Trustees must build rapport with younger beneficiaries

When 28-year-old Brady lost his mother to a sudden illness, in addition to grief and loss came questions about how to manage a large trust created by his mother. The mother’s estate plan distributed her controlling interest in the family business and other assets into separate trusts for Brady and his siblings, with each trust governed by Brady’s uncle Charlie, as trustee.

His mother had passed away before she or Charlie had a chance to discuss her intentions with Brady. When Brady learned that he was the sole beneficiary of his trust, he wanted a say in its direction. After all, he had a strong network, including many entrepreneurially minded individuals who had succeeded in their own businesses. He thought the trust should be invested directly into several startup companies that focused on alternative energy, vegan milk and cannabis. He contacted the trustee right away and made several recommendations for deployment of the investable assets.

Brady perceived that Charlie was dismissing all his recommendations. He figured this was likely because he was young and Charlie had a paternalistic style. Charlie, however, was not opining on the strength of the recommendations. His legal advisers had told him that the ideas were in conflict with the constraints of the trust and his fiduciary responsibilities. According to the trust document, the trustee was allowed to retain the family business, although it represented a large concentration in the trust. As for the other assets of the trust, Charlie had an overall duty to diversify and invest them prudently. Charlie was told that risky investments in a handful of trendy companies would jeopardize the principal and violate the trustee’s legal duties.

Charlie explained to Brady that he was required to respect the rules as stated in the trust document. Therefore, he told Brady, as a trustee he could not act on the ideas Brady had suggested. After many heated discussions, Charlie sent Brady the trust document, which was full of legal jargon and was hard for Brady to follow. When Charlie tried to enforce the rules, Brady grew increasingly frustrated with his inability to control the trust. Animosity grew between Brady and Charlie to the point where it became a source of angst for Brady and an issue for the family. This was the exact opposite of his late mother’s intent.

Misunderstandings and conflict occurred here because of a lack of empathy for what each party brought to the relationship, based primarily on a lack of effective communication taking generational differences into account. Shifts in attitudes, preferences and behaviors are redefining many aspects of our culture, and estate planning is no exception.

There is rarely a one-size-fits-all approach to the trustee-beneficiary relationship. Generational divides between trustees and beneficiaries can present especially unique challenges.

By emphasizing engagement, encouraging the beneficiary to become an active participant in the trust and respecting the spirit of the beneficiary’s proposals, a well-prepared trustee can foster communication, ultimately reducing the likelihood of conflict and misunderstandings while honoring the intentions of the trust creator.

Overcoming obstacles
The primary criterion for choosing a trustee is the ability to communicate in a way that optimizes the chances for the relationship to thrive and for the trust to function as originally intended: as a tool for security and happiness. Here are some steps that trustees and grantors (trust creators) can take to increase the likelihood of a productive relationship between trustee and beneficiary.

• Identify beneficiary expectations set by the grantor. If possible, this should be discussed very clearly, as early as possible before a trustee is chosen. Discuss the values that the grantor is trying to incent with the trust. If the grantor is deceased, the trustee could interview family members or the family office to understand the grantor’s goals. It may be helpful for the beneficiary to participate in these interviews and hear from family firsthand.

• Work to understand what drives the beneficiary. The beneficiary’s main motivations may not be monetary. A trustee should strive to understand what makes the beneficiary tick. With this understanding, the trustee should seek to align investments with the beneficiary’s personal values, while honoring the parameters of the trust.

• Articulate the trust’s terms and goals in plain language. A trust document at its core is a contract. The beneficiary must understand the agreement in order to have a sense of what is reasonable and what is not. However, the trustee should avoid lecturing and instead mentor the beneficiary, or work with qualified advisers who can readily connect and explain trust and financial concepts in language the beneficiary understands. Using visuals such as flow charts and avoiding complex legal jargon can help with these discussions. The trustee, and any other advisers, should be respectful and approachable so the beneficiary doesn’t feel embarrassed to ask for help going forward.

• Leverage webinars and other self-study tools that can be accessed remotely. The trustee should take advantage of digital content to help educate the beneficiary, and identify possible solutions to cultivate areas of investment interest. Meeting the beneficiary halfway can show that the trustee respects their ideas and wants an engaged relationship. Could the trust, for instance, loan the beneficiary money to invest in a startup personally rather than making the startup an investment of the trust?

• Show graphically how proposed investments impact the trust over time. The trustee should explain factors affecting an investment’s performance to underscore the importance of prudent investment selection.

• Create a chart that shows the risk of concentration and the effects of overspending. The trustee can use real-life examples to illustrate how poorly managed resources can be quickly and irreversibly depleted. This will help the beneficiary understand the impact of their financial behaviors on the trust assets.

• Encourage the beneficiary to take an active role. The beneficiary should endeavor to learn more about the trust and the constraints of its structure, and should take steps to provide budgets and business plans behind their investment ideas.

Communication is key
A successful relationship requires ample patience and understanding. When the relationship involves parties from different generations, communication serves an essential role in the trustee’s ability to uphold the intentions of the trust creator as well as positively engage the beneficiary.

The family business owner should choose a trustee who takes steps to understand what really motivates the beneficiary. The trustee should seek to communicate with the beneficiary in a way that resonates with their style and preference. In the case of someone like Brady, taking advantage of savvy digital tools and using plain, understandable language can go a long way.                                                                  

Copyright 2019 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact

Avoiding problems that often arise with complex ownership structures

The wealthy family often has a myriad of entities and assets to manage. These typically include real estate holdings, trusts and various operating and investing companies, designed through the collaboration of skilled professionals. This complex structure provides the family a level of asset protection and a way to effectuate the transfer of wealth from the senior generation to junior family members.

When these structures are initially created and funded, the overall enterprise reflects the desires and wishes of the family (or at least those of the patriarch and matriarch). However, with the passage of time, transactions occur, distributions are made, assets are sold and replacements are purchased. Without careful consideration, the once-beautiful plan looks more like a tangled spider web. When this occurs, value might be lost and asset protection compromised. To prevent such negative effects, certain best practices should be implemented, particularly related to communications and the flow of funds.

Communication is crucial

The failure of a family enterprise to maximize its value is frequently traced to a lack of communication. Typically, communication lapses occur between the family and their advisers or among family members.

Family communication. Every family, especially those with high net worth, should have a mission statement and set of core values, which can provide guidance in making decisions. Of course, this is helpful when the senior generation is transitioning management and control, but it is imperative when the patriarch and matriarch are deceased. The family should make it a practice to formally review the values and mission when deliberating major decisions affecting the family enterprise. This emphasizes to family members that decisions are made based on merit rather than as a matter of personal preference. This understanding helps mitigate the likelihood of hurt feelings and personal agendas.

Another best practice in the area of family communication involves holding regular family meetings, including an annual meeting. The purpose of the family meeting is to encourage open and honest dialogue among family members. The style and content of the family meeting should mesh with the family dynamics. Some families choose the company boardroom with a formal agenda, while others conduct meetings over dinner. Some families include spouses, while many do not. Regardless, the goal is to facilitate dialogue and encourage cohesiveness among the family members.

Adviser communication. Lack of communication among family members can give rise to discord and interpersonal conflicts. Lack of communication between advisers and family members tends to result in technical problems, such as unintentional gifts, income tax issues or legal titling problems. Many of these can be corrected, but lost value or a missed opportunity is a potential consequence of each misunderstanding. The most common problems occur in the transfer of money, whether between the entities, between the family members or between entities and family members.

An annual review is a great way to ensure that transactions and arrangements are structured in the most advantageous manner. The scope of the review varies by family, but the adviser will generally analyze the financial records, the titling of new assets and the latest legal documents to determine the need for revision. Conducting the review annually enables the advisory team to identify issues in a timely manner and recommend modifications if needed. The adviser can present findings from the annual review at the annual family meeting. This assists the family in understanding the overall plan and structure while illustrating the importance of coordination within the plan.

