As the prior chapter made clear, trustees and beneficiaries talk about many things, including administration of the trust, investments, taxes, as well as the trustee and the beneficiary's own lives and well-being. But probably the most charged topic of their mutual focus is distributions, the central function of a trust. In this chapter, we lay out some thoughts on how trustees can approach this delicate topic with true understanding, and how beneficiaries can prepare themselves to make thoughtful requests. To begin, we will start with one more story.
Your telephone rings. It's Susan—a middle-aged beneficiary that you have worked with for several years. Susan lives off the income from her trust. She's extremely stressed as she tells you:
I just received a letter from the IRS. They say that I owe them a lot of money! I guess I forgot to file my taxes. Even worse—I don't have enough money to pay what I owe. I'm out of my mind with worry and haven't slept for days. Can the trust pay the IRS?
Susan's trust pays income to her quarterly. That sum covers her living expenses with little to nothing left over. Principal may be invaded only for health-related expenses. Susan's health-related expenses have recently included routine check-ups and her psychiatrist's invoices.
Do you—as the trustee—honor Susan's request for funds to pay her tax deficiency?
The answer seems pretty cut and dried. You are permitted to invade principal for health-related expenses only. Susan's request is to clear up a tax matter. So you politely say “no” and explain why the language of her trust leaves you no choice.
Or do you?
Let's add a few more facts. Over the years, you have gotten to know Susan. You've learned that she's a recovering alcoholic who stopped drinking five years ago and regularly attends Alcoholics Anonymous meetings. This morning, she tells you that the IRS matter has tempted her to start drinking again.
Does this change your thinking?
This is a true story that we regularly make use of in a decision-making exercise that we developed for trustees. Invariably, participants decline Susan's request after hearing the first set of facts. After learning the additional facts, some aren't so sure.
Now, listen in to Susan's actual trust officer1:
I liked Susan very much. I thought this was a woman who had struggled all of her life and was trying very hard to pull her life together.
I thought about it. Maybe we had a way to say that her failure to pay taxes was making her ill. Maybe we could say that the payment for tax purposes was a medical expense.
“Would it be all right if I spoke to your psychiatrist?” I told her why.
“Yes, you may do that.”
I called the psychiatrist, who said that the IRS threat was the only topic on Susan's mind. Susan couldn't get beyond it, and it might interfere with her ability to stay sober. It was awful.
“Would you write a letter to me confirming that Susan's tax situation is worsening her medical situation?” The psychiatrist readily agreed to do so.
On the basis of that letter and my understanding of Susan's plight, I agreed to pay her outstanding taxes. We also set up a system to reserve a certain amount of her trust income to pay future taxes so she wouldn't have this problem again.
This worked because I knew Susan and I thought, “Why did her mother limit the trust's ability to pay only for medical purposes?” I concluded that she was worried that if Susan got her hands on the money, she would drink it or waste it in some way. I don't think she wanted Susan to be sick because of her inability to pay taxes.
Giving Susan the money to pay taxes was the right decision.
When does the analysis of a beneficiary's request for funds begin? Most trustees would answer: “The analysis of a beneficiary's request for funds begins when the request is submitted.” This posture is the norm, and it is logical. It is also reactive. It is one of the reasons that the distributive function of trusts is so often still-born: no one—the trust creator, the trustee, the trust advisers or protector—wants to think about distributions until a request lands in their inbox. And they may still not want to think about it even then.
We suggest that the analysis of a request works best if the process isn't reactive. Imagine the difference it will make to trustee and beneficiary if at the inception of their relationship, they deliberately begin to build a solid foundation for the analysis of requests. Over time, the trustee will come to know the beneficiary. Meetings, occasional phone calls, time spent grappling with issues both trust-related and otherwise will build trust. That, in turn, will help the trustee and beneficiary anticipate requests. And the trustee will understand the context and be in a better position to make a good decision when a request is made.
Because he knew Susan and had a pretty good idea what her mother would have wanted, when the trust officer heard Susan's request, he was armed with a narrative that (1) embraced the potential of the trust to be life enhancing and (2) was tempered with an equal dose of realism.
Granted, Susan's dilemma is out of the ordinary—and not everyone reading this will approve of the way the trust officer handled it. But this chapter, and much of this guide, is aimed at expanding perspectives and options.
Now let's tackle a beneficiary and trustee situation that's more run-of-the-mill—the request is for payment of living expenses for the coming year.
The trustee and beneficiary go through their annual ritual. The beneficiary presents a budget. The trustee reviews the budget with an eye toward the reasonableness of the expenses. Some minor negotiation and the budget is approved.
But what if a zig here and a zag there are slipped into the process?
What if a trustee asks a twenty-something beneficiary who is requesting coverage of living expenses: “If your trust were to pay your day-to-day bills, would you be giving up an important part of your independence?” This question could easily lead to a conversation about self-worth and dependency.
Or during a trustee's conversation about living expenses with a beneficiary who is further along in years: “What might you be giving up by having the trust support a certain lifestyle?” This could lead to a conversation about dialing back on lifestyle in order to have more funds available to support a favorite philanthropic undertaking.
Will either beneficiary's request or the ultimate outcomes be any different following these conversations? It is hard to say. But either way, a thought-activating conversation about what enhancing one's life really means is likely to take place.
There are two types of trust distributions. The first are mandatory distributions. As the name implies, the trustee must make mandatory distributions. Some common examples of mandatory distributions include the required distribution of annual net income to beneficiaries or the distribution of certain percentages of the trust principal to a beneficiary at a certain age (such as one-third at age 35, another half at age 45, and the remaining principal at age 55).
