For any individual or family, proper portfolio management requires an ongoing strategy that is designed to meet both short- and long-term financial objectives. However, in the wealth management arena, portfolio management stretches beyond day-to-day investment decisions. It often requires a structure that can help consolidate the control and ongoing management of wealth and allow for the distribution of assets to beneficiaries both now and in the future. For this reason, the use of trusts can be an effective solution for those looking to marry investment wealth with their overall wealth management plan.
Like a will, a trust is a critical part of an effective estate plan. Estates can be as diverse as the individuals who own them, and the flexibility of the trust instrument makes it useful for a variety of wealth management needs, including consolidating portfolio assets. Yet for all of their plusses, trusts remain underutilized in this capacity, largely due to a lack of understanding about the protection and control mechanisms they provide. This article will attempt to clarify why trusts should form the basis of most multigenerational wealth planning and asset preservation strategies.
Inheriting Assets Outright Versus in Trust
There is a common misconception that a trust must tightly restrict the control and use of property compared with outright ownership of assets. Assets inherited outright do offer distinct freedoms. The beneficiary has complete control of the assets and may use the assets for whatever purpose they desire -- whenever they desire.
With a trust, the creator, or grantor, determines the rules governing the management and disbursement of assets. This includes how a portfolio is to be managed and under what circumstances strategic changes can be made. Therefore, depending on the disposition of the grantor, a trust may give unlimited control and use of assets to beneficiaries or it may impose restrictions. In other situations, the grantor may make it possible for beneficiaries to impose restrictions on future generations of beneficiaries, if deemed necessary.
Aside from the control issue, a trust can be designed to offer two very desirable benefits that are lacking in a traditional investment account or from an outright inheritance: asset protection -- both from present and potential future creditors -- and tax reduction.
An asset protection trust with a "spendthrift" provision can build a protective wall between an individual's assets and his or her beneficiaries' creditors. Certain professionals -- doctors, attorneys, and accountants to name a few -- are susceptible to malpractice lawsuits. Senior company executives and board members are becoming more prone to liability claims from unhappy shareholders. In addition, ex-spouses are subject to property claims from former marriages even after a settlement has been made. The protective nature of the spendthrift clause prevents a beneficiary's creditors from reaching the trust's assets. This is achieved through the use of an independent third-party trustee who, acting on the grantor's instructions, maintains control over trust management and distribution decisions, thereby eliminating the beneficiary's enforceable right or power to assign his interest in the trust to a creditor.
The most important device for accomplishing wealth transfer while minimizing taxes has been the generation-skipping transfer (GST) trust. Such a trust benefits grantors' grandchildren or other more remote descendants while shielding their own children from a potentially onerous estate tax burden. The benefits of this trust mechanism can be multiplied when used in conjunction with the GST tax exemption. Income from the trust can benefit succeeding generations, and all asset appreciation accumulates free of transfer taxes.
The generation-skipping trust can effectively allow families to protect investment wealth and reduce estate taxes for generations, until it becomes subject to the "rule against perpetuities," which limits the life of such a trust to no more than 21 years after the death of the last beneficiary who was alive at the time the trust was created. For example, if a great-grandchild is an infant when the trust is set up, the trust can last for as long as that beneficiary lives -- plus 21 years. Some states, such as Delaware, allow the creation of dynasty trusts which, in effect, can benefit families forever.1
Despite the potential tax advantages offered by the generation-skipping trust, many families view such a strategy as unfair to the "skipped-generation" children of the grantor. Yet such a trust can be designed to give a child a substantial degree of control over trust assets, including the right to make distributions from the trust for his or her own benefit.
Protect Today, Preserve for Tomorrow
Establishing trust instruments that may protect your assets for the benefit of your family not only will provide peace of mind -- it also represents sound planning. To learn more about how trusts can assist individuals with their asset protection and wealth planning strategies, contact your financial advisor or legal counsel.
1 Rules governing these instruments may vary from state to state. You should consult your attorney to determine whether any of the asset protection instruments mentioned in this article can benefit you.