Analyzing the options

Many arrangements involving entities within the family enterprise are made to satisfy a tax, legal or financial requirement. Failure to consider alternatives or to properly document the transaction can cause a variety of issues. Frequently, the problems within a family enterprise arise from trust distributions, promissory notes and family member compensation.

Trust distributions. Entities are typically created to accomplish one of two goals: to provide asset protection or to allow for fractionalized ownership. When distributions are made from the entities to the individuals, these benefits are lost. If assets are distributed from an irrevocable trust to an individual beneficiary, they become available to the claims of creditors and predators. If the goal of the trust is to provide asset protection, careful consideration should be made as to whether the distributions are necessary or even appropriate. In recent years with rising tax rates, particularly for investment income within a trust, the solution presented by many CPAs is to make income distributions to the beneficiaries. Since the individual beneficiaries are taxed at a lower rate than the trust, less money evaporates from the family in favor of the government. Although recommended by a tax accountant, this might not be in the best interest of the family. By making the distribution, there are significant tax savings but at the cost of lost asset protection.

For instance, consider Trust A, which has $100,000 of taxable income, taxed at a combined rate of 49.4% (a federal rate of 39.6%, plus net investment income tax rate of 3.8% plus a state income tax rate of 6%). The beneficiary, A, is taxed at a combined rate of 31% (a federal rate of 25%, plus a state income tax rate of 6%). If a distribution is made, more than $18,000 of tax savings is realized. The problem is that a distribution must occur to realize these savings. In this case, $100,000 moves from Trust A into A's personal bank account. Net of taxes, A is left with an additional $69,000 in his bank account, subject to the claims of his creditors and predators. In contrast, if the assets remain in Trust A, $49,400 will be paid in taxes, but the remaining $50,600 will stay beyond the reach of A's potential claimants. The question becomes, how important is asset protection to the family? If it is important, do not let tax strategies trump the overarching themes of the family plan.

Promissory notes. Family enterprises often include multiple partnerships or limited liability companies (LLCs), each containing a different collection of assets. Some entities generate positive net cash flow, while others do not. Similarly, some contain liquid assets, while others are highly illiquid in nature. This disparity frequently requires one entity to fund the operations of another. When this need arises, the structure must be carefully reviewed.

Each entity has a distinct reason for existing. For example, one company may hold real estate that has a higher risk for potential claims, while another might house a business enterprise that must file financial statements related to a government contract. Assuming both entities have cash reserves in excess of the anticipated operating needs and related contingencies, either could provide cash for another family entity. The structure for the movement of the cash, however, might be different. To get the cash from the real estate LLC, a member distribution makes sense. Assuming sufficient member basis, no adverse tax consequences result from a distribution. Additionally, the cash is theoretically out of reach from potential claims related to the property (subject to fraudulent conveyance statutes and applicable statutes of limitations). In contrast, the operating entity likely wants to show the strongest capital position possible. If a distribution is made, the company's capital is decreased. For this reason, the use of a promissory note might be the preferred mechanism. This way, an asset of equal value is still on the company's books, leaving equity unaffected. This is a simple example, and all facets must be considered to make the determination, such as ownership structure, asset growth rates and inclusion in the taxable estate. The advisory team should be consulted to determine the most appropriate course of action.

When a promissory note is deemed appropriate, a legally binding, written document should be drafted and executed. The note should incorporate proper language under the laws of the governing state, bearing interest at a rate equal to or exceeding the applicable federal rate prescribed by Sec. 1274(d) of the Internal Revenue Code to prevent any adverse transfer tax consequences. To corroborate the validity of this promissory note, payments should follow the terms of the note. Additionally, if there is a fee for untimely payments and a payment is late, the fee should be remitted. In short, do not ignore the substance of the document because of the relationship of the entities.

Family compensation. A family member providing services to one or more entities within the family enterprise needs a written agreement outlining the terms of service, executed by both parties. From a tax perspective, this provides support for the deduction taken on the corresponding tax return (though it is still subject to the reasonable compensation standard under Sec. 162 of the Internal Revenue Code). Perhaps more important, the agreement demonstrates to other family members that the compensation is being received for specific services and that terms were considered in advance of the payment. This arrangement is most valuable when one child is participating in day-to-day company operations while other children are inactive shareholders. In many instances, the non-participating children deem it unfair that the participating child receives compensation from the business in addition to any value from his or her ownership interest in the company. Again, an employment agreement spells out the requirements of the participating child in his or her role and the total compensation received (salary, bonuses, insurance, memberships, vehicles, vacation, etc.) and shows that the compensation received was neither arbitrary nor unwarranted. The degree to which the details of the arrangement are shared will vary from one family to another. However, at a minimum, the non-participating children should be aware that such an arrangement is in place and that the terms have been fairly negotiated. This communication can be as simple as mentioning it at the annual family meeting or the annual shareholders' meeting.

Creating an enduring legacy

The enterprise of a high-net-worth family often has a complex structure—and for good reason. Frequent and transparent conversations among the family members allow the family enterprise to grow in a unified direction. Consulting the advisory team regularly ensures that the structure of the enterprise matches the goals of the family. Through careful planning and meticulous execution, the overall enterprise will be positioned for efficient growth and protected from potential claimants. With clear goals, genuine consensus and adviser input, the family enterprise becomes something greater—an enduring legacy for future generations.

R. Jeremy Wilson, CPA, CFP is a manager in Draffin & Tucker's tax service group in Atlanta, where he focuses on high-net-worth individuals, closely held businesses, family-owned businesses and estates and trusts (

Copyright 2015 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact

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What your estate and trust plans say about your family legacy

As successful business owners, you understand that carefully crafted estate and trust plans provide the tools for families to safeguard assets and protect their financial security. But these plans can also ultimately help families create their legacies. How can you have confidence that the planning strategies used in estate and trust plans, as well as the fiduciary appointments made to carry them out, accurately capture your legacy goals and objectives? We believe a legacy conversation—thought-provoking questions that go beyond the numbers—is a crucial prelude to crafting and updating estate plans.

During these conversations, it is important to respect family beliefs and values, and to acknowledge and understand the power of family dynamics, if your family wants to build both wealth that endures and a legacy that lasts. A personal discovery process will help your family recognize your wealth transfer plans from two perspectives: generationally, which reveals how you experienced wealth transfer; and multigenerationally, which reveals how you intend to transfer wealth to others. Asking appropriate questions, or noting why something or someone is important, will help you and your advisers craft estate and trust plans that reflect your objectives.

Themes of the legacy journey

In our experience, effective family legacy conversations focus on three main areas: beliefs, values and relationships. We have found that family legacy goals typically complement estate and trust planning objectives. Many of you probably have estate and trust plans in place, so you know that they can often address only the tangible, or quantifiable, part of a person's legacy. You likely want the peace of mind that comes with knowing that your plans will be carried out as you intended, without disruptions or oversights that could incur unnecessary taxes, expenses or legal hassles. Legacy planning provides the framework; estate and trust planning provides the practical implementation.

Family beliefs. Beliefs come from an emotional connection to wealth and how money influences the decisions you make during your lifetime. Think about your first encounter with wealth. Was it positioned in a positive light? Did it have a strong impact? Or was it divisive, controlling or limiting? Your personal experience with wealth can influence the beliefs that form the foundation of a thoughtful and effective estate plan. Also, understanding your beliefs and their inherent connection to wealth may provide some clarity on your wealth transfer goals.

Significant wealth often fosters a desire to give back to society, encouraging both the ownership and stewardship of wealth. Families who share philanthropic interests often become mission-minded in their actions. Charitable interests become part of the family's outreach efforts and a way to connect with each other, even across generations.

The following are some questions about beliefs that may prompt a frank discussion about philanthropy and wealth transfer:

  • What are your core beliefs? For example, do you believe in "giving back" to the community, and should all family members share this belief?
  • What do you and your family want to be known for?
  • What character traits are hallmarks of your family?
  • What opportunities do you want to create for stewardship of wealth?

