Trusts 101: What a Beneficiary of a Trust Should Know
One of the secrets to a good trust is an educated beneficiary. This is not to say that the best beneficiary is one with advanced degrees, but to advocate for beneficiaries that have been given the advantage of an opportunity to learn about trusts, their function, and how they relate to their specific family’s wealth. After years of working in this industry, this is something that we know for sure.
Beneficiaries who have been given an opportunity to learn about trusts, talk about them with settlors while they are alive, and understand their goals, are significantly better beneficiaries. They know what questions to ask and understand how to interact with trustees and other family advisors to ensure the continued success of their trusts. So, that leads us to how can you become a good beneficiary?
The key is understanding what it means to be a beneficiary. The term beneficiary itself is defined as a person or thing that receives help or an advantage from something. As a legal matter, it is defined as a third party who receives the benefit of property held by the trustee at the request of the grantor. In both cases, the term beneficiary is defined by the benefit it receives. To maximize his or her benefit, there are a few things that a beneficiary should know. This is the first in a series of articles to help beneficiaries understand trusts and what they offer.
Why Do Families Use Trusts?
Families utilize trust structures for a variety of reasons. Whether the settlor is the creator of first generational wealth or from a family with a deep-rooted history of wealth, the answer is often the same. The goal of most trusts is to employ wealth preservation strategies while also addressing a concern that knowledge of that wealth might somehow damage their family members. However, in highly successful trust structures knowledge has instead proven to be the key to success; on-going communication about family goals and the purpose of the trusts are key to maximizing their benefit.
Some of the key goals in setting up trust structures are:
Asset Protection
Trusts offer another layer of protection for the assets held within their structures. In states like Delaware, trust can be established with the settlor as a beneficiary of the trust. In these circumstances, so long as the assets are transferred from a solvent settlor into an appropriate structure, they will be exempt from creditors’ claims after a statutory period of time. In addition, non-settlor beneficiaries (often referred to as third-party beneficiaries) are given the ability to receive distributions from the trusts; however, the assets of those trust are not subject to the claims of their creditors as their interest is statutorily defined as a non-property interest.
Avoidance of Unnecessary Taxation
Individuals are subject to several layers of federal taxation such as estate and gift tax and generation skipping transfer tax. By placing assets in trust, it is possible to transfer property using federal estate and gift tax exemptions, as well a generation-skipping transfer tax exemption. Both of these exemptions currently allow an individual to shelter $13.61M of assets. These assets will continue to be protected from taxation from generation to generation inside the trust. Assets will continue to be subject to income taxation within the trust, although it is possible to structure the trust to avoid income taxation at the trust level and instead continue to have income tax paid by the settlor. This type of trust is known as a grantor trust.
Privacy
Some trusts are set up with the goal of retaining a family’s privacy with regard to their wealth. In some instances, it is to avoid the public disclosure of probate and in others it is to maintain privacy as to beneficiaries during the settlor’s lifetime. In states like Delaware, the creation of a trust is a private matter. It does not require public disclosures or registration.
Consolidation of Wealth Management and Consistency of Asset Consumption
By contributing assets to a trust, an individual can consolidate the management of wealth into one team. Whether it is through a trustee alone, or coupled with an advisor in a directed trust, it is one team of professionals working for the good of your family. Knowledge of the family’s values, the planning, and trust law can be communicated to the team and implemented. In the context of a trust, an independent trustee also provides consistency of objective decision-making with regard to beneficiary distributions. In addition, underlying businesses can be managed and held in perpetuity through the trust.
Relationship with the Trustee
Another important aspect of trusts is the relationship between the settlor, trustee, trust advisors, and the beneficiaries. Understanding the role of a trustee can help set beneficiary expectations and simplify communication amongst the parties to the trust. When setting up a trust, settlors often have a goal of maintaining as much flexibility as possible and empowering the beneficiaries. To this end, many trusts give beneficiaries the power to remove and replace trustees and other fiduciaries. This power is meant to allow beneficiaries to choose the type of trustee that works best for them.
Type of Trustee
The type of trustee can significantly affect the manner in which a beneficiary interacts with the trustee. Some trustees are full service, meaning that they handle all matters of investments, distributions, and overall trust administration. Others utilize the more flexible directed trust structure that allows a trustee to be solely administrative, or administrative as well as responsible for other trustee functions, such as exercising distribution discretion, but also includes advisors who direct the trustee as to specialized activities of the trust such as investments.
