Beneficiary’s Choice

One way to reduce the chance of creating trust fund babies

By Patricia M. Angus – Originally published in Trusts & Estates, August 2014

Among trusts and estates professionals, especially lawyers, but also family office executives, accountants and financial advisors, the topic of how to avoid creating trust fund babies dominates many a conversation. Clients with the opportunity to leave assets to children ask for advice about how to avoid harming their children with inherited wealth. Advisors who are on the receiving end of seemingly unreasonable demands by adult beneficiaries find themselves confounded on how to respond. Many in the field, including myself, have been observing and trying to find solutions to this perplexing problem for decades. Fortunately, we may be making progress identifying causes and potential solutions. This article describes one way of looking at the issue and offers some suggestions on how to handle it when it arises.

The Importance of Choice

In The Art of Choosing, Columbia Business School Professor Sheena Iyengar explores the concept of “choice,” showing how inestimably powerful it is in our lives. Drawing from a variety of disciplines, she explores how important choice is to humans and our animal brethren. Early in the first chapter, she describes several studies on the effect of choice on subjects ranging from rats to zoo animals to residents of a nursing home. In each case, the key differentiator for the health, well- being, actions and often outcomes of the subjects is their perception of whether they have a choice. For definitional purposes, she states: “When we speak of choice, what we mean is the ability to exercise control over ourselves and our environment.”¹ (Further, she clarifies: “In order to choose, we must first perceive that control is possible.”²) While reading these statements, I couldn’t help but immediately apply the concept to the trust fund baby dilemma. This may not be the only cause of the problem, but it certainly sheds light on one of the reasons it seems to occur with such frequency. Too often, trust beneficiaries have little choice over some of the most fundamental aspects of their lives. One can argue that they shouldn’t be ungrateful for the gifts they’ve received. But that misses the essential reality that trusts take away choice from the people they’re intended to help. Based on the studies outlined by Iyengar, even accounting for cultural differences on how choice is interpreted, the way in which trusts limit choice present a real risk of harming beneficiaries on emotional and physiological levels.

Creating Choice

The terms of a trust can foster or squelch the reality, or perception, of choice for a beneficiary. Often there are good reasons to reduce choice for a beneficiary. For example, a trust for a disabled child will need terms that restrict the beneficiary’s choice virtually to nil, and this can be a good outcome. The trustee must make all investment and distribution decisions and follow strict rules set out in the trust agreement. Similarly, a grantor retained annuity trust or charitable remainder trust will likely have simple terms for automatic, pre-determined formulas for the income that the beneficiary will receive. There are many examples, however, in which the beneficiary might be given some choice in trust investment, administration or distributions. A beneficiary might be given a power of appointment to choose what happens to trust property upon termination. In other cases, the beneficiary might be able to choose to become a co-trustee at some point. Each of these options could go a long way toward providing a feeling of choice. A grantor who’s concerned about the adverse consequences of limiting choice could reach out to potential beneficiaries for input on how the trust will be written and administered. In each of these cases, there are, of course, legal and tax implications, and many grantors will fear losing their own control over the process. But the choices could be more limited, such as having input on choice of designated trustees or distribution terms. The assumption and fear among advisors—that beneficiaries will always argue against having assets in trust—must be addressed directly by advisor and grantor alike. From my experience, if a trust is explained in simple terms and the benefits outlined, beneficiaries generally choose to have or keep assets in trust, especially if the discussions have been open with them.

Adding an Element of Choice

It might appear harder to create choice in existing trusts, which often triggers frustration in beneficiaries who may not understand the purpose of a trust created without consulting them. This reality can’t be changed, but the way in which the trustee and other advisors include the beneficiary in the process can ameliorate this beyond control feeling. For example, a beneficiary might be offered the opportunity to be involved in investment discussions, even if the beneficiary doesn’t have a legal right to direct them. The trustee and advisors can help the beneficiary understand that he has a choice to view the trust as a restriction or as an opportunity, hopefully resulting in the beneficiary choosing the latter perspective.

Choosing Choice

Iyengar states:   “The debate in the medical community rages on, but what’s clear is that, whenever possible, people reach for choice – we want to believe that seeing our lives in these terms will make us better off.”³ For the private wealth management community, I recommend that we each consider whether and how we’re providing or constraining choice for the beneficiaries of trusts that we create, administer, invest and inherit. It seems clear that reducing a beneficiary’s ability to choose how key aspects of their lives will play out can lead to potential emotional, and possibly physiological, harm. While reasons such as legal factors, tax consequences and asset protection goals, may require choice to be limited for beneficiaries, such limitations should be undertaken in light of the potentially adverse consequences. Choosing choice might just help reduce the incidence of trust fund babies.

Endnotes

1. Ibid. at p. 3.
2. Sheena Iyengar, The Art of Choosing (2010) at pp. 6-7.
3. Ibid.