Family values. Values are the actions behind your beliefs. This "thread," or passion, that flows through your family can often explain family members' behavior, relationships and traditions. Family values can be shaped by how wealth was created, whether it be a rags-to-riches story filled with hard work, discipline and sacrifice, or a fortunate event. Knowing your family's values can provide a glimpse into their biases toward wealth and its potential to help or do harm.

Generally speaking, wealth can provide freedom from financial worry. For some families, this may mean building a conservative nest egg to satisfy living expenses, with the leeway to pursue careers, interests and charitable endeavors. For other families, financial freedom signifies everything negative about wealth and how time and energy can be wasted commodities. Deciding how you and your family view wealth can affect how you formulate your estate and trust plans.

Following are a few questions to consider when discussing family values during your legacy conversation:

  • What is the most important thing wealth can provide?
  • What values, both growing up and as an adult, have influenced you, positively or negatively?
  • What are your greatest accomplishments? Regrets?
  • What do you want the generations beyond your lifetime to know about you and your family?

Family relationships. A historical perspective on your family relationships can be as important as the state of the family's financial affairs. Delving into a family's history provides information on more than just the quantitative data. Looking beyond the numbers helps you to understand the qualitative aspects of wealth -- the "whys" that explain the behavior behind financial decision making. How individuals and generations view and assimilate wealth in their daily lives can be understood by looking back and seeing the path each person took on his or her journey. How you experienced wealth transfer in your lifetime may influence how you direct the people and organizations involved in your own plans.

In our role as advisers, we have encountered families who have developed complex arrangements to restrict and control access to wealth for family members. This often has much more to do with family dynamics—for example, family members' perceived ability to manage wealth—than with anything else. But these restrictions can cause permanent, sometimes irreparable, divisions among family members. This emphasizes even more the importance of communication when it comes to estate and trust plans, and your legacy.

Most families will agree that family dynamics present some challenges, and confronting issues in the present can be uncomfortable. But communications after the fact can be misconstrued, especially when delivered over multiple generations. By addressing issues through a constructive discovery process, estate and trust plans can be crafted and communicated with minimal conflict and misunderstanding.

Family dynamics often come into play in the appointing of fiduciaries. For example, it may be best to discuss decisions regarding trustee appointments with family members in advance rather than selecting individuals who the family feels may not be in the best position to serve as trustees. Some may consider being named as an executor or trustee as an honor, but other family members may see it as a responsibility they do not want. An executor or trustee position is a lot of work, involving fiduciary responsibilities and decision-making power. Before appointing an executor or trustee, honestly evaluate the person's talents and determine if he or she has the time to fulfill the duties and obligations of an executor or trustee. Often families may opt to use the services of a third party, an objective decision maker who is not burdened with family dynamics. Such a decision should come after a candid conversation with family members.

Here are several questions related to family relationships that may help you explore your family dynamics:

  • How much control do you want, and why?
  • How do you define fair versus equal? Are there ways to offer a balance?
  • Should your plan provide incentives or some form of compensation to help achieve a certain standard, preferred career choice or lifestyle consideration?
  • Based on the personal talent, education and family relationships that exist today and those that may be forged later, who is in the best position to manage, preserve and protect your family's wealth?
  • What skill sets do the people involved possess to manage, invest and distribute wealth with objectivity and authority?
  • Whom do you trust to carry out your wishes based on their personal knowledge of you, your family and your intentions? Are there family members, advisers or corporate entities you trust and, if so, why?

Creating a bridge from thought to action

Conversations about estate and trust planning should not focus just on financial wealth. We feel families who do so miss an opportunity to capture the legacy lived today and redefined through generations. These conversations should also include strategic matters, such as your personal inspiration and motivation, embracing who you are, where you have come from and how you want to be remembered.

Families often avoid discussing estate and trust plans openly. After a death, it is common for heirs to be surprised to learn the terms of the estate plan, that assets were left in trust and that others are named in a fiduciary capacity such as executor or trustee. It is much more effective to ask the right questions now that focus on your beliefs, values and relationships so that resources are allocated at the right time, to the right people and in the right amount.

The questions highlighted in this article only scratch the surface of any family legacy conversation. Creating estate and trust plans that reflect multigenerational concerns typically requires long-term thinking and planning with your advisers to consider all the challenges and opportunities for family members and organizations.

Alan Titus, J.D., senior fiduciary advisor at Hawthorn, PNC Family Wealth, contributed to this article.

Richard Aronson, J.D., CFP is managing director, fiduciary services, Benjamin Ciocco, J.D., is Pittsburgh market director, fiduciary services, and Karen Ann Stollar, CFP, is senior wealth strategist at Hawthorn, PNC Family Wealth ( Hawthorn is a multi-family office providing integrated wealth management solutions to families and individuals with investable assets of at least $20 million.

Copyright 2015 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact

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Dynasty trusts offer protection of family assets

In the course of my practice, I often run into situations like this: Robert and his wife have a net worth of $20 million, of which $15 million is an interest in a family business. Their heirs include children, grandchildren and great-grandchildren. If upon the death of the surviving spouse they leave everything to their children outright, the family business and any unspent assets may again be exposed to estate taxation at their children’s demise. The assets will also be exposed to dilution if their children divorce.

Robert wants to protect his assets from successive estate taxation in multiple generations and the effect of a child’s divorce on his transmitted wealth. He would consider transferring stock in trust. However, Robert is not interested in surrendering control of the company at this point.

Robert and his wife should consider transferring stock in the company to a dynasty trust. In 2013, an individual may transfer up to $5.25 million ($10.5 million per married couple) without paying a federal gift tax or generation-skipping transfer tax (assuming no prior taxable gifts). If Robert transfers non-voting stock or ownership, he will not lose any control in running the company. The net effect is that so long as the stock remains in trust, it will not be exposed to estate tax in later generations and, assuming the trust is properly drafted, the trust assets will be free from the claims of creditors, including divorcing spouses of his children, grandchildren and great-grandchildren.

What is a dynasty trust?

A dynasty trust is an irrevocable trust that leverages a person’s federal estate, gift and generation-skipping transfer tax (together referred to as “transfer tax”) exemptions for as many generations as applicable state law permits. Dynasty trusts enable wealth to be passed from generation to generation while minimizing or avoiding transfer taxes. Distributions to beneficiaries are structured to be discretionary, meaning that assets retained in the trust may grow for an unlimited number of future generations.

The beneficiaries of a dynasty trust are usually the grantor’s children, grandchildren and great-grandchildren. The trust’s operation is controlled by the trustee, who is initially appointed by the grantor. The dynasty trust is irrevocable, which means that once it is funded, the grantor will not have any control over the assets and will not be permitted to amend the trust terms.

Why create a dynasty trust?

Clients often create dynasty trusts to achieve a broad spectrum of personal, financial and tax goals:

• Benefiting many successive generations of family.

• Benefiting family members while preserving family values.

• Protecting trust assets from creditors. (Asset protection laws vary based upon governing federal and state law. The applicability of such laws also depends on the terms of the trust.)

• Protecting trust assets from divorcing spouses.

• Avoiding multiple levels of federal and state estate, gift and/or generation-skipping transfer taxes.

How dynasty trusts work

Dynasty trusts are usually established to last for an indefinite period and are normally funded with gifts. There is a practical limit on the amount that may be gifted without paying federal gift tax. Assuming no prior taxable gifts, each individual may make a lifetime gift of up to $5.25 million and incur no gift tax or generation-skipping transfer tax. A married couple may transfer up to $10.5 million. This amount is indexed for inflation and will increase each year. Taxable gifts will reduce the estate tax exemption available at death.

With family enterprises, additional leverage for the transaction may be achieved through the use of discounted values for transfer tax purposes. This is a reduction of the value of assets to be transferred, which serves to reduce the amount of the taxable gift. (Use of discounts, though legitimate where appropriate, is often the subject of IRS scrutiny. Valuation should be determined by a qualified appraiser. It is important to confer with your tax and legal advisers regarding the use of this technique.)

