The Wealth Wave and Trusts: A Short Intro

A new series on the future of investing with trust-owned wealth

Practically everything we know about investment, risk, raising capital, and even (on the charitable side) soliciting donors is based on an environment where individuals own pools of capital. However, with the great wealth wave, that could be changing.

Why? Well, as a (recovering) estate planning attorney, I have seen a great shift. At the top and right-hand side of the bell curve, most individuals of at least modest wealth who have visited an estate planning attorney over the last 20+ years have created a plan that sets up lifetime trusts for the next generation. In some cases, these are even set up as dynasty trusts that will continue for future generations so long as the money is there, and so long as applicable perpetuities periods permit.

The outcome is that a significant amount of wealth transferring to Generations X, Y, Z, and Alpha over the next 2-3 decades will not be transferred directly, but instead will end up in trust. This changes the dynamics of planning across the board. It creates an environment where planners must be comfortable interfacing with trusts, and trustees.

And, while some may disagree with me or think I am being hyperbolic, I think this dynamic will significantly change the environment of capital in the U.S.

Business growth has, traditionally, depended on easy access to capital. Ease of access to capital has, traditionally, depended mostly on an individual’s risk tolerance. But, within a trust, we do not see the same degree of risk tolerance. Even in an environment where trustee’s duties (including the duties of prudent investment and diversification) have been relaxed, the shift of capital to trust at least creates an additional gatekeeper - a trustee - who may not be willing to put their neck on the line to create additional risk. While an individual has no duty to leave money for the next generation, a trustee might.

Even after examining investment duties, we must consider additional parameters within a trust. Where a creator of the trust (settlor, grantor, trustor, etc.) has expressed purposes within the trust, these purposes may limit the scope of investment. These limitations can even be created by the values espoused within the trust or family.

At the same time, we have a conflicting outcome. When structured correctly, an irrevocable trust protects its beneficiaries from at least some creditor risk. It may also avoid future transfer taxes (i.e., estate, gift, GST, and other inheritance taxes) when beneficiaries die. This creates an incentive, and possibly a duty, for a trustee to take greater risks. Why? Because if you can achieve hockey stick growth in a trust, the transfer tax and asset protection outcomes may be better than individually-owned assets. (Without proper structuring, however, you may miss out on some income tax basis step-up opportunities.)

Finally, I would remiss if I did not raise the issue of long-term care. How much of the wealth involved in the wealth wave might get depleted by future health and long-term care costs? And, if funds are irrevocably transferred to trust during life by someone who later incurs greater-than-anticipated health expenses, how can these funds be accessed and recovered (if at all)?

So, while you probably don’t care about my motives, I do see a need to prepare the next generations - both of wealth planners, and wealth recipients - for this new world. Much of what we know not just about investment planning, but also estate, tax, cashflow, consumption, and insurance planning, will change in a world where significant wealth is held in trust. (Confession - even after taking multiple classes on trusts and transfer taxes in law school, I didn’t fully understand trusts until I was out of school in active practice. If I didn’t understand them even with an incentive to learn, how well can we expect rising generations to understand them?)

And, that is even before taking into account psychological and emotional factors. While again perhaps hyperbolic, I predict that a lot of wealth recipients in the coming years are going to be angry when they discover their inheritance is “locked up” in trust. In the process, they are going to look for someone to blame unless they have bought in to the plan before it is implemented, and even then that may not be enough to avoid negative feelings. While perspectives may differ, saving taxes and protecting from creditor claims are often one-sided goals that impose (sometimes unwanted) trade-offs on the other side. As noted above, these trade-offs may be larger in scope and duration than anticipated, and may come as a surprise when implemented.

So, while this is a short article, I am writing it to tee up a broader series on what this whole new world might look like. What tools are needed to equip the next generations of trustees, and trust officers, for the increase in trust-owned wealth? How prepared are universities and professional programs to educate professionals about trusts? How are estate planning providers, including the current wave of online document preparers, affected when attempting to create forms and draft for trusts and powers of appointment? And, what are the bounds of current laws, including prudent investor rules, even when expressly or impliedly waived?

As part of this process, I am putting out a crowdsourcing call as well. To truly do this series justice, I can’t go it alone. For this reason, I am looking for contributors in a variety of spaces - trustees, investment advisors, private equity/alternative investment experts, crypto experts, etc. If you are a recipient of wealth in a trust with something to say (good or bad), I would also like to talk to you. If this is an area of interest to you, please reach out.

Stay tuned for more.