Maurice, one of our community’s longtime members, asked a question recently about the role of trust funds.
Of course, the term is probably one of the first things most people think about when they hear the term ‘Old Money’, with a list running something like: preppy, trust fund, Volvo, Nantucket, gin and tonic, cardigan and pearls… But let’s talk about the trust fund, what it is, what it isn’t, and how to look at the possibility of setting one up.
First, I’m going to point out that I am not an attorney who specializes in wills and trusts. Yes, I am familiar with trust funds, generally how they work, and some of the pros and cons to setting one up for family members.
(Since it’s been over 5 years since I’ve been posting on this blog, please forgive me if we’ve covered this before. And feel free to correct or expand upon any errors or broad strokes that I may be guilty of making here.)
My understanding is that a trust fund is a legal entity which holds assets on behalf of a beneficiary or series of beneficiaries. The trust is administered by a trustee or group of trustees who are often attorneys. These trustees manage the dispersement of funds to the beneficiaries in accordance to the dictates of the trust.
Trust funds are most often used by affluent families in order to preserve and protect assets that have been accumulated by one generation for the benefit of future generations. They can include cash, stocks and bonds, real estate, art, and other assets.
If the trust is properly managed, it generates an income from these assets, a portion of which may be designated to be paid to the beneficiary at regular intervals (monthly, quarterly…) or at particular chronological ages. Beneficiaries may get their first lump of cash or the start of disbursements at the age of 18 or 21, with common lump sum drops (percentages of the total value of the trust or fixed amounts) and on their birthdays every 10, 15, or 20 years thereafter, depending on the conditions set forth in the trust and the value of the trust.
Not getting all the money at once is a smart idea, for obvious reasons, and by the time a beneficiary is 40, their spending habits have been pretty much set, for better or worse, so they are hopefully able to manage future disbursements wisely.
For many people, being the beneficiary of a trust fund seems like a dream come true: money being regularly dispersed at predictable intervals with no strings attached. And for many parents, this seems like the ultimate legacy to leave a child: financial security for years to come.
Only it’s not that simple. People are human, after all. The best parts of a trust are the financial security it offers beneficiaries and the peace of mind it offers the people who establish the trust. A beneficiary’s education costs may be paid for. Medical bills can be addressed. Travel is possible. Doing something good through charity or holding public office is more possible if you don’t have to work for a living. And it’s not like a trust can benefit just one person or just one generation. Properly managed and adequately funded, they can last decades and even centuries.
The worst parts of being a ‘trust fund baby’ may be that it stifles the desire to work, pursue a passion or profession, because there’s no need to earn an income. A life of leisure can easily become a way of life, causing even the best of people to shirk responsibility and challenges, take the easy route, never really dig in and accomplishing something. I’ve seen plenty of these types: easily bored, constantly adrift, frequently wedded (and divorced), often the life of the party, always ready to criticize with confident condescension those who are out there, doing and trying. The only thing more miserable than being around these people is being these people. I almost feel sorry for them.
All of this brings me to my point: a trust fund is not going to help your children or grandchildren if they don’t get the important lessons of life early and often. Discipline, education, manners–all these things are more important than access to funds. With these Core Values, structured access to funds is rocket fuel for goals and dreams. Without that foundation, structured access to funds is a nightmare.
Of course, if, when, and how you establish your trust fund for your family members is completely up to you. When and how you tell them that they are beneficiaries of a trust fund is also tricky business. It’s easy for young people to get a big head and behave badly. (I’ve also heard about ‘generation skipping’ trusts that do just as the name implies: the children don’t get anything, but the grandchildren do, and so on, for decades to come. This ensures that someone has to keep working and keep their head in the game, while advantages are still present for others. Very Dickens, don’t you think?)
There are, of course, plenty of things to think about. The trustee you choose is critical because the very life of the trust depends on their ethical and competent management, i.e., will they administer the trust in accordance to your wishes and how will the assets of the trust be managed to ensure the best and longest benefit for the next generation?