• The common approach is to restructure the ownership of a company to include both voting ownership and non-voting ownership. In a corporation this involves the recapitalization of the stock. In a limited liability company, it involves a change to the operating agreement.

• The non-voting ownership may then be gifted to the dynasty trust.

• The non-controlling or non-voting membership interests are often eligible for a reduced value from the standalone fair market value. This reduction is ordinarily 20% to 40% of the standalone value of the company’s assets. These reductions, or “discounts,” are attributable to a lack of a market for the interests transferred, and to the fact that there is no ability to control the outcome of (or vote on) company matters.

For maximum creditor and divorce protection, an independent trustee is used to make discretionary distributions and other tax-sensitive decisions. The primary beneficiary (usually the grantor’s children initially) can be given the power to remove and replace the independent trustee with or without cause. Additionally, the primary beneficiary can be the investment trustee of the discretionary dynasty trust and thus can make investment decisions over trust assets. This co-trusteeship, although more complex than having just one trustee, provides a greater combination of control, estate tax savings and creditor protection. When assets are owned by a dynasty trust, undistributed trust assets are protected from transfer taxes in future generations. Additionally, many dynasty trusts offer creditor protection as relating to the beneficiary’s creditors, including divorcing spouses.

Economic results of a powerful estate planning tool

Estate tax savings can be substantial with the use of dynasty trusts. Consider Robert’s situation. If Robert’s company is worth $15 million, and the value of the business appreciates at the rate of 7.2% per annum, that business will be worth $30 million in ten years. Using the techniques described above, Robert would restructure his company ownership to include both voting (1%) and non-voting (99%) interests. He would transfer only non-voting interests to the dynasty trust. A qualified appraiser advises the value of the non-voting interests is $10 million, for purposes of the transfer.

Without incurring any gift tax or generation-skipping transfer tax, Robert could transfer 99% of his company to the trust using his and his wife’s exemptions. As long as the stock stays in the trust, there would be no estate taxation on the future appreciation. With the current federal estate tax rate at 40%, the saving is self-evident.

Despite these benefits, it is important to recognize that assets in an irrevocable trust will not receive a step-up in basis upon the death of the grantor. Additionally, thought must be given to the annual income tax implications associated with the trust.

How to create a dynasty trust

Here are five tips for the successful planning of a dynasty trust (or any trust) and the issues typically involved:

1. Work with professionals. A financial adviser with specific expertise in estate planning, working in concert with an estate planning attorney, a tax adviser and, often, a valuation expert provides the necessary expertise to navigate a dynasty trust. A knowledgeable attorney, who understands the grantor’s situation, can also craft the appropriate discretionary clauses. Discretionary distributions can be conditioned on each beneficiary’s ability to support himself or herself. With so many options, dynasty trusts can be tailored to the client’s wishes.

2. When choosing your financial advisers, ask whether they deal with high-net-worth clients. Also ask about the types of fees you should expect to pay.

3. Be sure you understand how distributions will be made to your heirs.

4. Work with your adviser to carefully select the initial trustees and to determine the mechanism to select successor trustees. For instance, should your child be a trustee or co-trustee?

5. Determine how long you want your trusts to last; how you will fund the trusts; and if you will fund them during your lifetime, at death or both.

The friendliest ‘bank’

You can fund a dynasty trust with cash, stock or other assets, such as life insurance. Over time these assets may be converted to cash or cash equivalents such as marketable securities. Life insurance is often an excellent way to leverage the value of the assets to provide additional value. The dynasty trust may then serve as a “family bank” for future generations. The dynasty trust shares with a true bank the goals of accumulating, managing, preserving and distributing wealth. It can be a prime resource for funding family members’ financial needs for successive generations. Though a dynasty trust is not actually a bank, it could become the friendliest “bank” the trust beneficiaries might ever know.

A properly drafted, funded and operated dynasty trust can be a powerful and tax-efficient tool for helping to realize a family’s financial objectives. It can be especially appropriate for helping to preserve a family enterprise.

Quentin Sturm, J.D./CPA, is managing director at Creative Financial Group, a financial services firm in Newtown Square, Pa. ( Creative Financial Group is a general agency of New England Life Insurance Company.







Copyright 2013 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permssion from the publisher. For reprint information, contact

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Grantors must act to clarify the personal side of trusts

“Put not your trust in money, but put your money in trust,” advised Oliver Wendell Holmes Sr. Countless family businesses have taken this advice, placing operating family businesses under the control of trusts. They have good reasons for doing so.

Trusts can reduce or, in some cases, even eliminate estate taxes. They can protect business assets against claims arising from divorce, creditors or lawsuits. They can allow business leaders to take care of heirs who are too young, not business-minded or otherwise incapable of managing the affairs of the company.

Yet trusts involve trade-offs. A trust is a legal entity created by a grantor to hold assets that are managed to help beneficiaries. The grantors are usually the current generation of family leaders, while beneficiaries are typically a spouse and children. A trustee is a person or group of people (such as a bank) assigned to manage the trust for the beneficiaries in accordance with the terms of the trust. Beyond this simple and broad definition, trusts can become complex entities that may require the help of professional advisers to set up and maintain.

Trusts may involve a loss of direct control of the assets. Third-party management can range from meaningless to absolute. This issue is often very important to the family business leaders who are often the grantors of the trust. Problems sometimes occur if later generations feel they are competent to manage their affairs. The next generation may resent the presence and activities of a trustee.

Finally, trusts may serve as focal points for discontent and conflict among family members who view the trust and its management as anything but a benefit. The potential problems in such cases can be tough to overcome, especially in the cases of dynasty trusts intended to preserve assets across multiple generations. For instance, trusts may last much longer than people, requiring the replacement of the original trustees with new ones. Trustees often have very broad powers, and they may take actions that the current beneficiaries—and even the original grantors—would disagree with strongly.

The grantors’ responsibility

It’s up to the leaders who establish the trust to communicate its purpose, structure and activities—in writing or on video—to the later generations who will benefit from it. This is not an idle responsibility. Trustees may decide matters that are very much at odds with the wishes of the original grantor. For example, one case I’m familiar with involved a seventh-generation ranch held in trust. The trustee felt the best financial move was to sell the land. Such a move would have ignored the value the family placed on the land as their heritage and as a vital family legacy.

Grantors must explain to trustees and beneficiaries the reasons for establishing the trust and the objectives of the trust. It’s particularly important for grantors to stress that family members must present a united front to the trustees. When a trustee is confronted with a split decision, in which some of the beneficiaries favor one course of action and others favor an incompatible alternative, the trustee is likely to proceed at his or her discretion, possibly in a way that damages some family members. On the other hand, if beneficiaries hang together, they can reduce the odds that the trust assets will be disposed of in a way that they or the original grantor would object to.

A good example is the recently announced merger of SABMiller and MolsonCoors. The deal is highly significant for the beer industry, because MillerCoors will control 28% of the domestic market and represent a serious challenge to leader Anheuser-Busch. It’s also meaningful for the town of Golden, Colo., where Coors started more than a century ago and where MolsonCoors is headquartered today. Federal regulators are looking closely at the merger’s antitrust implications. But more important than any of these is getting approval of the Molson and Coors family trusts, which together control about 67% of Molson Coors’ voting shares. Both families are said to have endorsed the merger, but clearly, without their OK, nothing would happen.

Grantors should ensure that the trust documents include provisions for removing the trustee. It is usually difficult to remove a trustee, especially a corporate trustee like a bank, unless specific rules for removal are written into the trust documents. It may seem unlikely that a reliable family member or longtime reputable adviser would ever violate the spirit of the trust. But remember that a long-lived trust may eventually be overseen by a trustee who knows nothing of the original grantor’s desires.

Beneficiaries often disagree with the selection of a trustee who is also a family member. Feelings of favoritism can make it difficult to achieve the unity that is necessary for a smoothly functioning relationship between trustee and beneficiaries. Appointing several family members as trustees can ease this problem but may also make the trust hard to govern if opposing interests tussle over management. Current leaders must explain their rationale for the selection of trustees and try to get all parties to agree that selection was sound.

