Understanding the role of trusts and how modern trusts can be designed for flexibility

Welcome to Future focused sophisticated Estate Planning with Wiggin and Dana. The show where CPAs, insurance professionals, investment brokers, trust companies, CFPs, and more confirm up on their understanding of estate planning strategies so they can better guide their clients to make wise decisions with their legacy. Future Focus is hosted by Erin Nichols and Michael Clear, partners of the private client services department at Wiggin and Dana. Subscribe to future focused sophisticated estate planning on your favorite podcast platform and share episodes with your clients. And now here are your hosts, Erin and Michael.

So on the podcast today we're talking about one of our favorite topics. It happens to be one that I think there's a lot of misconception about. So trust planning in the door, that is what clients want to know about.

Yeah, and I feel that oftentimes our clients come in with a misunderstanding or misconceptions relating to why we use trusts in our planning and really what purpose they serve. And maybe they have an old memory of trusts and how a trust that was formed by a grandparent was used and often have a strong dislike what those trust terms are. So our hope is our conversation today will dispel some of that misunderstanding and make trust a little more understandable to our advisor friends and our clients. As we think about this planning.

And I often find that across the board, not just with clients but people in the industry, the most common misconception is that trusts are only for ultra high net worth people and they're not necessarily something that middle net worth people need to be thinking about. But really, I mean there are three most common reasons why we plan with trust, and at least one of them is important to all networks. Right?

Absolutely. I think if we look at those three reasons, I'd say number one is tax planning. Number two is management of the assets for a beneficiary. And that third reason is often some sort of asset protection or protection from a divorcing spouse. And as we have conversations with our clients about planning in general, often one of those, if not multiples of those reasons, will come out as a reason why we should further explore the use of trusts.

You know, and it's funny because as soon as we mention creditor protection, I often get feedback like, my descendants aren't going to file for bankruptcy, or they're not going to have creditor issues without realizing that divorcing spouses are the most common creditor.

Right? Lots of clients will tell us whether it through an interview or a conversation that they're not concerned about credit or protection for whatever reason. We can point out if the kids are in, you know, doctors or lawyers, they might be in an industry that's more likely to be sued if a car accident can happen, which creates liability. But many clients, when you ask them if they want to protect their assets from their child's divorcing spouse, we'll say absolutely, they'll want their child to have as much control of their inheritance as possible, but they'll also want that divorcing spouse protection,

Right? And we like to make the impossible happen and give them both. So a way to protect assets that doesn't feel like the clients are locking up the inheritance because they don't trust the child or something like that. So once we've gotten people on board with the idea of trust planning, do you go right for a specific type of trust or do you sort of allow them to walk you into what they're interested?

It really comes down to how that conversation's going with the client and where we're coming from. And sometimes we use the idea of a spectrum, a spectrum of distribution options for your beneficiaries. And you have to remember the beneficiaries could be minors, they could be in their twenties, they could be in their sixties. The age is almost irrelevant. When we talk about the ultimate goal of that divorcing spouse protection or that asset protection, you think of that spectrum of distribution possibilities. And one is giving it to a child or a beneficiary when they're 18 years old. Terrible idea. The other end of that spectrum is putting it into a lifetime trust. In Connecticut, we can have that trust last for 800 years. People often won't say they want that, and I could say can only distribute in very specific situations or it only kicks out the income. That's generally not where we're going. We don't go to that end of the spectrum. We come somewhere within that 18 year old distribution and using lifetime trusts to capture that. Either the tax planning that we talked about, the management of the assets or the divorcing spouse asset protection feature.

And I think in general we're able to get people to agree that 18 is not the right age to be getting any amount of money outright. But some people are comfortable with a younger age, maybe getting some at 30, some at 35, the balance at 40, that's a common,

I feel like a lot of our clients will say, I don't want to rule from the grave, I want the child or the beneficiary to have as much control of the assets as possible. And they'll like that age distribution idea, they gives them a piece at a young age. If they screw it up and lose it all, they get another tranche. So they get three T tranches, three tries at it, and they feel very comfortable with that idea. So what's one of the drawbacks of that idea?

Three bites of the apple. I like the way you described that a lot. I think that the big drawback there is that every time there is a withdrawal or a distribution power, you're subjecting that portion of the trust to a potential creditor claim. So if you've structured an age-based trust in that 30, 35, 40 setup, then if the child gets divorced at 36, then potentially two thirds of the inheritance of the child is brought in to the divorce case and is factored in when they're splitting up assets.

