A Royal Pain?

Imagine, for a moment, the following: Your clients, George and Elizabeth, have decided to update their documents. Their two daughters, Elizabeth (Lilibet) and Margaret, are getting older, and their estate plan is a little out of date. You explain that their current plan is a typical A/B plan with an estate tax sheltered family trust and a marital trust with separate trusts for their children on the surviving spouse’s death. Each child is given the power to withdraw half of the principal at 30 and the balance at 35. 

“Codswallop!” exclaims George. “That’s much too young. And, what if they marry some deadbeat? We must find another solution.”

After further conversation, you recommend lifetime trusts for the benefit of each child and her descendants. To provide flexibility, the trustees are given discretion to distribute income and principal for any beneficiary’s health, education, maintenance and support (HEMS), and the independent trustees may also make distributions to or among the beneficiaries in the independent trustees’ absolute discretion. On a child’s death, the remaining assets pass in further trust for the child’s then-living issue. 

Sounds simple? Imagine further that Lilibet grows up to be none other than Queen Elizabeth II and that all of the immediate members of the British Royal Family (her four children, eight grandchildren, eight great-grandchildren and counting) are permissible beneficiaries of the trust you just drafted.1  

Sprinkle trusts are often considered a simple way to provide for multiple beneficiaries within the same family. However, factors such as longevity, differing beneficiary needs, family dynamics and other unforeseen issues may turn a seemingly simple plan into a royal pain.2 From a fiduciary perspective, these conflicts are often manifested when a trustee begins serving and is managing distributions, investments and information. How can advisors help mitigate these issues?

Estate Plan Design

The advisor must understand not only the nature of the assets involved and the client’s tax planning objectives but also the client’s non-financial concerns. Who does the client intend to benefit? What’s the family dynamic? The client may desire a simple plan, but his family situation or goals may be complex.

When planning for a broad class of beneficiaries, the advisor may recommend a single pot trust (such as for minor children) or multiple separate trusts (such as for child and child’s descendants). Sprinkle trusts often seem simple to the client: one family, one document, one trust. One analogy often used by advisors is that the trustee will act like the head of the family and will manage trust assets as a parent does for children. When compared to multiple smaller trusts, a single trust may also allow for a broader degree of diversification, expanded investment options and reduced administrative costs.  

Sprinkle trusts tend to function best when the class of beneficiaries is relatively small, the beneficiaries are all from the same marriage and they’re similarly situated in terms of age, relationship to the grantor and relative need. When one or more of those variables changes, a sprinkle trust can be a source of tension and conflict. At a time when adult siblings, cousins and more distant relatives no longer live with one another, a sprinkle trust can force everyone into one financial “household.”  

Demographic Trends

What are some of the complicating factors advisors should consider?   

Longevity and Next Gen. Demographic trends such as longer life expectancies are one complicating factor. We often speak of the “Next Gen” as shorthand for young adults and Millennials. But, in the face of longer life expectancies, who really is the Next Gen? At age 71, Charles Philip Arthur George Mountbatten-Windsor, known to most of us simply as Prince Charles, is the Next Gen of British Royalty. At the time of this writing, Prince Charles is the longest serving heir apparent in British history and, if and when he finally takes the throne, he’ll be the oldest Royal to ascend to that position.3 

Although the Windsors have been blessed with long life expectancies (the Queen Mother was almost 102 when she died in 2002), what was the exception is now increasingly the norm. According to recent data from the Centers for Disease Control, the average life expectancy for individuals born in the United States in 1950 was 68.2 years, but for an individual born in the United States in 2017, it’s 78.6 years.4 Other data suggests that the wealthy may enjoy life expectancies between 10 and 15 years longer than poorer Americans.5    

This means that people are waiting a lot longer to inherit. It also means that even in the case of a simple trust for a child and her descendants, the class of beneficiaries of existing trusts may very well be three or four generations strong. What might it mean in the future for the trusts we’re drafting for families today?     

Complex families. Another potentially complicating factor is the increasingly complex structure of today’s modern family. While deeply rooted in tradition, the British Royal Family is in many ways reflective of modern societal trends. Although Queen Elizabeth II’s ascension to the throne is the result of her Uncle Edward’s then-scandalous decision to marry the divorcée, Wallis Simpson, three of her own four children have divorced, and two have remarried.6 Family dynamics seem to be increasingly fragile, as the recent decision of Harry and Meghan to decamp to Canada indicates. 

