Tax-driven estate planning is too often divorced from the purposes of intergenerational wealth. While lifetime gifting to irrevocable trusts offers many benefits, including reducing gift and estate taxes and increasing creditor protection, the long-term purposes of the assets being gifted ought to be considered at the same time. How the donor (that is, the creator of the trust) wants the trust assets distributed – when, how much, and for what purpose – is a complicated set of questions that requires significant reflection.
Most modern-day irrevocable trusts provide a purely discretionary distribution standard, meaning that the trustee has the discretion to distribute any amount at any time to any beneficiary so long as the trustee deems such distribution to be advisable after considering their fiduciary duties. This standard is preferred by many estate planners and professional advisors because it provides significant flexibility, allowing the trustee to react appropriately to future unforeseen circumstances while maintaining the creditor protection so many donors desire.
Discretionary trusts, however, allow donors to postpone thinking about the purposes of the trust. Once the trust is drafted, signed, and funded, donors are often ready to take a break from estate planning, rather than doing the hard work of reflecting on their values and how they might envision the future use of the trust assets.
Here is the good news: If you set up a discretionary trust and would like to share your intentions for the trust and its beneficiaries, it’s not too late! In this article, we explore how you can guide a trustee, even after the trust has been created, to help ensure the administration of your trust is rooted in purpose.
Articulate Your Values
There are numerous tax and financial benefits to putting assets in an irrevocable trust, but being able to articulate the values that motivated you to create the trust in the first place is just as important. Conveying the purpose – the why – behind a trust helps future generations understand the planning and thinking of those who came before them and will help them make informed decisions when dealing with the trust as a beneficiary.
As BBH Senior Advisor Ellen Perry writes in “A Wealth of Possibilities: Navigating Family, Money, and Legacy”: “Strong, healthy families generally have well-defined, clearly articulated, life-affirming values. In such families, values are discussed openly, lived enthusiastically, constitute the organizing principle of family life, and define the nature and quality of many family relationships.”
Core values are big ideas – they are not a prescription for how beneficiaries should live their lives. For example, one family might value family relationships and connection between siblings and their children. This is a core value that the trust could support by using assets to pay for an annual family retreat or hiring a family historian. Another family may choose education as a core value and recommend that the trustee prioritize distributions for that purpose, whether that is paying for tuition or enabling a beneficiary to move to a new place and immerse themselves in that culture for some period of time.
The ways in which these values are experienced will differ among family members and generations and will change over time. Each generation will (and should) find its own way to embrace and shape the family’s values. Focusing on high-level core values instead of less consequential preferences will go a long way in helping the trustee evaluate distribution requests now and after the donor’s death. (Keep in mind that some trusts may continue in perpetuity so long as assets remain, so think long term!) It will also help beneficiaries understand the purpose of the trust and how it fits into their lives, including their relationships with their spouses, partners, and children.
Keep Your Trustee’s Perspective in Mind
When thinking about the trust’s purpose, it is important to consider the role of the trustee. An “independent” trustee is required for many irrevocable trusts. This may be a family member, professional advisor, or corporate trustee. This person or entity will be subject to fiduciary duties and faces a variety of considerations when presented with a distribution request.
First, the trustee must confirm whether the requested distribution is permissible according to the terms of the trust instrument. This article has focused on discretionary trusts, but there are many different types of trusts. While many trusts are discretionary, some require the trustee to follow a standard, such as limiting distributions for expenses relating to health, education, maintenance, and support (the HEMS standard), or direct that distributions are only permitted for specific purposes, such as education, or when a beneficiary reaches a particular age or milestone.
If a distribution request is within the permissible boundaries of the trust instrument, the trustee may need to determine whether the trust in question is the best source of funds to satisfy the request. Some trust instruments require or suggest that a trustee take into account a beneficiary’s other resources when evaluating requests. This often involves tax considerations and may result in the trustee advising that another source of funds be exhausted before turning to the trust in question.
