Key Takeaways
- Start a trust review by ensuring the basics are as you want them to be.
- Next, look for ways that a trust might be amended to pursue new rules or opportunities.
- Consider stress testing a trust to see how it may behave in problematic situations.
You may have one or more trusts currently set up to help you achieve your financial goals for yourself and your family. If you don’t, you may choose to do so at some point in the future. The large number of trust options that are available—from charitable trusts to marital trusts—means you may very well identify at least one that you find makes sense for your financial situation.
Consider, for example, CEG Insights research showing that among affluent investors with trusts, 45.8% have set up a trust to avoid probate—while 33.1% expect their trust to help protect their assets from being unjustly taken from them. Meanwhile, more than 15% of Millennial investors are holders of two or more trusts.*
But here’s the thing: If you haven’t reviewed your trust recently and assessed whether it’s still on track to deliver the results you want and expect, you could be putting some of your future financial plans at risk.
That’s potentially true even if you set up a trust just a few short years ago—and it’s more likely if it’s been five years or more since you reviewed your trust. Changes in the tax laws, developments in the financial markets and maybe even events within your family could mean that your trust is no longer ideally positioned to reflect your needs and wants.
That’s why it makes sense to pull up those trust documents and give them a careful review. Here’s some advice on how to go about doing it.
*Source: CEG Insights, The Pathway to Success, 2024.
Evaluating the all-important basics
One good way to approach a review of your trust or trusts is a checklist method. There tend to be a number of trust-related errors, mistakes and issues that arise frequently. Before you dig deep for esoteric problems, make sure you’ve got the basics covered.
For example, one common type of trust is a revocable (or “living”) trust. If you have one, examine it with an eye toward the following concerns that can have a big impact if the trust is not set up as you want it to be.
- Your successor trustees. Most people name themselves as trustee of their revocable trust (and their spouse as co-trustee) along with successor trustees. Make sure the successor trustees you named are still those you want in that position of authority. A once-healthy brother who has lost significant cognitive abilities may need to be removed from the agreements. Also review how successor trustees will step into their roles—for example, when either you or your spouse can’t serve as trustee, or not until after both of you die or become incapacitated.
- Protection from lawsuits, divorce and other problems. Is your trust set up to protect your children and grandchildren from creditors and divorces? If your loved ones are newly engaged since you set up the trust, for example, the answer may be “no.”
- The current estate tax environment, both state and federal. Estate tax laws at both the state and federal levels can, and do, undergo changes fairly frequently based on which way the political wind is blowing. What’s more, if you have moved to a different state since you drafted your trust, you may find yourself potentially facing higher (or lower) estate taxes.
- The ages at which heirs will receive trust assets. You may have set a specific requirement for the age at which kids and grandkids named in your trust will receive their inheritance. Maybe it’s 21 or 25 years of age. If they’re currently younger than the specified age, think about whether such a benchmark still makes sense. Has an heir become addicted to drugs? Conversely, has an heir shown particular financial savvy and responsibility? People change, of course, and how they develop may impact your decision about when they should access trust assets. You might even consider a series of ages at which they can get to the money—for example, by making half of the assets available at age 25 and the other half at age 35.
- The funding status of the trust itself. Far too often, in our experience, trusts are set up but never actually funded—that is, the assets designated for the trust are never placed in it. Any review should answer the question “Is my trust actually funded?” with evidence that the assets have been retitled as necessary.
The next step in trust review: the stress test
Tackling the basics is a great start. But one of the steps that affluent families are increasingly taking these days, saying it adds value to their financial lives, is to stress test their trusts (as well as other components of their wealth planning).
Stress testing is a process for examining and challenging some of (or even all) the wealth planning steps you’ve taken so you can assess the likelihood that they will deliver the results you expect them to in a variety of situations and scenarios. A stress test can give important insights in two areas.
- Opportunities. A stress test can reveal whether an effective strategy you’re currently using can nevertheless be improved on. A simple example is that a stress test might show how repositioning your investment assets could potentially help you generate higher returns in your portfolio without increasing your level of risk. This isn’t a problem, per se. Your current portfolio may be performing well—but a stress test could show how some new moves may help it perform better.
- Threats. Sometimes a stress test can shine a light on an actual, fundamental problem with a strategy you’ve got in place—a problem that could potentially “blow up” on you and jeopardize your financial health. Such problems aren’t extremely common—but they’re the type of issues that, if left unaddressed, could have a very real and very negative impact on you and your family. Stress testing can potentially uncover such red flags before they become major concerns, so you can fix them.
Note: You can also stress test wealth strategies that you’re considering implementing, to see whether they’re likely to behave as anticipated. This can help you decide whether you want to go forward with a proposed strategy or consider an alternative.
Potential stress test outcomes
Consider some hypothetical results that could occur when a trust is put through the stress testing process.
Making a good trust even better
A review revealed that one couple had purchased two homes in states other than their primary state of residence during the three years since they had created their trust. However, they hadn’t tied those two new residences into their trust—which meant that if they died, there would be probate in three different states. Their financial advisor immediately realized that by tying the two new residences into the trust, the couple could avoid two rounds of ancillary probate (and the many costs associated with them). By ensuring that there would be probate in just one state, they stood to save approximately $100,000.
Correcting a potentially disastrous error
Another stress test revealed that a couple’s previous financial advisor had structured a special type of marital trust incorrectly. The husband was a U.S. citizen while the wife was not. The plan should have provided that the husband would leave his assets in a special type of marital trust (a QDOT) for non-U.S. spouses to provide a marital deduction. The trust was set up backward—with the wife’s assets set to go to the husband in a QDOT. With that trust arrangement in place, the non-U.S. spouse would have incurred an immediate tax bill of approximately $20 million—rather than get the tax deferral on the assets that they expected to receive. The new advisor rewrote the entire trust to address this fatal flaw.
Conclusion
It doesn’t necessarily take long for a trust to become outdated or suboptimal—and potentially cost you a lot of money because of it. If your life hasn’t changed, chances are the tax environment has—and vice versa.
Best bet: Thoroughly review your trust documents and stress test them to see if they’re still set up to deliver as expected.
VFO Inner Circle Special Report
By John J. Bowen Jr.
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