Fragmentation and complexity also exist in U.S. families. While marriage is generally on the decline, there’s also been a sharp rise in the share of marriages ending in divorce or widowhood. According to the Pew Research Center, the percentage of children living with two parents in their first marriage has dropped from 73% in 1960 to 43% in 2014.7 Blended families are common with the U.S. Census Bureau reporting that in 2004, 17% of all U.S. children ages 0-17 lived in blended families (defined as households including stepparents, step-siblings and/or half-siblings).8 Family structures are increasingly fluid with marriage, remarriage and cohabitation.9    

Other demographic trends. Advisors should consider other demographic trends, such as advanced paternal or maternal ages, generation gaps between the siblings from a parent’s first and second marriages and artificial reproductive technology.  

Complex Trust Administration

These factors can make administration of a sprinkle trust far more complex than the grantor or the advisor expected. It’s important to remember that the trustee’s fundamental fiduciary duties of loyalty, impartiality and administration apply to all beneficiaries, both current and remainder. Perhaps most challenging in this context is the duty of impartiality, which requires a trustee to treat beneficiaries equitably, if not equally, while taking into account the terms and purposes of the trust in all facets of trust administration, including distribution decisions, investment decisions and
communication with beneficiaries.10  

Investments. Investing the assets of a sprinkle trust may be challenging, particularly when beneficiaries have differing needs, expectations and risk tolerances. Unless otherwise provided in the trust instrument, a trustee must manage trust assets like a prudent investor by considering the purposes, terms, distribution requirements and other facts and circumstances in developing an overall investment strategy with risk and return objectives reasonably suited to the trust.11  Economic conditions, potential effects of inflation or deflation, expected tax consequences, expected total return and capital appreciation must be considered alongside the beneficiaries’ other resources, the needs for liquidity, regularity of income and an asset’s special relationship or value to the beneficiaries or the trust itself.12  

The comments to the Restatement (Third) of Trusts Section 90 note that “the divergent economic interests of trust beneficiaries give rise to conflicts of interest of types that simply cannot be prohibited or avoided in the investment decisions of typical trusts.”13 The current beneficiary may seek income whereas the remainder beneficiary may favor capital growth. Risk tolerance may vary greatly depending on the beneficiaries’ financial and other circumstances.14 In the context of a sprinkle trust, these competing interests may be exacerbated because the needs of individuals within the same class of beneficiaries, current or remainder, may not be fully aligned. Tools such as the power to adjust or a unitrust conversion can help mitigate these conflicts but still require careful consideration by the trustee.

Distributions. If the expectation is that the trustee will act like the head of the household in terms of managing distributions from a sprinkle trust, consider how that analogy falls apart when there are multiple branches of the family sharing in that trust. In exercising distribution authority, the trustee must consider the language of the governing instrument, the needs and relative resources of the beneficiaries and such other factors as may be required. Distribution discretion tends to fall into two broad categories: absolute discretion or discretion limited by an ascertainable standard. Tensions arise when the language is unclear, the class of permissible beneficiaries is broad or the relative financial situations of the beneficiaries vary. 

Absolute discretion. Trusts in which the trustee is given sole or absolute discretion to make distributions can provide the most flexibility, but they also can cause the most friction. A trustee who’s granted “sole” or “absolute” discretion must exercise that power “in good faith and in accordance with the terms and purposes of the trust and in the interests of the beneficiaries.”15 The trustee must communicate with all beneficiaries to understand their relative needs and consider the impact of any one distribution on the future needs of the others.  

Ascertainable standards. Ascertainable standards, such as the typical HEMS standard, are often easier for beneficiaries to understand but can also lead to disagreement when those beneficiaries live different lifestyles. This language, which is derived from the Treasury regulations, is generally interpreted to allow for a beneficiary’s reasonable expenses and not just the “bare necessities.”16 Bare necessities for one beneficiary may seem like luxuries to another.