The trustee will also need to consider the interests of the other beneficiaries (if any) and those who will benefit from the trust after the current beneficiary or beneficiaries pass away, referred to as “remainder beneficiaries.” Depending on the trust’s terms, the trustee may have a duty to preserve the trust assets as much as possible for the next generation and beyond. This may restrict their ability to make discretionary distributions to current beneficiaries.
Finally, assuming all tax and logistical conditions have been satisfied, the trustee will evaluate whether making a distribution is in the beneficiary’s best interests. One benefit of holding assets in trust is creditor protection; so long as assets remain in an irrevocable trust, they are usually well protected from creditors, including a divorcing spouse. The trustee will want to confirm there is no exposure to creditors who may reach the trust assets once they are distributed to the beneficiary.
The trustee may also evaluate the beneficiary’s own financial situation and ability to manage large sums of money on their own. If the trustee has concerns about the beneficiary’s ability to handle a distribution, they may apply trust funds directly for the beneficiary’s benefit. For example, the trustee may be able to use trust assets to pay bills on behalf of a beneficiary or purchase an asset for the beneficiary to use, such as a house. If the distribution request is for something that will be an ongoing expense, such as starting a business or buying a home, the trustee will want to make sure the beneficiary has a plan for supporting those ongoing costs.
Put Pen to Paper
Once you’ve defined your family’s core values and understand the distribution standard of the trust, you can prepare a letter of wishes to the trustee. This letter, while nonbinding, can provide invaluable guidance to a trustee of a discretionary trust. It can be drafted after the trust is created and may be modified in the future as your family or its circumstances change.
Donors often delay (or forgo) writing a letter of wishes because it is hard work and challenging to begin. Frequently, clients will ask for sample letters so that they may have a starting place. While a template can be helpful, it is important to start with your own values when preparing the letter. Put yourself in the shoes of a beneficiary or trustee of a discretionary trust who is wondering what the trust is for: What types of distribution requests are acceptable? Are there particular distributions that should be off limits or would make you regret funding the trust?
When the trust is created, the beneficiaries might be too young to need or care about the trust funds. However, young beneficiaries grow up to have financial needs (or desires) and make requests of the trustees. Many donors begin to reflect seriously upon their intent and the purposes of the trust when distributions or requests for distributions begin. This may cause panic but can be used as a catalyst to think deeply about the purpose of the trust and put those intentions in writing. If a side letter exists but now seems stale or incomplete in light of a beneficiary’s request, an evaluation of that request can allow donors to take a new perspective and refresh the letter without having to revise the trust, which is not always an option.
While it is impossible to contemplate every distribution request that your trustee may face in the future, you can help prepare them for difficult decisions by providing guidance on how you would evaluate certain situations. For example, consider:
Do you want to ensure harmony among siblings, and is equal treatment necessary to do so?
If a beneficiary lives in an expensive part of the world, should the trustee take that into consideration to make larger distributions than you might otherwise consider prudent?
Should a beneficiary’s access to other resources (earned or inherited) be factored in when considering distribution requests?
How do you feel about one-time distributions vs. expected or repeated distributions that beneficiaries may come to rely on?
Most donors are clear that they do not want their trustees to facilitate a frivolous lifestyle but do want to provide for education, medical expenses, and emergencies. However, most distribution requests fall in the murky middle. While you do not want to bind the hands of your trustees to manage future circumstances as they have discretion to do, painting a picture of how you hope the trust assets are used will be valuable to them and to the beneficiaries down the road.
For all these reasons, it is important to be intentional when working with your estate planning team to create a trust and draft a side letter of wishes. Choosing the right trustee (and having a proper succession plan) who will carry out your wishes and help ensure the trust is used to support and perpetuate your core family values for generations to come is also critical. Reach out to a member of your Brown Brothers Harriman team if you are interested in learning more about our values-based planning tools or would like to get started on creating or modifying a side letter of wishes.
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