John D. Rockefeller:   “Control everything, own nothing!”

Take-Away: Implicit in Mr. Rockefeller’s observation,  and intrinsic to trusts in general, is that limited control and beneficial enjoyment are desirable, while holding title is harmful. That is because holding title to an asset invites taxes and creditors.  One could make a strong argument that inherited assets held in trust may be more valuable than inherited assets that are owned outright by the beneficiary. I suspect, however, that many beneficiaries will disagree with that observation.

Background: We all know why trusts are regularly recommended as a part of a comprehensive estate plan. Conventional wisdom is that a trust can be used to avoid probate, along with the costs, fees, and inherent delays associated with the probate process, either in the event of the settlor’s disability or upon the settlor’s death. We also know that, unlike a will, a trust does not become a matter of public record, so the financial affairs of the decedent and his/her family are better preserved. These benefits, however, focus only on the settlor’s objectives, with less consideration given to the impact of an inheritance on the settlor’s beneficiaries. There are other attributes that come from the use of a trust that get far less attention on what a trust relationship can accomplish after the settlor dies (i.e. a continuing trust for the settlor’s beneficiaries after the settlor’s death.)

Attributes of a Continuing Trust: A few of the perceived benefits that come from the use of a continuing trust for a beneficiary after the settlor’s death follow:

  1. Future Transfer Taxes Eliminated: Technically an irrevocable trust can exist for up to 360 years in Michigan without running afoul of the ancient Rule Against Perpetuities. Hence the current interest in dynasty trusts that continue for multiple generations. If the dynasty trust only gives a beneficiary-child the right to (i) receive all of the trust’s income, and (ii) the use of assets owned by the trust, the trust’s assets will  not be exposed to federal estate taxes on the child-beneficiary’s death. If the assets then continue to be held in trust for the benefit of the settlor’s grandchildren, distributing income to them and letting them use trust-owned assets, the trust can avoid application of the federal generation skipping transfer tax (GST) if the settlor’s GST exemption is applied to the trust. Distributing assets outright to a child or grandchild will expose those distributed assets to future federal estate and/or GST taxes which can be avoided through the use of a continuing trust after the settlor’s death. Even if the federal estate and GST taxes are repealed, chances are good that someday those transfer taxes will be restored in some form, so using a dynasty trust to hold title is a good hedge against the risk of the return of federal transfer taxes, or any replacement tax to the federal estate tax, e.g. the capital gains deemed recognition on the asset owner’s death.
  1. Frustrate Creditors: Depending upon the nature of the beneficiary’s interest in the continuing trust, it is possible to frustrate most, if not all, creditor claims against the beneficiary. If the trust is structured as a support trust for the beneficiary,  only a handful of creditors can attach the beneficiary’s interest in the trust: child support claimants, spousal support claimants, governmental agencies (e.g. the IRS) and those creditors who helped to establish or preserve the beneficiary’s interest in the support If a fully discretionary trust is established for the beneficiary, then the beneficiary is deemed to not possess any property interest in the trust under Michigan law. Consequently,  there is no property interest held by the beneficiary that a creditor can attach until after a distribution is made from the trust to the beneficiary. With the advent of the Michigan Qualified Dispositions in Trust Act- Michigan’s version of an asset protection trust- a continuing trust can be set up as an asset protection trust that will frustrate the claims of almost all creditors of the trust beneficiary. This is critically important if a big concern of the settlor is that their child-beneficiary might find himself/herself in a divorce; the Qualified Dispositions in Trust Act makes it very clear that a divorce court cannot take into consideration in dividing the beneficiary’s marital estate the assets held in the Qualified Dispositions Trust that benefits only the one beneficiary-spouse. In our highly litigious society, a continuing trust can be an extremely protective wrapper to hold an inheritance.
  1. Bankruptcy: For many clients a considerable amount of their wealth is held in IRAs and 401k accounts. We learned from the Supreme Court’s Bowbrow decision a few years ago that an inherited IRA is not protected if the IRA beneficiary subsequently files for bankruptcy. If, however, the decedent’s IRA is made payable to a continuing trust for that beneficiary, a trust which contains a spendthrift limitation, the IRA/401k distributions to the continuing trust cannot be taken in the beneficiary’s subsequent bankruptcy.
  1. Family Focus: As the world has become more complex, more clients have begun to appreciate the use of a continuing trust to hold inheritances to protect and promote their family values. Estate planning is becoming less asset centric and more family centric, with more trust provisions added [often referred to as making the trust instrument  more flexible] to respond to the changing needs of the trust beneficiaries in an evolving world. As I mentioned in my speeches to COIs and clients last week, there is a reevaluation of conventional estate planning to use a continuing trust to hold an inheritance as an investment in human capital, and not simply as a device to transmit wealth for the sake of transmitting wealth to the next generation. New uses are being added to continuing trusts to hold inheritances to enhance the quality of the beneficiary’s life, not merely make them wealthy or diminish their motivation to work: behaviors can be incented or rewarded and philanthropy encouraged with a continuing trust. If nothing else, use of a continuing trust after the settlor’s death will give the child/grandchild beneficiary sufficient time to grieve and to prepare them  to deal with their new responsibility to manage wealth (often large sums of wealth that they have never managed before in their life.)
  1. The Trustee-Mentor: Consistent with the previous attribute, clients are beginning to look at professional trustees as more than gate-keepers to an inheritance, but as mentors for their children and grandchildren- using the continuing trust as a life-long teaching device. Clients understand that the receipt of an inheritance will change their beneficiary’s behavior to some degree, and their hope is that the inheritance will lead to positive changes in those behaviors. A trust distribution provision can be used as a teaching opportunity to impart to the trust beneficiary the values that the settlor embraced that are reflected, to some degree, in the wealth that the settlor was able to accumulate during his/her lifetime. A continuing trust can  identify what the settlor considers to be quality-of-life-altering values, values that can be passed along to the next generation through the continuing trust’s administration and its distribution provisions. Ultimately, the goal of most settlors is to use a continuing trust to prepare their beneficiary to maximize their own potential, often with the encouragement and mentoring of the trustee. Positioning a mentor (the trustee) to work with the beneficiary to achieve their full potential often gives the settlor great peace of mind that an objective party will be positioned to work with their beneficiary, either to prepare them for the responsibility to someday handle substantial wealth, to assist them with difficult decisions that are associated with that wealth, or to instill in the beneficiary the necessary values- a lasting legacy from their ancestor.

Conclusion: As advisors we  need to spend more time with clients talking about family and less about finances. We need to engage in more difficult discussions (because they can often trigger emotional responses) about the sudden impact of wealth on their intended beneficiaries, and ask if handing over even more wealth through tax savings strategies to those beneficiaries will actually make them happier? In the process of these discussions which  tend to focus more on values, goals, and the desire to leave a lasting legacy, regardless of the amount of wealth involved, hopefully our clients will derive comfort and satisfaction from the knowledge that the wealth that they leave for their survivors will enable those who they most care about to enjoy better and more productive lives. In sum, clients often need to be reminded that with their continuing trusts they can leave more than just wealth to their loved ones, but also values that will instill happiness.