In a multigenerational trust, the term “health” can pose special difficulties. What exactly did the grantor intend? Does it include alternative medicine, in vitro fertilization or cosmetic surgery? Should a beneficiary be required to maintain health insurance, or should the trustee pay those premiums directly? How can a trustee balance the long-term, chronic health needs of one beneficiary against the anticipated future needs of the other beneficiaries? “Education” can also be tricky. Public versus private colleges, scholarships, merit awards, inclusion of graduate education and the rising costs of higher education are all factors to be considered, particularly when the class of beneficiaries is broad and age differences are wide.17 

Sometimes, an ascertainable standard will be supplemented or modified by language referring to a beneficiary’s “lifestyle” or “standard of living.” While the grantor’s intent may be simply to ensure that the beneficiaries will be able to enjoy the same standard of living that they enjoyed during the grantor’s lifetime, such language can prove problematic, particularly if beneficiaries have chosen significantly different lifestyles. While the grantor may not be able to foresee the future for any beneficiary, planning attorneys might want to discuss these issues before defaulting to this type of language in a sprinkle trust.  

Consideration of other resources. Trustees often grapple with the question of whether to consider a beneficiary’s other resources. The decision can have a material impact, both on the trust’s balance sheet and on the beneficiaries’ psyches. A beneficiary with means may feel disadvantaged by a trustee who takes those outside resources into consideration, but needier current beneficiaries and remaindermen may be adversely impacted if a trustee doesn’t take outside resources into consideration. If the governing instrument directs the trustee to consider a beneficiary’s other resources, or, similarly, prohibits a trustee from doing so, the trustee’s course of action is relatively clear. If the instrument is silent, the trustee is placed between a rock and a hard place. 

There are three different schools of thought about a trustee’s duty when the instrument is silent.18 The first approach is that the trustee needn’t consider other resources, with the inference being that a beneficiary is entitled to support from the trust fund regardless of other means.19 Another view is that the trustee may consider other resources. A careful reading of the trust instrument is required as the determination may turn on the matter of a few words.20 The third view is that the trustee must consider the beneficiary’s outside resources before making any discretionary distribution decision.21 In states that have adopted this view, to what extent should a beneficiary’s outside resources be taken into account? In one Connecticut case, the court held that a trustee should look at outside resources, even to the point of potentially exhausting those resources, before exercising discretionary distribution authority.22 When beneficiaries have different financial resources, silence in the document can be a trap for an unwary trustee.  

Unequal distributions. Provisions authorizing unequal distributions can be a double-edged sword in the context of a sprinkle trust: allowing for much needed flexibility on the one hand, as well as potentially exacerbating long simmering family tensions on the other hand. Depending on their place in the class of beneficiaries, some beneficiaries may expect to receive priority, while others expect to be treated equally.  Absent specific language in the governing instrument, the trustee must consider the needs and interests of all beneficiaries—both current and remainder—when exercising discretion. Even when the purpose for which distributions (such as education) are to be made is clearly expressed, differences in ages among a large class can result in perceived inequality simply because of rising costs. 

Spilling the Tea

One of the fundamental duties of a trustee is to provide information and to account to the beneficiaries. While under the Restatement (Second) of Trusts, a trustee had no affirmative duty to provide information to a beneficiary except under limited circumstances, the more modern view is that the trustee must provide sufficient information about the trust assets and administration to enable the beneficiaries to protect their interests.23 Today, unless the governing instrument provides to the contrary, beneficiaries are entitled to know about the existence of the trust and to examine the trust property, trust accounts and statements.24 Depending on the jurisdiction and specific terms of the trust instrument, a trustee may be required to take a very proactive approach to communicating with the beneficiaries.25 Uniform Trust Code (UTC) states may require a trustee to provide the qualified or current beneficiaries with a complete copy of the trust instrument, relevant information about the trust assets and liabilities and administrative
details and a trust accounting at least annually and on termination of the trust or change in the trusteeship.26 Many non-UTC states also have enacted legislation that mandates the disclosure of certain information to trust beneficiaries on an annual or periodic basis.27   

At the same time that a trustee must provide information to the beneficiaries, the duty of loyalty also requires that a trustee avoid unwarranted disclosure of information acquired in the course of the fiduciary relationship, particularly when the trustee knows, or should know, that disclosure would be detrimental to a beneficiary.28  

