When It Comes to Trusts, Silence May Be Golden

The idea of leaving a significant inheritance to your children or grandchildren may give you pause. Could the promise of wealth make your heirs act financially irresponsible or reckless? Anticipating a cash cushion, will they neglect their education or fail to pursue career ambitions?

You might want to look into a “silent” trust.” It limits the amount of information shared with beneficiaries or, in some cases, keeps the existence of the trust a secret. Silent trusts offer several benefits. But before you establish one, make sure you understand the potential pitfalls.

Sharing Information — Or Not

Most states require trustees to keep beneficiaries (at least those who’ve reached the age of majority) reasonably informed about the existence of trusts as well as their terms and administration. At a minimum, a trustee generally must provide a beneficiary with a copy of the trust agreement and an annual accounting of the trust’s assets and financial activities.

The majority of states allow you to place limits on the information provided to beneficiaries, but rules vary. Some states, for example, allow the trust agreement to waive the trustee’s duty to inform the beneficiaries. Others allow the trust’s settlor (the person establishing the trust) to limit the trustee’s duty by executing a separate waiver document. In some states, a settlor can limit the disclosure of information by appointing a third-party surrogate (a trusted advisor, for example) to receive notifications and other information from the trustee on the beneficiaries’ behalf.

Eventually, beneficiaries must be given information about a trust. Some states require disclosure after a specified time or upon the occurrence of a specified event (such as the beneficiary reaching a certain age). Others allow the settlor to determine when beneficiaries will be informed.

5 Advantages

The ability to keep a trust’s terms or existence a secret offers several important benefits. For example, silent trusts may allow you to:

1. Keep your financial affairs and estate planning arrangements confidential,

2. Avoid beneficiary scrutiny of your trustee’s investment and management of trust assets,

3. Prevent the disclosure of information about your trustee’s management of family business interests,

4. Protect beneficiaries from becoming targets of fraud, identity theft or other nefarious schemes.

5. Potentially reduce disincentives for beneficiaries to behave in a financially responsible manner, pursue higher education and gainful employment, and lead productive lives.

Several Drawbacks

Another significant drawback of a secret trust is that it defeats one of the key purposes of informing beneficiaries: to enable them to monitor trustees’ activities and ensure trustees are acting in the beneficiaries’ best interests. Without anyone “policing” the trust, there’s an increased risk of litigation years or even decades down the road, when beneficiaries learn of decisions by a trustee that they believe breach the trustee’s fiduciary duty. This may be less of a concern, however, in states that allow a third-party surrogate to monitor the trust.

Another potential pitfall is that secret trusts may not be effective in discouraging irresponsible or destructive behavior. It may be nearly impossible to keep your wealth a secret from your children, so they’ll likely expect to share that wealth one day, regardless of whether they know about a trust. But failure to explain the details of your estate plan to your children can lead to hurt feelings and disputes when they learn about them years later.

Offering Incentives

Instead of avoiding disincentives to positive behavior, which may or may not be effective, a better approach for many families is to provide incentives for such behavior using an “incentive trust.” Rather than keeping the trust a secret, an incentive trust provides positive reinforcement by informing beneficiaries of the trust’s terms and by conditioning distributions on behaviors you wish to encourage. Examples include obtaining a college or graduate degree, maintaining gainful employment, pursuing worthy volunteer activities, or avoiding alcohol or substance abuse.

Note that an incentive trust that requires beneficiaries to meet certain goals — such as finishing college or maintaining a certain income level — could discourage other, equally worthy, life decisions. Examples include being a stay-at-home parent, performing volunteer work or starting a nonprofit organization.

One alternative that accommodates these choices is a principle trust. Rather than condition trust distributions on specific behaviors, the trust outlines general principles for distributing funds to beneficiaries who demonstrate responsible behavior. This provides the trustee with broad discretion to apply these principles on a case-by-case basis.

Unique Circumstances

Your unique circumstances, family concerns and goals will help determine whether a silent trust makes sense — or whether you should consider an incentive, principle or other types of trust. Discuss your options with Kirsch CPA Group at 513.858.6040.