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- [00:00]
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Foreign.
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What is up? And welcome back, everyone, to another episode of the Practical Planner podcast. I'm your host, Thomas Goldman, here with me and Rhodes, and just the two of us today. So I. Maybe this is a natural time to just say, like, sad to see Dave go. Like, for all the longtime listeners, Dave took a new role. We're all very sad but happy for him about it. So we, moving forward, it's really gonna be Ann and I. We're still gonna pull in some other wealth people who have some different expertise. But, Ann, good to see you.
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A
Yeah, good to see you too, Thomas. And, yes, I echo the sentiments. You know, Dave was a wonderful colleague. I am so glad that I had the opportunity to work with him here at Wealth. We really do just wish him the best. And so, Dave, if you're listening, still, you may be pulled in someday to be a guest star. And we. We very much love you.
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B
He will be. But this is back to our roots. This is how we started the podcast, just you and I. And then you went to maternity leave, like, forever ago. And then things change. But excited to do an episode with just the two of us. And today we're going to really just be going through and talking about, like, what do you do? Your client basically inherited a trust, and they want to think about, do I leave it in? Do I distribute it? What do you think that conversation even starts?
- [01:24]
A
Yes. So here we're talking about a client as a beneficiary of a trust. So they're not setting up the trust as a trustor. They're not, you know, the trustee, but very much, you know, they know that they have an inheritance. It got wrapped in this trust. There may be another trustee involved in this, let's say an uncle or even a trust company. And they just want to understand, like, what are my rights to. To access the money and how do I access the money? So let's talk about that. I think fundamentally, number one is, does your client even have information rights over this trust? Do they even know of the existence? I mean, at this point, hopefully they do, because they've come to you with this question. But there are some states actually that have silent trust statutes. That's what they're called, where the trust creator. So let's say that's dad or mom put together this trust and said, you know, I honestly just don't want my kids to feel like they're trust fund babies and that they can just do things, you know, and not contribute to society. So I'm actually going to withhold certain rights that the beneficiary, naturally, or naturally by state law, under default law, would have over this trust and instead put a lot of the information rights into the hands of the trustee. So, trustee, you get to decide what you reveal to this beneficiary. So those are silent trust provisions. And within the trust agreement, the trust needs to override the default laws and insert the silent trust provisions. So that's, number one, is that your client may just not know what the trust even says. But let's say, for example, you get past this hump and you do know your client's gotten their hands on the document at this point. There are a lot of different ways in which distributions can be made. And it's really important for your client that, and ideally, you know, to be represented by an attorney at this point, to go through the trust provisions and kind of get a lay of the land of what kind of things, you know, they can, how they can access the money. The two most basic ways are, one, there are mandatory distributions to the client, and number two, there are discretionary distributions and the discretion is the trustees. Right. And there's a third that I want to mention up front because I think too often people get stuck in this idea that you only look at distribution language, but actually how you change the trustee to be somebody friendlier to your client, that actually affects the distributions too, because you can imagine that if your client could just appoint themselves as the trustee, maybe reaching a certain age or, you know, with some sort of restrictions, but at least they can become their own trustee, then of course they can access the money much more readily. So I wanted to mention those three kind of as a framework, because then, you know, we can talk about some of the details. But mandatory distributions, discretionary distributions, and how much control do you have over the trustee?
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B
Okay. Do you think that as we think through this, we have to go one by one from those three? Because I think there's like the situation where there's no rules, right? You're like this, this is a trust. You're over the legal age of what was written in the documents. You can distribute it all. Maybe that's the first place to start. Like what would stop somebody from distributing all of it in that situation?
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Truthfully?
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Asset protection.