Addressing delicate issues

Trusts are necessarily somewhat abstract legal entities established to deal with contingencies that are both distant and unpleasant, since trusts usually involve the death of the current leadership. They also call for surrendering control, which family business leaders typically are extremely reluctant to relinquish.

Not unsurprisingly, because of the delicate issues involved combined with the complexities of trusts, many business leaders fail to investigate or implement them. That’s unfortunate, because trusts are a powerful tool for estate planning and ensuring the continuation of the family enterprise.

Family business leaders should, at the very least, investigate the suitability of placing assets of an operating family business into a trust. And they should also prepare themselves for the vital and sometimes very difficult job of managing the succession issues that can arise when an operating family business is owned by a trust.

There is no shortage of expert legal and accounting advice to help with the technical job of structuring, implementing and managing a trust. But the purely personal side of a trust is of equal importance. The grantor is the only one who can take on this challenge. The family business leaders themselves are the sole source of the authority, experience and caring that are necessary to help reduce conflicts between beneficiaries and trustees of family business trusts. A well-placed word now can avoid trouble in future generations.

James Olan Hutcheson ( is the founder of ReGENERATION Partners, a consulting group dedicated to working with family-owned and -managed enterprises.

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Dissident trust beneficiaries can alter power dynamics

High-profile legal battles have increased the burden on trustees. Two examples come to mind: Liesel Pritzker's suit against her father for $1.6 billion over his handling of her trust, and Bruce Winston's suit against Bankers Trust for $1.3 billion on claims that it mismanaged the trust's ownership in legendary diamond company Harry Winston Inc.

Grantors generally create trusts to hold family business stock for three reasons:

• To avoid or defer taxes on company shares.

• To prevent their children or grandchildren from knowing how much wealth they will inherit.

• To protect the business from being run into the ground by the next generation.

But after the senior generation is gone and their beneficiaries succeed them as managers of the company, the dynamics of power, control and information flow can become tricky.

Take, for example, the case of one of my clients, a second-generation family business involved in manufacturing and distributing cleaning products. Before his death, the founder had named the local bank and trust company as the trustee for the family business shares he placed in a trust. After his death, two of his sons, who shared power in the company, created very ambitious strategic growth plans, which included developing some facilities in China.

Over several meetings, the board weighed the advantages of Far East sourcing against the possible risks of such an investment. With the help of an adviser, the board presented the strategy at great length to the family council, which included the founder's widow as well as three other children. Ultimately, the family council voted to go forward. To finance the China project, the board decided to seek private equity to fund what it considered to be a very lucrative investment for the company, with limited downside.

Prior to the closing of the financing, family representatives informed the trustee of their intention to seek private equity to fund the Chinese project. But the bank and trust company opposed the expansion and the financing, despite the beneficiaries' unanimous support of the venture. This resulted in a lengthy legal battle between the trustee and the beneficiaries, which jeopardized the private equity financing and ultimately the China project.

Why has it become so difficult for trustees to exercise their fiduciary responsibilities?

• The generational transition often weakens the relationship between the beneficiaries and the trustees. Many trusts that contain family business stock were established by a senior-generation member who found and named a trustee, typically a bank or an adviser with whom he'd had a long-term relationship. As the beneficiaries come of age, many of them assume leadership roles in the business. When the senior generation edges out of the business, beneficiaries may become anxious about the trustee's job performance and whether the trustee is acting in their best interest.

• Significant appreciation of the value of assets in trust, especially private company stock, owing to mergers and acquisitions along with appreciation in the private markets. This development has raised the stakes. Trustees must ensure they are acting in the best interest of the beneficiary, and within the guidelines under which the trust originally was set up. Trustees may believe it's prudent to sell highly appreciated shares and invest them in a more diversified portfolio.

• Recent growth in the financial services industry has resulted in many trustees developing extensive asset-management capabilities. Trustees may face an awkward conflict of interest, since they could potentially manage the assets and earn significant asset fees in trust when a liquidity event arises.

In fact, that seemed to be the case with the company whose trustees nixed the private equity deal. We had to get lawyers involved to educate the trustees and exert some pressure on them. Ultimately they agreed to vote to allow the financing to proceed.

But the situation might have been avoided had the trustees found ways to improve relations with the beneficiaries. Some recommendations:

1. Know what's in the trust. Trustees must know the value of the assets included in the trust and the options available to them to maximize the value for the beneficiaries. In today's capital market, options abound for enhancing trust assets. Strategic opportunities may further the growth of the business. Liquidity opportunities through the private equity market or the strategic market may spark interest in recapitalizations or refinancing.

2. Know the beneficiaries. What are their views of the business and the trust? What are their liquidity needs? It's possible to ascertain this information through regular contact with the beneficiaries. In larger families, tools such as beneficiary surveys could provide information to trustees.

3. Open the lines of communication. It behooves trustees to initiate and maintain communication with beneficiaries. The heirs must be aware of the assets held in trust. At the same time, the beneficiaries must communicate their needs and desires to trustees.

The ‘trust effect'

An outside adviser can help trustees to perform their fiduciary duties by evaluating the assets in the trust and the options available to maximize the value of these assets. Such a resource person may assist by performing beneficiary surveys and developing other methods of communication with beneficiaries. He or she can also offer an objective viewpoint.

An atmosphere of open communication, objectivity and free information flow will create a “trust effect”—a strengthening of underlying relationships, bringing trustees and beneficiaries together to harmoniously work through issues affecting the trust and the assets within it. After all, that is what the grantor of the trust intended.

François de Visscher is founder and partner at de Visscher & Co., a Greenwich, Conn., financial consulting and investment banking firm for closely held and family companies (

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Generation Skipping

Until Congress enacted the generation-skipping transfer tax in 1986, passing assets to grandchildren was an excellent way to help keep a business in the family. Under current law, wealth transferred directly to grandchildren is subject to a 55 percent tax, the equivalent of the top estate tax rate. The modest exemption allowed—$1 million for each grandparent—would not be enough to transfer a business of any size directly to the grandkids.

A new estate planning strategy, however, promises to leverage the amount of wealth that can be transferred to grandchildren. The strategy has been discussed at recent conferences of leading tax attorneys who are already using it. Although it has not yet been tested in the tax courts, the attorneys believe it will stand up to IRS attack if properly designed. If so, the technique may make it possible to transfer $20 million to $30 million or more in family business stock or other assets.

The technique requires setting up an "intentionally defective" grantor trust with generation-skipping provisions. Here's how it works:

The grandparent-grantor sets up an irrevocable trust for a grandchild or group of grandchildren. The trust then buys family business stock from the grandparent using an installment sale note. The sale does not trigger income taxes or capital gains taxes for the grandfather. In addition, his estate is "frozen," since the appreciating stock is sold for the installment note. The transaction thus removes from the estate any appreciation in the stock value after it is sold. And since the transfer is a sale not a gift, it is not subject to gift tax or generation-skipping tax.

In order to pass muster with the IRS as an arm's-length transaction and not an attempt to evade taxes, the trust must have some resources in it to begin with. Such installment sales are likely to be viewed more favorably if there's at least 10 percent of the purchase price in the trust. The promissory note and other requirements must be met before the transaction can qualify as an arm's-length transaction.

Let's say the grandparent-grantor puts into the trust the $1 million in assets that's exempt from the generation-skipping tax. The trustee then buys 10 times that amount of family business stock from the grantor—a total of $10 million.

The grantor is given a promissory note for the $10 million and is paid interest by the trust. The trust is designed to be "intentionally defective" so that the grantor continues to pay income tax on any earnings or dividends from the stock now in the trust. In other words, for income tax purposes, no sale has actually taken place.

The same goes for purposes of the capital gains tax. No sale, no taxable gain. The $10-million note does remain in the grantor's estate, but not the stock, which presumably will appreciate in businesses that grow substantially. If the trust is designed to hold S Corp. stock, the distributions that flow to the trust can be used to satisfy interest obligations on the note.

