Letter of Wishes: A Valuable Tool in Domestic Trust Planning
Creating a trust is a huge leap of faith for most individuals. It means trusting someone else to make decisions about the needs of the people most important to you. No longer can you determine whether your daughter should be given money to buy a house or your son given money to start a business from the assets used to fund the trust. In creating and funding the trust, you have given that responsibility to the trustee.
In many cases, this individual is a corporate trustee with policies and procedures to follow, an objective perspective, and specific standards to follow when determining who will receive a distribution and under what circumstances. The trustee has only your trust document, with all of the legal and technical language, to rely upon as guidance. There are words like health, maintenance, education and support. The legal definitions of these words may be very different than your own. That legal definition is what your trustee will be following, along with existing case law. Does that align with what you want? Are those the expectations of your family members?
In domestic trust planning, settlors have long been faced with these concerns. When the trust is drafted, they are told that there are very specific words that must be used to achieve estate planning goals, with definitions that may not fall within the settlor’s comfort zone. How can a settlor become more comfortable that a trustee truly understands his or her family, their needs, their relationship?
While the solution has long been used internationally, only recently have US families begun to utilize a special document meant to provide additional guidance, information about beneficiaries, and a better understanding of the settlor’s relationship with the same. This document is commonly referred to as a letter of wishes.
What is a Letter of Wishes?
The letter of wishes is a document drafted by the settlor, either contemporaneously with the execution of the trust or later, which communicates information about the family’s values, insight into individual beneficiaries, and the trust’s purposes not found in the trust document. It is a non-binding document, meaning that the trustee is not obligated to follow it in the same way that it is a trust; however, many trustees value its content as a glimpse into the settlor’s true intent in creating the trust stated in simple terms using common, more natural language.
While it cannot modify the terms of the trust, it can provide background and additional information about the family and its values that was not able to be included in the trust document itself. It can provide hypotheticals as examples, provide additional information regarding the settlor’s values and personal definitions, and inform the trustee of at risk or vulnerable beneficiaries.
Important Considerations for a Letter of Wishes
While quite flexible as to its contents, the letter of wishes walks a fine line between providing insight and providing direction. It is important that it is a resource and not as a directive to avoid negative estate tax consequences under IRC Section 2036(a). This section of the Internal Revenue Code contains a trap for settlors who try to retain too much control over monies placed in a trust.
Its specific language indicates that any “property in which the decedent [our current settlor]… [had] a right, either alone or in conjunction with [another person] to designate the person who shall possess or enjoy the property or the income therefrom” may be included in that individual’s taxable estate. For this reason, it is important that a settlor not attempt to control the trustee through the letter of wishes. The trustee’s decision-making must be independent and the letter taken as one of several items to be considered when making a discretionary decision about the trust.
When creating the trust, the settlor ceded control of the trust assets and decision-making with regard to those assets to the trustee in order to properly complete the gift to the trust. Any retained authority, absent that expressly permitted by state or federal law, would make the gift instead incomplete and subject to estate taxation.
To avoid this result, it is important for a settlor to:
- Expressly state that the letter of wishes is not binding on the trustee;
- Be sure that it is clear that the letter is intended solely for the purpose of advising the trustee and providing guidance; and
- Avoid any language which could be used to create an enforceable right in a beneficiary where the trust is expressly discretionary.
This concern does not undermine the significance of the letter of wishes. Adhering to settlor intent is paramount to a trustee when exercising its discretion, especially when considering distributions to beneficiaries. Any information that can provide insight in that regard is considered. The difference is that the letter of wishes is used as part of a broader process of independent decision making by the trustee. Its value is significant, but it cannot be directive in nature.
How to Draft a Letter of Wishes
To guide a settlor in drafting his or her letter of wishes, it is important to ask difficult and defining questions. Some prefer to provide a series of questions on topics such as (1) family legacy and understanding of wealth, (2) what does it mean to be productive, (3) what should be considered maintenance and support, (4) how do you define family, (5) how do you define education, and (6) what medical care is necessary and what is simply a want. Below are some sample questions:
- Family: When considering who to include as a beneficiary of your trust, how do you feel about the inclusion of stepchildren, adopted children, children born out of wedlock? Would you want to include surviving spouses of your children or same sex partners when the blood-related family member is deceased?
- Productivity: Would you like your wealth to support family members in non-income or low-income producing role? Do you expect family members to give back to society with their talents, efforts, or financial resources?
- Education: What is the role of education in an individual’s development? Is it for the sake of learning only or strictly to prepare an individual for a career or vocation?
- Medical Care: Do you want to include vacations meant to relieve stress and tension of daily life? Do you want to include cosmetic surgery or gender reassignment?
- Maintenance & Support: To what extent should the ability to make gifts to charities, stepchildren, partners or a family member’s individual investment be approved? Do you want trust assets to be used for “life events” such as weddings, bat mitzvahs, graduation parties?
If you do decide to write a letter of wishes to assist the trustee in understanding your thoughts and intent in creating the trust, it is important to understand how and when it will be used. The trustee will likely include the language contained in the letter as one of several points of information included in its discretionary decision-making process.
Since letters of wishes are fairly new in the US, there is not a lot of existing case or statutory law governing when the letters will be viewed by someone other than the trustee. Internationally, beneficiaries are not automatically entitled to the disclosure of a letter of wishes. Decisions surrounding this topic seem to be based upon a desire to protect any sensitive information they contain. The exception to this rule is when a trustee has been accused of acting in bad faith.
The letter of wishes can be a powerful tool for families to convey key information to a trustee charged with caring for his or her family. The key is understanding both their power and their limitations. With the rise of dynastic trusts and the repeal of the rule against perpetuities, trusts are lasting longer. The letter of wishes may be the perfect way to convey your family’s values to future generations.
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.