You’ve worked hard to build wealth. You have more money than you will need in your lifetime and you want to ensure your assets will benefit your family once you’re no longer at the helm.
One way to do this is to leave your estate to your loved ones through a will. Even though our focus here is on trusts, it’s important not to downplay the importance of a will. According to a recent survey by Caring.com, almost 60% of U.S. adults do not have a will or a living trust.[i] Everyone needs a will, no matter how much money they have. However, if your assets are worth $500,000 or more, it’s important to consider a trust as well.
What Is a Trust?
A trust is a legal entity created by an individual (the grantor) giving someone (the trustee) the right to manage the grantor’s assets for the benefit of one or more beneficiaries.[ii] Often in the case of trusts created during one’s lifetime, the grantor is also the trustee, allowing him or her to retain control of the assets in the trust until such time as he/she is not capable of managing them. The trustee can also be a third party.
There are many reasons a trust starts to make sense as your net worth increases. One advantage of many types of trusts is that they can avoid the lengthy and expensive probate process. Even more importantly, trusts can provide significant asset protection from creditors and sometimes from the trust’s beneficiaries (typically the spouse and/or children), and even from the individual who establishes the trust.
Why Would I Need Protection from My Own Family?
It doesn’t seem logical that assets would need to be protected from the very people who stand to benefit from them. However, it’s quite common to run into situations where beneficiaries can’t or shouldn’t be handling money on their own. This may be because they are mentally incompetent, or there could simply be concerns about a beneficiary’s ability to make sound decisions and exercise good judgment.
Sometimes the mental capacity of the individual who owns the assets declines significantly as he or she ages, perhaps due to dementia. As most of our clients are living well into their 80s and beyond, we unfortunately see this quite often. Or, a triggering event can cause an elderly person to behave erratically when it comes to financial matters. Sadly, older people can be vulnerable to financial manipulation by others, including relatives and caregivers, which can have a significant negative impact on that person’s assets.
I’ve seen all of these scenarios happen too often. I personally plan to use a trust to protect my personal assets for my loved ones. At TFG, we feel so strongly about this protection that we have conversations with virtually all of our high net worth clients about establishing trusts. And quite frankly, it’s less about whether they should establish a trust and more about when they should do it.
What Types of Trust Can Provide this Protection?
There are three main types of trusts used for the asset protection we’re describing here. The first type of trust that’s commonly used is a Living Trust established during the asset owner’s lifetime, which is a revocable trust (meaning it can be changed). The person establishing the trust (the grantor) may be both the trustee and beneficiary. When the grantor dies, the trust becomes irrevocable (meaning it can’t be changed) and the assets are transferred seamlessly to the successor trustee. Living trusts incorporate all the terms of a will so technically they can serve as the individual’s will. However, we recommend that individuals with Living Trusts also have wills with a “pour over” provision, because sometimes people fail to properly title their assets in a Living Trust. Such a will simply provides an added layer of protection and ensures that all assets not already in the trust transfer into the trust after death.
The second is a Special Needs Trust. As the name implies, it’s used when a family member has an impairment that would interfere with his or her ability to handle a direct inheritance from the estate. This trust is commonly used when the impairment is known and the situation can be identified in advance. It includes specific language to prevent the beneficiary and any creditors from gaining control of the assets. Another benefit of a Special Needs Trust is that, for beneficiaries who receive government benefits, the trust helps to ensure they are still able to qualify for those benefits.
A third trust we commonly see is a Testamentary Trust. This type of trust is created upon death, triggered under the terms of a will. Some people prefer a Testamentary Trust because there’s no trust to maintain during their lifetime, which does involve some effort and cost.[iii] However, because a will is involved with a Testamentary Trust, probate still applies. This is why, in my opinion, it’s better to have a Living Trust and avoid probate. There are a variety of other types of trusts, such as asset protection trusts and IRA trusts, so it’s important to consult your financial and legal team about which one(s) may be right for you.
How Does a Trust Protect My Assets?
The beneficiaries of a trust can only access the assets in it pursuant to the terms of the trust. Typically, the terms specify that beneficiaries receive the income the trust generates. Other provisions are often made to allow for larger purchases such as buying a home, or paying for medical care or educational expenses. The limits on the use of the assets in the trust are designed to prevent the beneficiaries from doing something reckless with those assets. The trust can also be protected against creditors, which helps to ensure that any debt the beneficiary incurs will not infringe upon the trust’s assets.
Another key advantage of trusts is that the assets can be set up to be professionally managed. This provides additional protection for the trust’s assets. Without this protection, a beneficiary could inherit the estate and make poor investment decisions, with severe negative consequences. With prudent investment management, a sizable trust can even develop into what is sometimes referred to as a “dynasty trust,” meaning a trust that can last for generations.
The Key Takeaway?
The single most important factor when establishing a trust is choosing who will serve as the trustee either at inception or upon the death or incapacity of the person who set up the trust. The trustee is an independent party who steps into your shoes and makes all decisions on management and disbursement of trust assets pursuant to the terms of the trust. This person is a fiduciary who is obligated and personally accountable for looking after the best interests of the beneficiaries.
The role of the trustee is complex, and the responsibilities are weighty. The best trustees are highly experienced in the role and have a proven track record of sound decision-making and good judgment. There is also the important human factor—the ability to understand and effectively navigate the nuances of family dynamics. While the trustee may be an individual, most are affiliated with a firm such as a bank or investment advisory firm, that helps to guide the investment of the trust assets, fulfill the administrative duties, and ensure there’s a succession plan if anything were to happen to the designated trustee.
In most situations a trust is the best way to ensure the wealth you have worked so hard to create will continue to provide for your loved ones after you are gone. A properly administered trust will protect family members from themselves and others, and possibly even extend your financial legacy to your grandchildren and future generations. I have served as a professional trustee for hundreds of trusts over the past nearly 40 years. As a TFG client, we can help you to understand the benefits of a trust and to help choose the right type for your situation. Don’t put it off any longer – reach out to us to start the conversation.