It's often an easy question back to the client, do you have any friends that got divorced post pick the age of the distribution post 35 post 40? Often the answer is yes. So they say, okay, how can we achieve that goal of trying to protect these assets, but also knowing that we're okay with them having more control? How can we help a client do that?

And I think that's really where we sort of move toward the middle of that spectrum that you talked about. Because structuring a trust as a lifetime trust still gives it some pretty good asset protection that feels like it's, you know, a pot of money away from creditors. But then we look toward the administration of the trust itself. So for clients who want their children to be involved, for example, they could have that child serve as a co-trustee of his or her trust, which is often something that people like because they get involved in the investments and the portfolio management aspect of it,

It's about control and it's about educating the beneficiaries the parents have selected who that top line trustee is, who that first person is, and let's just go with that situation where we're planning for that 20 year old and we'll say when that child hits 25, they can become a co-trustee. So you've given them a little more access to the trust, maybe not access to the actual funds, but they're going to have a say in how the trust assets are invested. They have a seat at the table that can't be taken away from them. So that's definitely one of the strategies that will encourage clients to use when they want their beneficiaries to be more involved in the in the trust administration. Sometimes we'll also give the power to remove trustees.

And I would think of the power to serve as a co-trustee as sort of one step on the spectrum if they're comfortable going another step away from asset protection as giving that child the ability to remove and replace trustees. This can be incredibly important for clients because they never want a descendant to be stuck with someone that isn't doing a good job as trustee or isn't serving the interests of the beneficiary. But as one could assume it's a power that could be abused, we certainly can put limitations on it. It's not uncommon to see a provision that limits the number of times a beneficiary can exercise that power. But like most things that we talk about today, it's the way we draft it, but then very much about how the powers are used and how the trust is administered

When you're looking at it from that asset protection standpoint. But if we're looking at that client who's walked in and said, you know, I'm okay giving my child all of the funds at 40, and then we've convinced them to go farther in the spectrum to provide the possibility to have better tax planning from a generation skipping perspective or the possibility of later creditor protection, that ability to serve as trustee and then later on that ability to remove the trustee is that second level of control that you're able to give the beneficiary. So often we delay it, serve a trustee at some age, become able to remove the trustee at a later age. Sometimes you'll define the class of who the next trustee can be.

Yeah. And that certainly can help allay some concerns with an abuse of that remove and replace power because you can limit the class of trustees that are eligible to serve. And typically, what we see is that it would be limited to a professional trustee where that term is defined as a C P A, a financial planner, a lawyer or a bank or trust company. They could also, and this would be the case for anyone using this power, you would draft it in a way that they couldn't appoint someone who was related or subordinate to them. We're all familiar with those buzzwords from the code, but certainly you can define the eligible class of trustees in whatever way you thought was appropriate.

So we have that client who likes the idea behind the divorcing spouse protection, but also likes the idea of giving the kid control. So we've given that child the ability to serve as trustee at 25, we've given them the ability to fire the trustee at 30 and then pick a professional or another trustee. Maybe we're moving away from the assets protection, but that's okay. What else can we do if we've convinced them that using a lifetime trust is helpful, can we structure it so that the child at some point can be their own trustee?

Yeah, and this is where it gets more interesting, at least for practitioners like us who are in now a state that has adopted some form of the uniform trust code because presumably serving as his or her own trustee would involve that beneficiary having the power to make distributions to him or herself. And because the beneficiary is obviously an interested party, we won't be allowing them to make distributions for any purpose, but as allowed under the code, a beneficiary could make distributions to him or herself under an ascertainable standard. So health, education, maintenance and support. And the reason why I a jurisdiction like Connecticut is that prior to 2020 in our enactment of the U T C, putting a distribution provision like that in a trust made the trust susceptible to creditor claims because there's an ascertainable interest. Divorce courts could factor in some calculation about what that ascertainable interest is and add that to the pot of money to be divided. Now under the U T C, more people are getting comfortable with the idea that that ascertainable standard does not attract creditors. It does not subject the trust assets to creditor claims, which sort of provides a whole new world for some of this lifetime trust planning.

