2012 CTC Newsletter

December 30, 2011

How do you get a trustee to take care of the ones you love like you would?


What every good settlor of a trust wants to know is how he (or she) can organize his trust so that it will take care of things like he would. After all, while the many tax planning, succession planning and other reasons to establish a trust are important, one of the stumbling blocks for settlors in actually putting the plan in place is always giving up control. Sometimes it is control over the assets, but, equally as often the concern is giving up control over the determination of how much money will be distributed and under what circumstances. Perhaps one of the best ways to ease these concerns is to help the settlor better understand what each of the possible distribution standards truly mean (when will they allow a beneficiary to access the funds of the trust and when will they not) and how they can best convey their intent to future trustees.

The first step is understanding what types of distribution standards are typically utilized and what they mean. The most common standard found in trust instruments is the ascertainable standard established by the Internal Revenue Service under IRC Section 2041 (b)(1)(A), “health, education, maintenance, and support.” While state statutes and common law determine the specific meaning of the terms within each trust, generally health and education can be understood to mean what they would appear to, medical care and treatment and ongoing tuition for the beneficiary; however, these terms have been interpreted somewhat more broadly on occasion. For example, the term health has been interpreted as including some things that a settlor might not typically expect such as gym memberships, golf club memberships, and extended vacations to relieve tension and stress. The term education has been interpreted to include all levels of education from grammar school to graduate school as well as support, both during the semester and between semesters, and any related expenses. These may or may not be the intentions of the settlor. Support and maintenance are often considered to be synonymous terms. Not limited to the bare necessities of life, these terms can be interpreted to include mortgage payments, life insurance, vacations and even the needs of family living with the beneficiary. Generally, it does not include enabling a beneficiary to make extraordinary gifts or to enlarge their personal estate.

While the ascertainable standard is most common, many other “unascertainable standards” are used as well. Some of these standards include terms such as comfort, benefit, welfare, and happiness. In some instances, settlors even opt to leave distributions in the complete discretion of the trustee, with no guiding principles to follow. For a settlor who is concerned that the trustee will exercise its discretion in the same manner that he would, perhaps the best means of ensuring this predictability is to incorporate language within the trust instrument expressly defining each discretionary term, especially if the settlor’s intent is different than the common understanding of a particular discretionary standard. Absent such a definition, the trustee will be left to conclude what the settlor intends from relevant common law principles, local statutes, and analysis of the facts and circumstances of the particular situation, which may not result in the settlor’s preferred outcome.

The second step is understanding what other means are available to a settlor in conveying their intent. The most simplistic means of conveying a settlor’s intent is to include a general purpose statement in the trust instrument. A general purpose statement is simply a paragraph (or maybe more if necessary) which provides the trustee with some background regarding why the settlor established the trust, what his intentions and goals are, and how he would like for the trustees to use the trust funds for those with a beneficial interest. It can be used to explain that a trust is set up with the intention of providing for a settlor’s children, but not spoil them; to support charitable endeavors and philanthropy, but, not slothfulness; to encourage education and using wealth to create opportunities rather than allow it to retard ambitions or inhibit achievement; or other facts specific to the settlor’s family.

Often, a general purpose statement is useful not only to allow a settlor the opportunity to express what he is attempting to achieve with the trust personally, but, also to educate beneficiaries about why the trust was established and who the settlor was; what were his core values. A general purpose statement can also be useful in providing for a hierarchy with regard to trust distributions, perhaps establishing the settlor’s desire that one beneficiary be considered first, and the other beneficiary’s needs to be deemed secondary. One benefit of a general purpose statement is the fact that it is included in the trust instrument itself. While it intentionally does not direct the trustee as part of the trust instrument, it does impact the trustee’s decision making. In addition, as part of the actual trust instrument, it is more likely to be considered by a court when reviewing a trustee’s actions as it would not be deemed extrinsic evidence as it falls within the four corners of the trust document.

Alternatively, a settlor may choose to express his intent in a separate document known as a “letter of wishes.” Similar to a general purpose statement, a letter of wishes is used to state the settlor’s intentions for the trust. While the letter of wishes does not bind the trustee, it is persuasive evidence of the settlor’s intent and thus useful in determining the settlor’s goals and preferences. In addition, another useful means of ensuring that the trustee’s distribution practices will align with the settlor’s intent is the use of a direction adviser or committee. The direction adviser can be given the power to direct the trustee, consent to distributions or simply consult with the trustee, dependent upon what is established within the trust instrument. Often, to ensure the maximum benefit of using a direction adviser, the settlor chooses a close friend or family member to fill this role; someone who is familiar with the family members for whose benefit the trust is established and the settlor’s relationship with each. This is particularly useful in situations where a settlor has concerns regarding substance abuse or addiction of a beneficiary. Someone close to the beneficiary (or his family) will likely have greater contact with the beneficiary and his family and is, therefore, more likely to know of problems and better able to assess whether a distribution to such individual would be beneficial or harmful. In addition, a close friend or family member will be more familiar with what the settlor themselves would have preferred under the circumstances.

A third means of conveying the settlor’s intent is to include prerequisites within the trust instrument which must be met prior to permitting distributions. This may mean anything from requiring that the trustee consider a beneficiary’s other available resources, consider their standard of living or even that the trustee obtains advice from experts prior to making a distribution to a beneficiary. The simplest of these is the requirement that a trustee consider a beneficiary’s other available resources. Often this is included in a trust where a settlor has a particular concern that the trustees limit distributions to essential needs so as to preserve trust assets over multiple generations or to ensure that a beneficiary is living the lifestyle that the settlor intended. Standard of living provisions are used to help the trustee ensure that the beneficiary continues to live in the manner that he or she had become accustomed to either at the time of the settlor’s death or at the time that the trust was created. The standard of living established at that time will most closely approximate that which the settlor intended. The use of experts is often used in determining if a particular type of distribution is appropriate, particularly in areas where trustees may not have the knowledge required to make the determination, such as a request for money to start a business.

No matter what a settlor’s hesitation when setting up a trust, the best approach for any trustee is to do as much as possible to understand the settlor’s intent. These techniques can be quite useful to a settlor in ensuring that his intent is as clear as possible. Knowing that the trustee is doing everything to understand his intent and providing the settlor with the opportunity to maximize his statements of intent both within and outside of the trust instrument may give a settlor the comfort that he needs to move forward with his trust planning. As with anything else, it is always good to know that although you are giving up control, things will continue to be taken care of as if you were doing it yourself.

Commonwealth Trust Company is pleased to provide this article as a guide. Commonwealth Trust Company is not engaged in the practice of law and is not providing legal advice by the provision of these materials. Commonwealth Trust Company recommends that clients seek the opinion of their attorney regarding the specific legal and tax issues addressed in this article.