It's easy to see how such a transaction can enhance the tax benefits of the transferred assets. If both grandparents put $1 million in the trust, the trustee can purchase up to $20 million of family business stock or other assets. And if the trust purchases units of a family limited partnership (holding C Corp. shares) instead of buying the stock directly, it could be worth as much as $30 million, as a result of the discount given to partnership units because of lack of stock marketability

As indicated, this strategy is still very new and business owners should consult their tax advisers about the risks. If the IRS successfully challenges the valuation of the stock sold, for example, the assets could be drawn back into the grandparent's estate. That is why a good appraisal before transferring the assets is essential. The tax courts have lately been ruling that valuation discounts for lack of control or lack of marketability cannot be arbitrarily determined; a solid rationale must be established for the discount used.

Regular purchases or sales of family business stock to nonfamily members can provide some basis for determining value, even though the price in such sales may be below book value. A recent volume provides a comprehensive method for establishing the value of closely held stock: "Quantifying Marketability Discounts" by Z. Christopher Mercer (Peabody Publishing, Memphis, TN; phone 901-685-2120) may set a standard for the field.

If sales to a defective trust prove to be an effective strategy, it will be helpful not only to the grandparents' tax planning but to that of their adult children—that is, the grandchildren's parents. Typically in families that are using this technique, the grandparents are in their 80s, the parents are in their 60s, and the grandchildren may be in their 30s and 40s and already working in the business. The parents are themselves thinking about retirement, so generation-skipping in the transfer of assets helps to prevent a buildup of appreciated assets in their estates, too. For example, the grandparent could gift (or sell) voting shares to his children and put non-voting stock in a trust for grandchildren.


Our firm sees the generation-skipping trust not just as a tax strategy but as a powerful way to promote understanding and harmony in the family. When some trust beneficiaries are running the business while the others have different careers, the group has to work together to manage the trust. This cooperation can be furthered by provisions in the trust agreements that encourage active involvement of family members in the administration of the trust. For example, there can be provisions to create committees of beneficiaries to vote the trust shares; or, if it's non-voting stock, to interact with those who have voting shares; or to oversee trust investments.

Trust beneficiaries have long complained about being in the dark about assets left to them, and their lack of control over these assets. Beneficiaries of family business assets become more excited about their shared future and retaining the business in the family if they are part of the decision-making before and after agreements are set in stone. Ultimately, this could be the most important benefit of the new strategy, not just for the grandkids but for those who come after.


Mike Cohn is a family business consultant and president of the Cohn Financial Group Inc. in Phoenix. He is author of "Passing the Torch: Succession, Retirement, and Estate Planning in Family Owned Businesses" (McGraw Hill, 2nd edition, 1992).

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The New Frontier in Asset Protection

To protect wealth from the claims of creditors, litigious spouses, and the rulings of courts, Americans in recent years have moved billions of dollars in assets offshore. Some 17 jurisdictions, from Belize in Central America to the Channel Islands off the Normandy coast to the tiny island of Vanuatu in the South Pacific, have passed laws making it difficult for creditors to seize assets held in trusts set up on their territory. Proponents of offshore asset-protection trusts argue that they have legitimate uses and that many business owners and high net-worth individuals benefit from them. Doubters, however, argue that the trusts carry serious political risks and are used largely by those who, for one reason or another, seek to evade the U.S. legal system.

Now business owners who don't want to expose themselves to the risks of going offshore have an alternative. A recent law in Alaska permits you to set up a trust in which you remain a possible beneficiary while keeping the trust assets beyond the reach of creditors and out of your estate. Only one caution: Your life should be in order when you create an Alaskan trust, because if it's set up for the specific purpose of avoiding an imminent threat to your assets, the act will be considered a "fraudulent conveyance."

Under legislation passed in April 1997, Alaska became the first state to prevent creditors from seizing assets in a trust from which the grantor may benefit. The statue was written by a New York attorney, Jonathan G. Blattmachr, who says the new trusts pose a challenge to the whole offshore asset-protection-trust industry. Individuals and businesses, he argues, can now seek the same protection within the safest and most stable legal system on earth—that of the United States—by setting up an Alaskan trust.

Under a well-developed body of law, assets transferred to a lifetime trust will not be considered part of your estate when you die as long as you retain no right to benefit from or to control those assets. If the trust is legally subject to the claims of creditors, however, the assets will be included in your estate.

In most and perhaps all states, you can name yourself as one of the beneficiaries of a trust along with, say, your spouse, your children, and grandchildren. This doesn't mean you're automatically entitled to receive income from the trust or to get back the trust assets upon request. It means the trustee is authorized to make payouts to you, if, in his discretion, your request is reasonable. Since corporate trustees tend to do what the beneficiaries want, they are likely to make such payouts—for example, if you suddenly fall on hard times and need money.

Assets in such trusts are still allowed to accumulate estate-tax free. But in every state save Alaska (and possibly Delaware, which is weighing a similar statute), the assets would be liable to the claims of creditors because you are a possible beneficiary. Therefore, the trust contents will be subject to estate tax when you die.

As indicated, an Alaska trust will not protect your assets from creditors if it can be demonstrated that it was set up in the first place to avoid a court judgment or some other immediate threat such as the claims of a divorcing spouse. Blattmachr, who is with Milbank, Tweed, Hadley & McCloy, the largest estate planning firm in New York, says clients who come to him seeking offshore asset protection usually have just such evasions in mind. They're breaking up with a spouse and want to put their assets beyond the spouse's reach; or they're on the brink of declaring bankruptcy and want to minimize what their creditors can hope to grab; or there is a court judgment pending against them for a car accident in which several people were seriously injured.

Many offshore jurisdictions that do a big business in trusts do not have rules against fraudulent transfers. Others have rules with convenient exemptions, according to Blattmachr. For example, they may specifically exclude spouses from seizing the assets. Some favorite offshore jurisdictions require people trying to seize assets to prove beyond a reasonable doubt that the fraudulent transfer was directed specifically against them and not against any claimants.

"Some of these places don't just say, 'You can create an asset protection trust here,'" notes Blattmachr. "They have passed laws prohibiting their courts from enforcing an American judgment against assets in the trusts." The lawyer who has won his case in a U.S. court may thus face insuperable difficulties in collecting on the judgment. "You'll have to retry the case in another jurisdiction," according to Blattmachr. "You'll have to bring your witnesses and documentary evidence 12,500 miles to a place you can't find on a map. You'll have to prove your case beyond a reasonable doubt and not just by a preponderance of evidence."

Judges in the U.S. bankruptcy courts tend to take a dim view of offshore transfers that appear to have been set up under pressure from creditor claims and threats of lawsuits. In one recent case (In re Portnoy, 1996), a New York businessman seeking a discharge in bankruptcy argued that the judge had no jurisdiction over a trust he had set up in the Channel Islands. The Marine Midland Bank was seeking to collect on a $1 million business loan for which Portnoy had given a personal guarantee. Denying his motion for a summary judgment, the judge ruled that he had created the trust soon after learning the bank would call the loan, and had concealed it from the bank. Portnoy was, moreover, a beneficiary of the trust; he retained the right to use of the assets.

While the judge may not have had jurisdiction over the trust, she made it very clear that the court did have power to determine whether Portnoy was entitled to bankruptcy protection. "If you want a discharge in bankruptcy but have done something to evade the American legal system," says Blattmachr, "don't expect a judge to come out in your favor."

The Alaska Trust Act is still fairly new and untested, and lawyers who specialize in setting up offshore asset trusts suggest it may not work as advertised. They argue that claimants will be able to seize assets in an Alaskan trust simply by getting a court judgment in another state. Under the "full faith and credit" clause of the U.S. Constitution, courts in one state honor the judgments of courts in every other state.

Blattmachr disagrees. He contends that Alaskan courts would honor another state's judgment against an individual, but would permit access only to the individual's assets and not assets held in a trust created under the new statute.

