession, but it is as important to consider who has this right after the donor. Keep in mind that the trust may last for multiple generations, so having some governance structure that works with an evolving world is important.
Optimizing Your Trust Performance
A trust is a vehicle by which your assets can be transferred to future generations, and it ultimately controls how your legacy is protected. Executing a trust should be a collaborative effort between your estate attorney and wealth advisor to ensure the distribution parameters are optimal for your goals, and reflect your intentions with respect to your heirs.
Your financial legacy is the culmination of your hard work, and represents a gift to your beneficiaries that will last long after you. Considering these different approaches to your asset distributions and trustee provisions will help ensure your legacy will be protected for future generations, and leave you with the peace of mind that your assets will be used the way you intended.