“From shirtsleeves to shirtsleeves in three generations.” This famous quote, attributed to Andrew Carnegie, is a fear present in many of our clients’ minds. For business owners in particular, worries about how to safeguard the wealth you have spent your life amassing for the benefit of your children and grandchildren is legitimate. You may be concerned about how to provide a lasting legacy while ensuring future generations contribute to society in a meaningful way and do not need to rebuild or establish themselves from scratch. Thankfully, there are several wealth and estate planning techniques you can employ to prevent or minimize the dissipation of family assets. For example, you may engage in pre-sale planning, transferring interests in your successful business to trusts for your children and more remote generations. If you have sold your business before starting the planning process, you may fund trusts with cash and marketable securities. Either way, as the creator or holder of your family wealth, coming to terms with the need to irrevocably part with some of those assets can be challenging. However, transfer tax and related future planning considerations are often compelling enough to overcome the inherent discomfort. Most likely, you have spent significant time analyzing these issues, decided that the potential benefits to you and your family far outweigh the difficulties associated with relinquishing control and established a trust or trusts for your children and more remote descendants.
Trusts, particularly when administered by an independent trustee, can provide a flexible framework through which future generations can be well provided for while still protecting the bulk of the family assets. The next and potentially larger issue you face is how to get your family to understand how beneficial trusts can be. This article sets forth some of the top benefits of a trust from the beneficiary’s perspective, including the establishment of a reliable income stream, protection from creditors, alignment of interests regarding business decisions and the ability to participate in future decisions related to trust governance.
Reliable Income Stream
Trusts can provide a consistent source of income. Knowing that funds are available and understanding the parameters for distributions can allay the concerns of a beneficiary unsure of how to plan for her future financial needs or fearful that her trustee will maintain too tight a hold on the purse strings. Among other approaches, you could establish your trust with a mandatory income distribution provision or provide discretion to make distributions for any purpose, with guidance to your trustee to consider an annual percentage distribution that is sustainable over the long term. While the amount and frequency of distributions will inevitably vary based on both your family’s needs and market conditions, creating a fairly recurring distribution structure affords beneficiaries flexibility in a number of ways. One such benefit is that it can provide the opportunity to enter into a rewarding but not otherwise lucrative career. Depending on your family values, this possibility may be of particular interest. For example, knowing that funds are available to supplement a salary that might otherwise be insufficient may encourage your child to pursue a career in the public sector, such as teaching or working for a charitable organization. Additionally, giving your child a sense of stability may be helpful in financial planning or preventing excessive and large requests from the trust for nonessential items. Thus, trusts can help establish budgeting techniques, and the trustee can guide your family toward a view of the trust as a lifelong support stream to supplement living expenses rather than a short-term cash cow.
Protection from Creditors
One of the most valuable benefits a trust can provide is creditor protection, particularly if your children have difficulty managing money or are not yet on sure financial footing. Trusts can provide beneficiaries protection – from themselves, from traditional creditors such as lenders and from less traditional ones, such as a potential ex-spouse should your child find herself in the midst of a divorce proceeding.
The fact that an independent party is making the decision of whether, when and how much to distribute generally keeps the trust safe from creditor attachment. The distributions themselves may be subject to claims, particularly for any amounts that comprise a mandatory distribution or over which your child can exercise a withdrawal right. However, most trusts provide the trustee with the discretion to pay either directly to, or on behalf of, the beneficiary. In such a case, essential items like rent or insurance premiums could be paid directly from the trust with little or no funds deposited with the beneficiary. Bypassing the direct payment to your child can both reassure her that her basic needs are met and prevent creditors from reaching the portion of the distribution paid directly to the service provider.
From an interpersonal perspective, if the bulk of your child’s assets are in a trust you have established for her benefit, it can either assist with, or obviate the need for, a premarital agreement. Trusts you establish for your child’s benefit do not need to be disclosed to a future spouse unless spouses are also included in the class of beneficiaries. If the majority of your child’s assets are held in an irrevocable trust, the conversation regarding what to do with her remaining assets or items acquired during the course of the marriage may be less contentious or largely unnecessary. It can also be helpful to establish a pattern of separate property by the trustee making trust distributions to a separate account in your child’s own name rather than commingling them with her other marital assets. In the event of divorce, assets held in trust are generally protected from the review of court and marital disposition, particularly where an independent trustee has been named and evaluates each distribution request on its own merits.
Alignment of Interests Regarding Business Decisions
If you transferred your business interest to your trust and it is still held in the account, having a single trustee hold the voting control can make ongoing business decisions easier. This may prove useful when you have named a trusted business associate as your trustee or trust advisor and your children are not yet old enough to participate in business decisions. They may also rest assured that the family business is in good hands and managed according to your wishes if they are not otherwise engaged in its daily management. When the time comes to sell, having the authority over decisions in the trustee’s hands can make negotiations easier, as it provides a single point of contact and, depending on the percentage interest held by the trust, can be the voice of majority interest.
Participation in Future Decisions Related to Trust Governance
Despite the protections afforded, often beneficiaries are uncomfortable with trusts because they feel they have little control over their financial situation or other important decisions with respect to their trusts. With the right drafting and clear expectations, some of these concerns can be tempered. On the financial independence side of the issue, your children can be given a number of options to allow some flexibility over the amount that is paid out of the trust, including an annual right to withdraw the greater of 5% or $5,000 of the trust principal. You could also provide, or allow the trustee to grant, the power to decide what happens with the trust principal upon the death of your children through a general or limited power to appoint.1 Additionally, each of your children could be given the option to serve as a co-trustee upon reaching a certain age or the ability to remove and appoint the trustee, within certain parameters. For example, while your child would not be able to participate in distribution decisions for payments to herself, she could participate in investment decisions, or you could give her the power to remove a trustee so long as the successor she names is also an independent, unrelated party.
While initially daunting to grantors and beneficiaries alike, trusts have many features that are attractive and helpful regardless of your relationship to them. Understandably, deciding how to broach these topics with your family can be a puzzle, particularly knowing where to begin. At Brown Brothers Harriman (BBH), we are committed to helping our clients navigate these challenging conversations. Next generation education is a critical component to ensuring that your financial, philanthropic and general family goals are understood and can be carried out by future generations. For assistance with planning these conversations, please contact your BBH wealth planner, relationship manager or trust officer to discuss how to frame these issues.
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© Brown Brothers Harriman & Co. 2016. All rights reserved. 2016.
1 A power of appointment allows the holder to decide who receives the assets, usually including whether they should be distributed outright or remain in further trust. A general power allows the holder to appoint to anyone, including herself, her creditors, her estate or the creditors of her estate. Any assets subject to a general power of appointment are includible in the holder’s estate for estate tax purposes. A limited power excludes those four categories and allows distribution to a class of beneficiaries defined by you as grantor, usually to the beneficiary’s descendants or your descendants.