Settlor’s Letters of Wishes – Don’t be Afraid to Ask for Them

Take-Away: While a trust should always contain a material purpose clause to guide the trustee, and possibly guide a probate judge as well, as to the settlor’s intent in establishing a trust, if the trust instrument confers discretion on the trustee with regard to distributions, the settlor should also supplement the trust instrument with non-binding letters of wishes.

Background: Whenever I speak on behalf of ICLE to attorneys at its annual drafting seminar, I harp on the importance of including in the trust document that they draft the inclusion of a material purposes provision. Admittedly lawyers are getting really tired of hearing me on this material purpose clause. But it is important, which is why I continue to annoy my audiences.

Trust Instrument’s Material and Stated Purposes: My nagging is, in part, because the Michigan Trust Code regularly makes reference to a trust’s material purposes, e.g.  an irrevocable trust may be modified, but only so long as the proposed modification is ‘consistent with its material purposes.’ [MCL 700.7411(1)(a).] In addition, the Michigan Trust Code often assumes that the trust instrument will contain a stated purpose. [MCL 700.7412(2)- ‘the court may modify the dispositive terms of the trust if.. the modification will further the settlor’s stated purpose.’] But most settlors are unwilling to have multiple pages of their trust instrument dedicated to a litany of the purposes that their trust is to serve. As a result, while there might be a material or stated purpose provision in a trust instrument, it is usually generalized, terse, and not particularly helpful to the trustee that is called upon to exercise its discretion to make distributions from the trust, an area where the trustee probably needs the most guidance to ascertain the settlor’s intent.

Restatement of Trusts: The concept of a trust’s purpose  also regularly appears in the Restatement (Third) of Trusts. Section 50(2) provides: “[t]he benefits to which a beneficiary of a discretionary interest is entitled, and what may constitute an abuse of discretion by the trustee, depend on the terms of the discretion, including the proper construction of any accompanying standards, and on the settlor’s purposes in granting discretionary power and in creating the trust.”

Settlor’s Intention and the Trustee’s Discretion: In his seminal article (usually referred to with hushed reverence by law professors) Dean Edward Halbach in the 1961 Columbia Law Review, repeatedly stressed that drafters of discretionary trusts have been notoriously negligent is drafting discretionary trust provisions. He notes: ‘formulation of the donor’s intentions is apparently one of the most neglected aspects of estate planning.’ In addressing the importance of the settlor’s intent to assess a trustee’s exercise of discretion, Halbach notes ‘no trust involving dispositive discretion in a trustee should be drafted without providing at least a basic answer to this inevitable question.’ Edward C. Halbach, Jr., Problems of Discretion in Discretionary Trusts, 61 COLUMBIA LAW REVIEW (1961) pages 1442 and 1457. If a material or stated purpose clause in a trust instrument is inadequate to guide the trustee ( or probate judge) as to the settlor’s intent, how should that intent be communicated?

Non-Binding Letters of Wishes: If the attorney who prepares the trust document is reluctant to draft a discretionary power that possibly could run on for four or five pages elaborating on the purpose of the trust and the settlor’s worldview, the attorney should assist the settlor to complete a non-binding letter of wishes to be held by the trustee that administers the trust. The letter of wishes would contain a fairly detailed statement of the settlor’s intentions with regard to discretionary distributions from the trust. The letter of wishes could also contain examples of typical parental situations and explain what the settlor would decide in each particular situation. While the trustee is left to make the final decision, such a letter of wishes gives to the trustee, and a probate judge when faced with challenges to that trustee’s  exercise of discretion information and insight as to the settlor’s intent to which they would not otherwise have access.

Examples:  One example of a settlor’s letter of wishes might be to provide examples that describes when and  how the trustee of a discretionary support trust should ‘consider the beneficiary’s other financial resources’ when making discretionary distributions, and address the importance of indicating the level of support the settlor intends the beneficiary to receive from the trust. Should the beneficiary receive a discretionary distribution from the trust if the beneficiary lives in a $750,000 home, mortgage free, but has only $2,000 in his checking account? Does the beneficiary have access to  other resources, if he has no savings, but does own $1.0 million in his rollover IRA?  Does the beneficiary have no access to  other resources when she is a stay-at-home mother, but her husband enjoys an annual salary of $250,000? Normally a support trust [MCL 700.7103(k);  700.7503] is intended to maintain the beneficiary’s accustomed lifestyle, the exception being if the beneficiary’s lifestyle is very low. A letter of wishes from the settlor might, after the drafting attorney discusses this issue with the settlor at some length, indicate that the settlor desires an increase in the beneficiary’s lifestyle from modest to high, or even to maintain a lavish lifestyle using the assets held in the trust, or simply express a desire that the discretionary trust is intended ‘to only provide a safety net if the beneficiary experiences financial hard times.’ Giving the trustee discretion to make distributions is one thing, but the scope of that discretion, or the impact of using trust assets to support the beneficiary is an entirely different subjective determination, where the settlor’s guidance is always helpful.

Conclusion: Dynasty trusts are gaining in popularity, now that states have modified, or abandoned, their rule against perpetuities. Dynasty trusts  also attract interest as a means to avoid incurring estate tax or generation skipping tax on the death of the trust beneficiary, or to accumulate income to avoid state income taxes. As such, the future suggests more and more discretionary trusts that will be administered by trustees for multiple generations, long after the settlor’s death. Consequently, it will be important for the trustee to clearly identify the stated or material purposes of the trust. The addition of letters of wishes or instruction from the settlor can  also help to provide guidance to the trustee in the exercise of its discretion in making distributions (or in how the trust corpus is to be invested) over an extended period of time. Saving taxes is clearly a material purpose behind establishing a dynasty trust. How that dynasty trust impacts the quality of life of the trust beneficiaries over several generations is where the letters of wishes will be extremely  important.  Hopefully when a trustee is presented a proposed discretionary trust to administer, the trustee will also be given companion letters of wishes from the settlor that will enable the trustee to better understand the settlor’s intent for how the trust is to impact the beneficiaries’ lives. If no letters of wishes are provided, there is no harm in asking for them. A settlor should always be encouraged to work with his/her attorney to prepare these supplemental sources of the settlor’s intent in how the trustee is to exercise discretion to administer the trust.