Absolutely. I think two points on that. One is if you had a client, the opposite client in what we've talked about who walked in and said, I want absolute asset protection, we probably would not include in health education, maintenance and support standard. The beauty of that Connecticut provision is that we can set up for the other client for the one who wants their kids to have as much control as possible, but still benefit, have the possibility of benefiting from the divorcing spouse protection, the generation skipping tax protection and some control. That provision gives us more flexibility so that client can become trustee at 25, can fire the trustee. I'm making these ages up, right? We have that conversation with the clients well, so become a trustee at 25, fire a trustee at 30 and be their own trustee at 35. And that allows them to have more control of the assets, but also at least maintain the tax planning and have opportunities for planning later on. My favorite analogy with trusts is a trust is like a tube of toothpaste. While the toothpaste in the tube, it's protected and once it comes out it's not protected. And have you ever tried to put the toothpaste back in?

Sure haven't.

You haven't tried or you haven't been successful? I haven't... Well, if you tried, if you try later tonight, you won't be successful. Once it's out, it's not going back in. The trust distribution is the same way. If we say at 40 it's going out, it's going out and we make that distribution, they're going to have it if we keep it in the trust and give those more flexible terms, we've provided a stronger base for the family moving forward.

And it's funny that you bring that metaphor up because I was sitting in this exact spot with a client yesterday talking about my colleague's favorite metaphor. And I think it's a good way to think about the options because for the client walking in the door who trusts their child to manage assets and receive an inheritance and doesn't want to control from the grave, they might be more interested in that age-based trust. But when we start talking about the potential for a divorcing spouse, we can familiarize them with the lifetime trust tenants that we've just talked about, but also discuss the option of bringing in a side letter describing to clients that they absolutely can have a memorandum of intentions is what we call them. And it will contain preparatory language that essentially can mirror what an age-based trust would say, giving guidance to the independent trustee that assuming there are no present creditor risks, so the beneficiaries living a great life and a happy marriage. Here's what I would want distributions to be made for or hear ages that I would expect distributions to be made at.

Those almost always start with I have a strong desire for my child or my beneficiaries to be a contributing member of society. It's a common phrasing and it really hits it. They want the trust to be there. They want the trust to provide support. They want some control, they want their AKA can eat it too. And that's okay, depending on our client's overall goals, we can help them create that structure. I think your conversation right there about options also brings up a common concern or question from clients, especially when I'm talking to clients now whose kids are in their twenties. They often will say, well, what do we do then if the child wants to buy a house? And I think the optionality of the trust structure is just such a perfect example of the flexibility that the trust provide to me. I think there's three options when the child wants to provide the house.

One, you make a distribution from the trust, so you take the money out of the trust, you give it to the child, we've squeezed the toothpaste, the tube of toothpaste, the money's out no longer protected, but they have it. They either had it for the entire payment of the house or they had it for a down payment. Two, the trust can loan money to the child. They can maybe loan money for the down payment. They can serve as the bank for the entire amount depending on the size of the trust. We still have some creditor protection when we do it that way. We still have our tax planning when we do it that way. Or three, the trust could buy the house and then the beneficiary can live in it. So we have that optionality because we've used the trust structure and we've created it with these flexible terms. And I think when we explain clients to those options, they start to see, oh, I get it now what if it's a business? And that's the next question,

Right? And really the same optionality exists within the business realm. We could have the trust be simply a, an investor in it. We could have the trust be a form of ownership structure of a new business. You could have the exact same iterations for a child's goal in a business that you would with a house.

I think what we've hit on today is kind of the flexible nature of being able to use trusts and even lifetime trust when the situation arises. And really thinking about this conversation in that situation where we've helped the client understand the benefits of using a trust that last longer than they were thinking of the benefits of giving the child or the beneficiaries some control over the assets and different ways of doing that. Now again, it's not always the right strategy. We don't always do that, but it's a conversation I think with a lot of our clients who are thinking of that younger age distribution standard to actually end up more on that lifetime trust standard with some flexible provisions.

And I think that that is the perfect summary and really what we need to provide clients to start learning about trusts and dispel those myths that we talked about.

Well, thanks for joining me today, Erin. It was a pleasure.

It was a great conversation. For our listeners, we'd like you to subscribe to our podcast, share it with your other centers of influence as well as your clients, and follow both of us on LinkedIn. Thank you.

Thank you for listening to future focused sophisticated estate planning, hosted by Erin Nichols and Michael Clear, partners of the private client services department at Wiggin and Dana at Wiggin and Dana. Our aim is preserving the wealth that a family has worked so hard to create and pride ourselves in offering value driven solutions and results. Subscribe to the show on your favorite podcast platform, share episodes with your clients and follow our highly talented, creative and experienced lawyers on LinkedIn for even more Great insight. We'll see you next time on future focused sophisticated estate planning.