It should be pointed out that there are other ways to tuck away assets so that they are immune from creditor claims. In some states, cash inside an annuity contract is exempt from such claims—again, unless put there for the specific purpose of defrauding someone. Blattmachr calls such annuities "a phenomenal deal" in the various states that permit the exemption, but points out that Alaskan trusts have unique advantages as well.

Asset protection wasn't the main reason Blattmachr wanted the state of Alaska to adopt the new trust law. He believes the statute opens up a new dimension to estate planning. The biggest benefit of an Alaskan trust, he says, is that it enables the grantor to be an eligible beneficiary and still have such protection.

Yet very few of his clients have so far come forward to set up such a trust. Why? It's human nature. People just have a mental block to kissing assets goodbye forever by putting them in a lifetime trust—even if it will ultimately redound to the heirs' benefit. Blattmachr's point is that people don't have to do that when they create an Alaska trust.

"Under the Alaska statute, the trust is perpetual. You can gift $1 million to it now, and it can grow forever. You and your heirs will never have to pay tax on it. If you live another 30 years and trust assets are invested wisely, they could be worth $30 million when you die.

"The problem is, people say, 'Well, what happens if I need that $1 million some day?' The Alaska statute breaks down that psychological barrier. If the trust creator falls on hard times, he can go to the trustee and say, 'How about giving me some of that money back?' And the trustee does it. Of course, you've wasted the [gift tax] exemption. But that should make the IRS happy."

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Prisoners of Distrust

It is often said that wealthy people create trusts for their heirs mostly out of distrust. They do not trust the beneficiaries to use the money wisely and avoid exploitation by unscrupulous people. Likewise, when estate planning professionals set up trusts, they tend to focus too exclusively on tax and legal issues. The elaborate strategies they devise are effective in protecting the money and shielding the heirs, but often neglect the heirs' own needs to learn about life and develop into mature adults.

I know something about all this because I was an inheritor myself and because I have interviewed and worked with many inheritors and their parents. I have heard six common reasons for setting up a trust for one’s heirs. Let me examine each of the six and explain why I think each can turn into more of a burden than a blessing because of the psychological handcuffs they create.

1. Avoiding taxes. Hardly anyone outside of the IRS is going to question the goal of using trusts to avoid taxes. Almost everyone approves of doing all that is permissible to minimize what goes to the tax collectors. Yet some heirs who have been hurt by trust arrangements will tell you that the tax savings were not really worth it.

Not long ago I consulted with a family in which the father chose to pay an extra $100,000 in taxes in order to treat his children equitably in their inheritance. This man's father had set up trusts that had the effect of favoring one of his grandchildren over the others. Judging that the emotional impact on his children of any such unfairness was more important than the money itself, he chose to set up trusts for them that corrected the inequity but cost more in taxes.

2. Protecting children until they are mature. This is also a laudable motive, but subject to misuse. For example, a woman whose trust fund is still controlled by her father keeps asking him when she is going to be mature enough to handle her own financial affairs. This woman is 35 years old and has had years of psychoanalysis. She feels strongly that his refusal to relinquish control of the money means that he doesn't trust or respect her.

Seeing and treating young people as immature often becomes a self-fulfilling prophecy: They don't grow up. This kind of overprotectiveness applies particularly to daughters. A number of my female clients have complained bitterly about how their fathers have withheld from them information and responsibilities that were given to their brothers.

3. Preventing children from making costly mistakes. A well-intended idea that may have a psychic toll. Testing one's capabilities by taking risks is an essential element in growing up. We all learn from our mistakes, often painfully, but most of us don't seem able to do it any other way. Overprotectiveness is a major factor in the slow maturation of many inheritors. One symptom is indecisiveness and inability to reach closure on many decisions in their lives, such as whether to leave the parental home and establish their own home or whether to end an unsatisfactory love relationship.

4. Guarding inheritors from the world's dangers. Certainly the world is a dangerous place, moreso perhaps for the rich. Inheritors can and often do get involved with people and causes that are dubious in terms of good judgment, ethics, even legality. “When a man of wealth and a man of experience get together,” says the proverb, “the man of experience gains wealth while the man of wealth gains experience.”

But parents need to balance the risk that their children will be cheated or make foolish use of their inheritance against their need to experiment and learn from experience in order to become responsible adults. Wealthy parents usually provide their children with the best possible academic educations, but too often seem to be unaware of the need for education in the school of life. Children have to learn about living, about themselves, and about how to function in the world. This education comes mainly from life experience and often from making mistakes, rarely from the advice of parents or teachers.

5. Maintaining control over the children's lives. The motives for this reason to set up a trust are often shadowy. Most parents who seek such control know, or learn painfully, that this doesn’t sit well with the children. Yet trusts are often used in this way long after the children have become adults and such parental control is appropriate. I have heard many potential heirs describe, with sadness and anger, how their parents have held out the promise of inheritance, and the threat of disinheritance, in an effort to coerce them into behaving in ways that are satisfactory to the parents or trustees.

One way that parents stay in control is by setting up trusts and legal systems that are so intricate that it is nearly impossible for inheritors to know where they stand. A surprising number of wealthy young adults are in the dark about the extent of the family fortune, how much will come to them, in what form, and when. This means that they will have difficulty planning their lives.

One form of this sort of control is forcing children to work in the family business, without taking into account their talents and inclinations. Sometimes an invitation to work in the family enterprise is an opportunity for a young heir that is consistent with the person’s career aspirations. But many heirs spend their working lives in occupations that don’t really suit them, at great emotional cost to themselves and often to others.

Of course, children do need to demonstrate a certain level of maturity and competence before they can be given responsible jobs or control over a great deal of money. But there is a clear and crucial difference between making the distribution of a fortune dependent upon demonstrated maturity and trying to fit children into a mold. The latter fails to honor the children and permit them to become the individuals they really are and want to be.

6. Establishing and continuing a dynasty. Some rich people try for immortality by establishing monuments of various kinds. Others establish trusts. This last reason is the one with the greatest potential for damaging inheritors. Wealthy parents, I have learned, can become quite captivated by the prospect of having their descendants continue their legacy—the American equivalent of the European aristocracy. They set up trusts that provide not just for their children but for future generations.

While their stated purpose is usually to provide for the security of grandchildren and great-grandchildren, too often the real purpose is a form of self-aggrandizement. One clue is that most of the trust instruments in these cases are named after the donors and not the beneficiaries.

To me, healthy, well-functioning adult children are a much more satisfactory form of immortality. A young couple I know embraced exactly this philosophy in their estate planning. Their parents and grandparents had set up a dynastic system of trusts of extraordinary complexity and stringency. The young couple decided, instead, to leave their own money directly to their children, with no provision for future generations. Their principal reasons: They felt that it was important that their children know that it was up to them to provide for their own children, and that their parents trusted them to assume this responsibility in their own ways.

In a family meeting that I facilitated, it became clear that two of the children wanted the money to come directly to them, while the third felt that some of her inheritance should be left to her children-to-be, so they would have the satisfaction of knowing that their grandfather cared deeply about them. The family worked out separate arrangements for the third.

Now consider the case of a wealthy father who tried to force his four children to hold onto their fortunes for the sake of future generations, to make sure that they put more into the pool of funds managed by the family office than they took out. The father's dynastic ambitions clearly backfired. The offspring rebelled against his attempt to get them to operate as a family unit and found ways to get around it that, in the long run, were destructive of their own happiness. Three of the four have not had any children of their own—and probably never will. All four have also steadfastly refused to have much to do with one another or to cooperate in sharing and maintaining family properties.

I am not opposed to trusts. They obviously have their uses in reducing taxes and in protecting immature young inheritors until they are ready to be responsible guardians of their own money. My only concern is that in creating trusts—and wills and other documents—parents make sure that the process enlarges the opportunities for children to become well-functioning adults rather than retard their development and maturation.

Let me offer, then, several suggestions to parents considering the creation of trusts for their offspring.