A trustee can also be either an individual or a corporate trustee. Corporate trustees are typically chosen due to the expertise that they bring to the administration of the trust, but they also provide longevity and continuity. If a particular state has beneficial trust laws, using a corporate trustee can also provide settlors with access to specialized trust jurisdictions. Individuals can also serve as trustees and can bring advantages such as personal knowledge of the planning and the parties to the trust.
One word of caution: it is often a bad idea to have a close family member serve as trustee of their siblings’ trusts. This is not because they are not kind, but because while siblings may be close, the introduction of financial issues and decision making can prove stressful for the best relationships. Placing one sibling in charge of another’s trust removes a layer of personal privacy and can put them in a strained or uncomfortable relationship. No one wants to fight about a distribution request over Thanksgiving dinner.
On-Going Administration
Trustees are responsible for the centralization of information regarding the trust. This means that they are responsible for ensuring that accountings are accurately maintained, and income taxes are filed in a timely manner. The trustee must be aware of all aspects of the trust’s administration. As the hub of trust activity, they speak with advisors, beneficiaries and other professionals to coordinate activities in a manner meant to facilitate the best interests of the beneficiaries. Corporate trustees are also responsible for regular regulatory review by state and federal administrative agencies to ensure the highest standards of trust administration are maintained.
Some trusts, known as silent trusts, are written to delay beneficiaries’ knowledge of the trust for a period of time. This might be due to the beneficiary’s age, to address privacy concerns of the settlor, or a variety of other reasons. During these periods, representatives known as “designated representatives” are appointed to ensure that someone is standing in the place of the beneficiary and receiving statements, tax information and other information about the trust. Designated representatives serve in a fiduciary capacity, which means that they are charged with looking out for the best interest of the silent beneficiaries.
At the end of the silent period, trustees are responsible for ensuring that the beneficiaries are aware of the trust. At that point communication switches to trustee-beneficiary. Trustees are able to communicate directly with beneficiaries, available to answer questions about the trust, and facilitate distributions and other trust transactions. In many cases, trustees are also able to provide beneficiary education.
Distribution Requests
Trustees are regularly given discretion over distributions to beneficiaries. There are many reasons for this that range from tax planning to objectivity. In some instances, one of the goals of engaging a corporate trustee is ensuring that there is an independent decision maker able to determine when to make distributions to beneficiaries.
From a tax planning perspective, this allows a more flexible distribution standard as a corporate trustee will not generally be deemed to be controlled by the settlor or his/her family. This independent action provides a separation between the settlor as the donor of the original gift to the trust and the decision to distribute funds to beneficiaries, thus preventing the trust from falling into various tax traps.
Understanding the distribution process is important for a beneficiary. Knowledge of what types of distributions are acceptable under the standard outlined in the trust instrument, how to request a distribution, what documentation is necessary to provide, and how long the review process takes are all key components of beneficiary education. The more informed a beneficiary is with regard to these components, the better he/she is able to set expectations and communicate effectively with the trustee.
Accounting and Tax Information
The trustee is responsible for maintaining an accounting of all transactions involving the trust. This accounting is the basis for providing tax information to beneficiaries, preparing trust tax returns, and helping inform advisors in making decisions about the trust assets. Every trust is slightly different with regard to the frequency of providing beneficiaries with accountings. Some require them annually, some periodically, and others limit the provision of accounting information to specific individuals for a period of time.
Education
Corporate trustees also provide beneficiary education. Whether it be through broad-based educational programs or trust specific, many trustees have established programs. The goal is to provide beneficiaries with sufficient information to be able to understand the purpose of the trust, the relevant parties and their responsibilities, and how to best utilize the trust. Education is the key to a successful trustee-beneficiary relationship. With the current focus on Beneficiary Well-Being programs, there are many new opportunities available for beneficiaries to learn about trusts.
As you can see, the first step in establishing a positive trust relationship is creating open communication and a better understanding of trusts and how they work. Knowing who your trustee is, how they work, and what you should expect is at the heart of understanding your trust. Coupled with an understanding of why the trust was set up, what family goals are being achieved, and your part in the overall plan is the best way to set up a successful trust administration.
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.