- [04:49]
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Yes, a couple of things, right. So maybe there was a tax plan in place. And I always love taxes because that's where I practice. Right. The kind of high net worth, ultra high net worth space. But you don't want to undo a trust without understanding why it was formed in the first place. When it's an irrevocable trust. So, you know, way back, many, many episodes, we all talked about, you know, objectives for forming irrevocable trust. You may be causing more issues by actually wanting the money in your own hands as the beneficiary. So that's number one. Number two is asset protection. Like you said, Thomas, there may be a reason why you want that trust in place because that removal from your own assets is a good thing for divorce protection, you know, creditor protection, debt, you know, et cetera. So people actually go out there to seek putting together these trusts for themselves when they know there's a big judgment coming after them. You, as the beneficiary, happen to have a trust set up potentially to do that for you. So why undo it? And then I think it's about convincing the trustee that there's a reason to undo the trust. And here these would be called terminating distributions. And there are really three big ways, I think, of this. So reasons to ask the trustee to terminate, number one, and most common, I think actually is just this trust holds so few assets. You know, I'm a pretty responsible beneficiary. I know how to handle, let's say, $2 million. But keeping the trustee around, keeping the CPAs around, all the things that need to be there to kind of maintain this trust, it's just not economical anymore. Like, I just, you know, I'm spending too much in fees to make this $2 million that's in the side pocket, like, worth it to me as a beneficiary. So having that conversation with a trustee is very important to see how you can deplete that trust and eventually make one final distribution. And under default state laws, you might want to, you know, look with your beneficiary, you know, your client. But most state laws have uneconomical trust termination provisions where at a certain line, you know, let's say $50,000, $100,000, the trustee can just make that trust go away, even if the trust doesn't have the language within the document.
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Okay, I mean, that I think it's interesting, right? Because as you think about this, so let's say you, you know, the two main reasons I see trust other than asset protection, one of them is, you know, estate tax planning. So you inherited. The estate tax planning is mostly over at that point, unless you are the next generation who is extremely wealthy and you're like, yes, let's keep letting this grow outside of my estate or do something else or. The other one is, it was a revocable Trust that just became irrevocable. Right. And now you have the ability to take it out. And so I find a lot of times those people are like, oh, you know, maybe I don't have as much control in certain ways. Like, maybe there is an investment advisor that I don't really want to continue to work with. Maybe I'm paying a lot of fees to a trust company or to a cpa and now it's even less tax efficient than putting into my name. And so I think for as an advisor, you'd want to look at, right. Like, hey, is this in a different state? If it's in a different state and avoiding state taxes, maybe it's not less tax efficient. But if it is in the same state, you're in the same tax structure, it's going to be more tax inefficient than putting this into your own name, most likely.
- [08:15]
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And I think it's also kind of understanding why the trust creator even put this in a trust sometimes. It's actually for family harmony. And there may even be letters of wishes or something where the trust creator said, listen, I have three kids. One of them really not great with money or special needs, you know, has special needs, some sort of reason why I had to put in place a trust for this sibling. But the other two kids, they're fine. You know, they. I actually expect them to be okay. But when I die, I don't want that the first child to feel different. And so I ended up putting in place a trust for all three of my kids. But truthfully, I feel like, you know, you client, like this child is okay handling that amount of money. And so sometimes that form that the trust took was for family harmony or other reasons. And so you might actually find that your trustee is perfectly happy to work with that beneficiary to figure out a way to kind of unwind that trust structure more quickly.
- [09:18]
B
Yeah. And this is also a situation where multiple trusts might have been a better solution. Like, I have a client we're working on now where they had one trust, irrevocable trust for their kids. And now that their kids are older, it's kind of like, you know, they're going to want to use it for different things. And now if you have one trust, one person takes it out. Like, it would just be simpler to have two individual trusts that you're seeding in the exact same way. That way I think it becomes a little bit cleaner and easier to track, too.
- [09:42]
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Yeah, absolutely. I mean, as a drafter, I would always recommend if you're doing what's called a pot trust, meaning there's at least two or more beneficiaries that you kind of, you know, think through. Like what. What potential problems would this cause if one beneficiary needs more money and asks for more money than the other one, you know, is it better to maybe, like, split it into shares? So that's something that you can do with trusts, split them into trust shares if the document allows for it or the state law allows for it. So that's another way in which you kind of also negotiate the dynamics of distributions with the other beneficiaries. So that's an excellent point, Thomas.
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Okay, so anything else we need to talk about in distributing in this situation,
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like, I mean, uneconomical trusts? Here's another place in which you might want to think about it. So there are certain trusts that were set up, you know, for tax reasons, whatnot, but because of income taxes, you know, somebody is actually on the hook for the income taxes of that trust. Any assets within the trust generating rental income, you know, capital gains, whatever, you name it, you know, the trust has to file and pay income taxes. And it's an individual who, because of some quirk of the tax law, becomes the owner of that tax and needs to actually pay out of pocket. So you can imagine this, like, discrepancy trust is earning income, recognizing income, but the person who's paying the taxes on the income didn't actually get any distributions. So all of a sudden there's this phantom income, and they need to take money out of their own pockets to pay what the trust owes. And so for that, oftentimes in the trust documents, look for something called a tax distributions clause. For this reason, some drafters are very, you know, just kind of boilerplate. We'll put tax distributions language. So don't always just look at the same provisions within the trust where you expect the distributions language to be. That kind of administrative provision might be somewhere else in the trust as well to give some leeway to make distributions so that that income owner can go and pay the taxes.