The other type of distributions are discretionary distributions. Again, as the name implies, the trustee has discretion over these distributions: the trustee may make them but does not have to. Sometimes the trust document will spell out certain standards to guide the trustee's discretion. The most common such standards are “health, education, maintenance, and support,” which together are referred to by the acronym “HEMS,” and which are known (for specific tax reasons) as “ascertainable standards.” These words have specific meanings based on past cases in trust law. In some cases, such as in Susan's trust described above the standard is very narrow: only for the health of the beneficiary. In other cases the standard is very broad: the “well-being” or “comfort” of the beneficiary.
In the face of litigation from ex-spouses or other creditors, it has become more common in recent years for trusts to include no mandatory distributions and no standards to guide the trustees' discretion. This way, someone suing a beneficiary cannot argue to a court that the trustee must or may distribute trust funds for such and such purposes. If a trustee has such discretion, without standards to guide it, then the trustee is said to have “absolute discretion” and the trust is referred to as an “absolute-discretion” trust.
In what follows we are going to focus on discretionary distributions, since they involve judgment and choice. Every trustee who needs to consider discretionary distribution requests should have some sort of structure for a process for the beneficiary to follow in making requests. We have suggested the outline of such a process below:
In “real life,” a trustee may not require all this information for every request. Doing so would probably be quite an annoyance to the beneficiary! More likely, the trustee will work with the beneficiary to compile this information from their interactions (whether in person or over the phone) and from the trustee's own files. The goal here is not to send the beneficiary scurrying for data or to put hurdles in the way of distributions. Rather, it is to keep in mind the various questions that could help the beneficiary make the most thoughtful request possible.
In the authors' experience, the best decisions are made when the trustee begins by discussing the request with the beneficiary. The conversation may occur before or after the formal written request is submitted. Again, such a conversation might supply a fair amount of the information needed in the formal request.
Here are some conversation starters:
Following the conversation and review of the formal written request, ask yourself: “Will making (or not making) the distribution be more likely (or less likely) to enhance the beneficiary's life?” As we mentioned in Chapter 10, in discussing preambles, this question probably will not appear in the trust document itself, and some trustees may feel awkward “intruding” it into the forefront of their decision-making process without the authorization of the document. It may seem like “rewriting” the document. However, if you have read this far, you would likely agree that, whether this question appears in the trust document or not, it is at the heart of the trustee's virtues of fidelity and discernment, virtues that underlie the activity of discretion. The goal here is not to rewrite existing trusts but to broaden our lens of evaluation to take into account the true breadth of possibilities and consequences of trust distributions.
Once you have considered the human question of life enhancement, then it is time to turn back to the document, and ask yourself: “Would approval of the beneficiary's request be a reasonable exercise of discretion according to the language of the trust?”
If the answers to these questions lean toward approval, there are several others to consider:
Now the trustee is ready to make a decision. Once made, communicate what's been decided and the reasoning behind it to the beneficiary. Be transparent. Answer the beneficiary's questions. Address the beneficiary's concerns. If the request has been denied and the beneficiary is disappointed, offer to spend time brainstorming alternate ways of reaching the beneficiary's goals.
The last step is to document in writing the process and analysis that led to the decision. This will be a useful aid for analyzing future requests and an invaluable resource for future trustees, and it provides an important record should the decision be challenged, either in the “court of family opinion,” or in a court of law.
Many trusts are drafted when beneficiaries are young, maybe not even born yet. The nightmare to be protected against might look something like this:
A soon to be 21-year-old had been orphaned at a very young age, his parents killed in a tragic car accident. Growing up, many of his expenses are paid from a trust holding substantial life-insurance proceeds. Upon turning 21, the trust will come to an end and he will receive a considerable sum. Might this approaching event add firmness and a real sense of future to his perspective? In this case, no, for he happens to be immature, showing little inclination to plan beyond his payday. He tries to game the system by creatively plotting to secure an early distribution to keep his “friends” around. Within a year following his 21st birthday, the money is gone, and so are the friends.
Or, on the positive side:
A recent college grad asks for help drafting her first business plan. The conversation includes how the trust might support her dream and what would be required of her to receive financial backing. She does her homework and concludes that the idea is not sound. She goes back to the drawing board to start over again.
At the same time, it's not uncommon that the parents of “baby boomers” in their sixties are going strong in their eighties. So to think of newly-minted beneficiaries as strictly as children or emerging adults may be a disservice to beneficiaries who are further along in life. For example, does it make sense to bypass a spouse of thirty years in the chain of inheritance? Or to fail to include language permitting a beneficiary to seek funds to support a favorite philanthropic endeavor?
When performing the distributive function, we suggest that a trustee keep in mind that “enhance” depends on facts and circumstances, including the stage of the beneficiary's life. While this may seem obvious, a woman in her forties had this to say to one of the authors:
“My life is successful by almost any measure. I am a tenured professor at an Ivy League university. I have a wonderful husband and children. I sit on several non-profit boards and currently chair my family's foundation. The only place that I am treated like a child is when I visit my trustee. I have come to terms with this, but what concerns me is that my children will have to go through the same thing.”
Think back to Susan's story that began this chapter. Was the trustee's approach more “partner” than “parental” because Susan was middle-aged rather than just starting out in life? When we use this story as the basis for an exercise with groups of trustees, the age that we assign to Susan does seem to make a difference.
TrustWorthy contains many examples of what enhancing the life of adult beneficiaries looks like. For example, in “We All Felt Like Godparents,” thoughtful analysis leads to a decision to release funds for in vitro fertilization where trust language permits distribution for medical expenses only. In “Does Anybody Really Need a Helicopter,” a request that on its face seems like a slam-dunk “no” leads to an affirmative decision for an executive whose business travels take him to remote, dangerous corners of the world. And in “For the Love of Siblings,” a trustee takes the initiative to reunite aging brother and sister in an assisted living facility.