The conditions set forth for beneficiaries should be well-thought-out. When and how do they receive their disbursements? Do you set up a ‘spendthrift’ trust to prevent the assets from leaving the trust quickly, dictating, for example, that only 5% of the trust assets can be dispersed in one year? But what if the beneficiary has medical expenses or tuition or legal problems and needs more cash? What happens if a beneficiary has a drug problem? Do you still continue to give them money? What clauses are in place for future spouses or children?
There are tax issues for trusts, too. They are legal entities, and if they make money, they pay taxes. So a lawyer and a CPA are probably part of the team when you start to look at a trust. Good ones are not inexpensive.
Finally, you have to ask yourself if this is an ego trip for you to say you’ve set up a trust for this person or that person? Or is there a real concern you have or real advantage that exists if you set up a trust for a particular person, in your particular situation?
What is the purpose of the trust? What do you want to see happen to the person who is the beneficiary of the trust? How do you want this to really help them? Is money, or a trust fund, really the way to go about realizing that dream?
No one can answer these questions but you. The important thing is to ask the questions now, before going down the long and often expensive road of establishing a trust.
Most people don’t need them, but if you do, they are tremendously valuable and very powerful tools.
I’m looking forward to hearing everyone’s comments on this.
Thanks.
- BGT
I worked for a trust company on the West Coast when I was in my 20s. I was a client relationship associate, and administered accounts for high-net-worth families, so I got to set up trust accounts and worked with the grantors, trustees and beneficiaries. At the time, my husband and I were young, married and living the simple life in a studio apartment, cooking our meals, backpacking and traveling on our vacations. So working with these clients was a contrast to say the least.
The trusts were often set up for income distribution with scheduled principal payouts. It was a very eye opening, to say the least. The families I worked with varied greatly. As you’ve stated, having a trust can be a double-edged sword. On the one hand, it can provide seed money to start businesses or get a good education. On the downside, the beneficiary can be satiated and ever “feel the hunger” to go out and make something of themselves. I knew very few beneficiaries that I was impressed with for that reason.
When there is money that has been gathered over two, three or perhaps more generations then I think a trust fund which ‘controls’ its release to a following generation is the better way – rather than a once-off inheritance. Even if the latest-in-line inheritor(s) are ‘tear-abouts’ at the time of inheritance they will often settle down later on when they’re more mature and then do something useful with the money such as, for example, giving their own children private schooling.
Trouble often arises when a large once-off inherItance is dumped into the hands of the ‘tear-abouts’. A lethal combination. A controlled release provides better chemistry in the long run. So what if one generation in the middle doesn’t ‘make something’ of themselves. It isn’t a guarantee that it will perpetuate through those next in line.
Thanks, Byron. An interesting topic.
My parents have a trust set up for my older brother. I’m not 100% certain how they have the money disbursement scheduled, but it wouldn’t surprise me if he got a percentage every so often. My half of the inheritance will be in one lump sum. The reason is because my father is confident I know how to manage money and I will not go crazy. My brother, on the other hand, has never met five dollars he couldn’t waste.
I see what you did there with the title.
Thanks for writing this thoughtful and insightful piece.
I realized that I need to start with the objective first and work from there. A trust has the real potential to negatively impact lives. The bottom line is start with the objectives first and work with an expert to do this correctly.
Also great comments from readers of this blog.
Long ago when working on my Doctorate in Economics, there was an older man who would appear now and then, when he was not sailing in St. Lucia. His parents had made him a beneficiary of a trust fund as long as he was getting a university education. Thus, he decided never to finish his degree(s).
Like so many things legal, precise draftsmanship plus tax analysis is crucial.
Once upon a time in graduate school (economics), a fellow student would appear for a semester and then return to his life of sailing in St. Lucia. His parents had set up a trust fund to support him as long as he was getting a university education, which his is probably still doing.
That’s funny! Thanks, Jasmina. – BGT