- [11:49]
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Okay, that makes sense. So what other type of distribution rules, things do we need to plan for or think about?
- [11:56]
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Yes. So on the mandatory distributions, it is very common for trusts to have some sort of, you know, graduated table where the beneficiary ends up with more and more of the inheritance over time. So think very typically you have, you know, at age 25, when that beneficiary attains that age, give a third of the trust, then five years later, at age 30, give them another, you know, the half of the trust. So effectively another third. And then finally when they reach 35 or 40, whenever I think that they're going to be, you know, adults who can handle money, give them the rest.
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Yep.
- [12:30]
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These days in modern planning, there is something that is taking the place of the mandatory distribution because people realize that, you know, asset protection, other reasons, like sometimes beneficiaries are just lazy and they like don't actually want. They think the trust is working great and they want to keep the trust as is. There is something called a withdrawal. Right. So that's another access point for your client to go and request money from the trustee and say, I had this right within my hands. You know, I just need to write you a letter, I don't have to explain myself. And you have to give me, you know, X amount of the trust. So again, having the trust document is very important because you can see kind of those types of rights and what
- [13:13]
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are the common ones there? Is it really like. Like buying a house, starting a business, you know, education, things like that, or
- [13:21]
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distributions from the trustees perspective, where the discretion is, you know, the trustee makes that decision that be. Usually the common formulation is hems, health, education, maintenance and support. The reason those exist as standards is actually because of tax law and they're called ascertainable standards. So that actually if the beneficiary acts as a trustee. So there's kind of like that piggy bank effect. Right. I'm the trustee of my own trust that the tax implications are. There are no implications potentially. So that's why you see that formulation over and over again. But it's also also seems just kind of like common sense. The problem is you can read a lot into health, education, maintenance and support because usually maintenance and support is in your accustomed lifestyle. Right. So if you are, it's not like shirt sleeves here, you need to be
- [14:16]
B
destined a month spend.
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Exactly. So if you are, you know, your beneficiary, like your client is used to kind of a more sophisticated, you know, expensive lifestyle maintenance and support can actually encompass quite a bit. And so then there is a distribution standard. So this is the discretionary distribution still that we're talking about. Where Thomas, what you're mentioning comes into play, which is what are outside reasons, outside of health maintenance and support, where the trustee gets to make a call and that would be any reason, or for forming a business, for a down payment on a first home, all sorts of things that the trust creator has spelled out as particularly interesting or intended purposes. But I think of these as just falling under, like a catch all category of whatever is in the best interest of that beneficiary. And usually only an independent trustee can make that decision. So your beneficiary, who's also a trustee cannot make that kind of distribution without causing potentially some tax consequences to that trust.
- [15:23]
B
Okay. And do you see like, as an advisor, like, you have a client, they're the beneficiary. They are like, oh, this would be, I'm going to start a business instead of an SBA loan. This would be really beneficial. Is it like coach them on talking to the trustee or is this like they should be meeting with the client and the trustee?
- [15:38]
A
Yeah. So I mean, practically, you know, it depends on the relationship of the beneficiary to the trustee. I think most of the time the, the relationship is very good. And in fact, the trustee probably can be removed by somebody who's close to the beneficiary, you know, oftentimes. And again, that goes back to something we mentioned at the top of this episode, which is your trustee does not need to. May not be as set in stone as the trust document makes it to be. So actually removing and replacing the trustee could yield to the outcomes that your beneficiary is looking for. And so just be aware of that. Right. Because the trust is like the constitution for that trust is that legal document to read it, because you might actually have more power than you think you do as a beneficiary.
- [16:29]
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I think it's important call out because I think a lot of times people think that you can't change anybody in that trust, like trustees said or, you know, the CPA overseeing it. Like, I met with somebody who was a young kid who inherited a lot of money and he was like, I'm stuck. Like, you know, I'm paying all these fees to, you know, an attorney and I have a trustee who's not really helping. But I paid $180,000 between the two of them last year. They like, tell me I can't move my money anywhere, even though, like, I don't like the advisor who's managing this. And so you can typically change those.