First, make clear to the professionals with whom you work that you do not want your estate plans to appear to dictate behavior or impose other restrictions that may frustrate the beneficiaries in pursuing their own life goals.

Second, consider the process of drawing up trusts (or wills) as an opportunity, not just a duty. It is an ideal time to clarify your own values and ideals—to make a personal statement to your children about what really matters to you. Few of us ever do a very good job of communicating what we care about most deeply to those we love. These messages can be very meaningful and moving for the beneficiaries long afterward.

Third, be sure to keep your children informed and involve them in decisions regarding their inheritance. Set up meetings at which you and your financial advisers make presentations that clarify the inheritance arrangements for them and clear up any points at issue. It is often useful, too, for the family to meet without attorneys or other professionals to discuss the estate planning process. Involving children in the process doesn't mean democracy—the kids don't get an equal vote. But their views should be heard and respected as the parents make their decisions.

Fourth, avoid the flaw, so common in trusts and wills, of delaying too long in giving responsibility to inheritors. Withholding responsibility and power too long from children, or imposing rigid restrictions on them, is usually interpreted as a lack of trust. If their parents don't trust them, they may come to feel that they cannot trust or respect themselves.

Obviously, there is no simple way to safeguard an inheritance completely against foolish behavior while allowing beneficiaries use of the funds for their needs and development. Families have found a few formulas that seem reasonable. One way, for example, is to divide the inheritance into three allotments (not necessarily equal), with the first going to them at age 21 and the next two at intervals of 5 to 10 years—often contingent upon demonstration of some ability to handle the money responsibly.

Fifth, consider including a charitable element in your estate. The tax savings from setting up a charitable remainder trust, for instance, can be considerable. Just as important, however, is the example that parents set by putting all or part of their estate into such a trust. Especially when the parents work out trust arrangements jointly with their children—which I believe they should—they make it clear that philanthropy is a major value for them. I have found that inheritors who lead productive and satisfying lives are, surprisingly often, the ones for whom philanthropy is, likewise, a major activity.


John L. Levy, a consultant in Mill Valley, CA, counsels parents, children, professional advisers, and therapists on the emotional consequences and problems of inheriting wealth.


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A Death Benefit That Saves Taxes

One of the most underutilized business and personal planning tools is the Voluntary Employees’ Beneficiary Association trust, which provides a death benefit for employees who participate. When a VEBA is structured correctly, the family business owner often reaps great benefits. Like life insurance, the VEBA pays when a participant dies, and the money can be used to pay estate taxes. Normally, however, life insurance premiums are not tax deductible, and when the benefits are received, estate taxes and possibly excise tax must be paid. The contributions to a VEBA, which is a trust, are tax deductible, and the payout is free of estate taxes, excise taxes, and gift taxes if structured properly.

VEBAs can be set up by any type of family business entity. They are often used in addition to pension and profit-sharing plans, but because of the costs involved, they are most appropriate for owners who make in excess of $200,000 a year and pay $30,000 or more in taxes annually.

VEBAs have been used by large corporations and union organizations for decades. However, for smaller firms, the best way to use them is to join an existing VEBA that has already received a favorable letter of determination from the Internal Revenue Service. VEBAs must have an approved independent trustee—typically a bank.

Technically speaking, a VEBA is an employee health and welfare benefit plan, authorized under Section 501(c)(9) of the IRS code. It is a tax exempt trust that provides benefits to its members. The bank is the trustee, owns the insurance contract, and pays when an employee dies. The company makes the annual contributions for eligible employees who wish to participate (usually $200 to $800 per participant). The contributions are tax deductible to the company, and the ultimate estate tax benefits to the family far outdistance the costs.

As with a company pension or profit-sharing plan, participation in a VEBA must be open to any and all employees who are eligible and interested. If a person joins and dies while employed by the company, a death benefit is paid to his designated beneficiary. However, if an employee leaves the company, he is no longer enrolled, and the contributions on his behalf remain behind.

Since the IRS considers the company’s contribution for each enrollee to be an employee benefit, each enrollee must pay annual income tax on the value of the contribution. Typically, the yearly cost to the employee will be a few hundred dollars, and those employees who are interested in long-term estate planning will likely be the ones who will join.

This leaves the family business owner in a good position; he benefits from the plan, the costs are paid by the company, and the company ends up covering the cost of only the participants. In most cases, since benefits are based on the ages of the participants and a multiple of their compensation, 85 to 90 percent of the plan’s contributions to the trust will apply to the life of the owner. The plan can be set up to continue to cover a retired employee, such as the owner, who meets certain criteria.

When the owner dies, the benefit is paid from the trustee (the bank) to an irrevocable trust, which the survivor can use to cover estate taxes. Because the benefit is in trust, it is not included in the estate, saving the family more money. In contrast, life insurance can be put into an irrevocable trust, but the premiums are not tax deductible, and if they are large, gift taxes will have to be paid also. If funds are left over after the estate taxes are paid, they go to the survivor without any income or gift tax.

The workings of a VEBA may seem complicated, so let’s consider a brief example. Plastics Plus Inc. is a $10 million pet products manufacturer founded by a husband and wife, each about 65 years of age. Three sons are in the business, each in his 30s, and there are 10 employees. The parents determine that an annual company contribution of $250,000 to the VEBA will cover their estate planning needs. The three sons, and five nonfamily employees, are the eligible employees who decide to join; Plastics Plus will pay about $800 a year for each of them. Should either spouse die, their beneficiaries would receive about $2.5 million—income-tax, excise-tax, and gift-tax free, and the benefit can be structured to be estate-tax free. The VEBA would continue to cover the sons and the five nonfamily employees as long as they remained at Plastics Plus.

The downside is that the company must pay the annual costs. Also, as noted, each participant must pay income tax on the annual economic benefit received from the plan.


The fine print


There are a number of very specific requirements for a VEBA. There must be at least two participants in a plan (a spouse who works at the company qualifies). The benefits are based on annual compensation and age. All full-time employees who have completed up to three years of service and are at least 21 are eligible, although employees who are represented by a collective bargaining unit may be excluded. A VEBA must comply with some ERISA rules, including the 505(b) non-discrimination requirements.

The VEBA’s assets are not held in any one participant’s name. Instead each employer’s plan assets are held in an unallocated reserve for the exclusive benefit of the participants, their dependents, and their beneficiaries. The plan prohibits any reversion of assets to the employer sponsor; however, the plan can be amended or terminated by the employer at any time.

The IRS considers a death benefit to be a taxable economic benefit. No employee is required to participate in the program.

The survivor benefits can be constructed so that they will not be subject to income or estate taxes because participants have no “incidents of ownership” in the assets. The VEBA trustee is the owner and beneficiary of all contracts. The participant has no vested interest, other than the right to receive and convert the bare contract (no cash value) to individual ownership upon termination of employment. To avoid the estate tax, a participant should make an irrevocable designation of a beneficiary; a trust for the benefit of one’s family would create the greatest advantage in most cases.

Oftentimes, owners consider a VEBA when they reach the limit of tax deductible contributions they can make to pension or profit-sharing plans. Under a 401(k) plan, for example, the most an owner making $250,000 can contribute tax deferred per year is $9,000—not much, given the salary. VEBAs provide a way to accrue more long-term benefits using tax-deferred contributions, and create a tax-free means for paying estate taxes.

Because VEBAs are not yet widely used among small and mid-sized businesses, the family’s biggest initial challenge may be finding an organization that administers a VEBA, and finding a financial management company that can properly design and administer a program. More firms are beginning to offer these services. Owners who find possible providers should ask if they have a comprehensive due diligence package with a credible legal opinion and letter of determination; whether the VEBA in question follows the appropriate compliance requirements; and what other organizations it has worked with—accounting firms, law firms, financial institutions, educational forums—in setting up and administering VEBAs. Once an owner is satisfied in having found an appropriate sponsor, he can begin to implement the plan.


Allen F. Ross is chief business strategist for Asset Accumulation Inc. in Plainview, NY, a tax-oriented strategies consulting firm.


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