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Yes. And in fact, the ultimate sort of trump card that a beneficiary always has, and this is the United States, so you can always go to court and explain why it is that you're not working well with a trustee. But having spoken to so, so many trustees, I will tell you they don't want a bad relationship with a beneficiary. By the time it Gets to that point, they would rather just recuse themselves and say, hey, let's look together for my replacement, and you get to exercise your powers to remove me, or I will recuse myself and appoint my successor. I don't think that trustees generally want to be stuck in a bad relationship either. But of course, there are fees and other things that might incentivize them in a way that.
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Yeah, exactly. Everybody works with bad clients at some point. The fees are good enough.
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Exactly.
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Okay, what else do we need to talk about with distributions?
- [17:58]
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So I think that there are a couple of other tools or features of a trust that are not called distributions, but effectively act as distribution. So we talked about the withdrawal power, but it's called withdrawal, not, you know, an allocation or distribution. And then the other one that I wanted to point out is, is if you're working with a client who's looking to make distributions to others, maybe not themselves, but they feel stuck in how perhaps if they pass away, they'd like to have this trust benefit their spouse potentially. And this is a family trust. Right. So the spouse is not a natural beneficiary, a natural kind of heir to the person who set up the trust, that patriarch. Or they just want to benefit charity or something like that. They're working with an inflexible trust, and they kind of just want their own lives and their own beneficiaries to be reflected within the document. There is something called a power of appointment that you should look at. So trusts oftentimes to build flexibility into these pretty rigid documents. Otherwise grant somebody the power to redirect trust assets and maybe even reform brand new trusts out of the old one. And so that power is called a power of appointment. And usually it is in the hands of your beneficiary. And it will say, you know, my beneficiary has the ability to appoint principal or income of the trust or one or the other. And then here's a permitted set of people that can, you know, be where the trust money can be directed to. And oftentimes it's descendants of the trust creator. So think of your beneficiary wanting to benefit a niece or nephew who's descended from the same line. Great. Use a power of appointment. Charity usually is included and sometimes even spouses. So just make sure that at that point in time, you're working with an attorney and letting you know, working with your client to understand how they're redirecting the money potentially at their deaths or even during life.
- [20:04]
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Yeah. Moral story is there's a little Bit more flexibility. And I think people realize.
- [20:08]
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Yeah. And that power of appointment is critical to good planning. So it oftentimes is in more sort of modern trusts. So don't ignore it.
- [20:17]
B
Yeah. And I think this episode's actually helpful for people who are scared of using irrevocable trust because I think, you know, there's. There's the people who are so wealthy that, you know, the asset protection, the estate tax planning is a no brainer. Then there's people who are like this middle ground where it does make sense, but they're fearful of kind of giving up all of that control. But I think the more conversations we have around this, the more you realize there is still some control embedded in there. Yes, you give up some. But like, it's not like everything's frozen forever and nothing can be changed.
- [20:45]
A
Exactly. So oftentimes what we say is put in place. You know, it's easier to hold back the money initially and then to find ways to kind of like leak it out to your beneficiaries. And so, you know, it's okay to put in place that trust as long as you understand the flexibility of it. Right. If that's your goal. There are some people, of course, who don't want any flexibility. For whatever reason, that beneficiary really should not have a very flexible trust. But don't fear that somehow your beneficiary has to live with a very rigid trust. That's not really the ethos of modern trust planning and trust drafting anymore.
- [21:21]
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Yep. And again, another important reason to have quality trustees who are going to help carry out the things that you want, because your documents are going to have that. You also need the other person who's going to oversee it to help make sure that things go the right way.
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Exactly.
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Okay, cool. Anything else you want to hit on or feel like? We got everything covered.
- [21:40]
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I think this can be a short and sweet episode, you know, so if you ever worked with someone who had this issue of accessing the money and their trust, we'd love to hear from you and see sort of what eventually worked. Hopefully it didn't get to court. That really is a last resort arbiter. But, you know, how did you figure out a way forward with the trust or the trustee?
- [22:03]
B
Yep. Okay, cool. Super interesting. All right, Ian, we'll love doing the episode, just the two of us and everybody, hopefully you enjoyed it as well. If you did, please don't forget to rate us 5 stars. Subscribe, share the episode with a friend or another advisor and tune back in for another episode in a couple weeks,
- [22:33]
A
Sam.