Within a sprinkle trust, multiple beneficiaries with concurrent interests may all be entitled to information about the trust, its investments and distributions. A trustee may find that transparency can ignite family disputes and must be careful about what information is disclosed. Because all of the beneficiaries are entitled to receive statements on request, the beneficiaries will all have knowledge of distributions made to other beneficiaries. A grantor who wishes to limit the flow of information should clearly reflect that intention in the governing instrument. It’s also very common for one beneficiary to appoint himself as the “family spokesperson” who acts as a gatekeeper to the flow of information to and from the beneficiaries. Last, when the class of beneficiaries includes minors, information may need to be provided to such beneficiary’s parent who might be the dreaded son or daughter-in-law, or worse, ex-son or daughter-in-law. The advisor may also recommend that the trust be established in a state that allows for confidential trusts or the appointment of a “designated representative” to receive information on behalf of the beneficiaries.29  

Forestall Future Issues

So, what can advisors do to forestall future issues?

1. Establish priority (or lack thereof): While it’s fairly common to see language naming one beneficiary, such as the spouse or adult child, the “primary beneficiary,” it’s less common for the trust instrument to specifically state that no beneficiary or class of beneficiaries should have priority. 

2. Address outside resources: Don’t leave the document silent on this subject.   

3. Define ascertainable standards clearly:  Modifications can be muddy. Also, take care not to overdefine any standard when a beneficiary is also named as trustee or risk adverse tax consequences. 

4. Investment guidance: The grantor’s investment philosophy or attachment to particular assets may not be shared by more remote family members. Caution the trustee who blindly relies on retention provisions, particularly in states that don’t allow the waiver of the duty to diversify.

5. Privacy and information: Pay special attention to the provisions regarding accountings, notice and other information about the trust. Consider including provisions for the appointment of a notice recipient or other third-party fiduciary to represent the other beneficiaries if permitted by state law.

6. Provide an exit route: Entrust the trustee with the power to divide the trust into further subtrusts, decant into separate trusts or terminate the trust altogether.  Sometimes it may be best to say, “Arrivederci!” 

Endnotes

1. Michael Stillwell and Emma Dibdin, “The British Royal Family Tree,” Town & Country (Nov. 6, 2019), www.townandcountrymag.com/society/a20736482/british-royal-family-tree/.

2. See R. Hugh Magill, “Estate Planning and Trust Management for a Brave New World: It’s All in the Family . . . What’s a Family?” ACTEC L. J. Vol. 44, No. 3 at p. 257 (Summer 2019), for a comprehensive discussion about the changing nature of the family, demographic trends and wealth transfer planning.

3. Cecilia Rodriguez, “Prince Charles At 71: Breaking Records As ‘King In Waiting,’ In Photos,” Forbes (Nov. 15, 2019), www.forbes.com/sites/ceciliarodriguez/2019/11/15/prince-charles-at-71-breaking-records-as-king-in-waiting-in-photos/#2c0c3c666dac. Charles is the longest waiting heir apparent, having surpassed the prior record of 59 years, two months and 13 days set by his grandfather, King Edward VII, who inherited the throne from his mother, Queen Victoria.

4. U.S. Department of Health and Human Services, Centers for Disease Control, National Vital Statistics Reports, Vol. 68, No. 7, “United States Life Tables, 2017,” Table A, www.cdc.gov/nchs/data/nvsr/nvsr68/nvsr68_07-508.pdf; Women born in 2017 have a longer life expectancy than men born in the same year (81.1 years for women, 76.1 years for men).   

5. Raj Chetty, Michael Stepner and Sarah Abraham, et al., “The Association Between Income and Life Expectancy in the United States, 2001-2014,” JAMA 2016; 315(16):1750-1766.doi:10.1001/jama.2016.4266, jamanetwork.com/journals/jama/article-abstract/2513561#Results. 

6. Stillwell and Dibdin, supra note 1.

7. Pew Research Center report, “Parenting in America,” www.pewresearch.org/wp-content/uploads/sites/3/2015/12/2015-12-17_parenting-in-america_FINAL.pdf.

8. U.S. Census Bureau report, “Living Arrangements of Children: 2004,” www2.census.gov/library/publications/2008/demo/p70-114.pdf. 

9. In 2004, 3.3% of all children lived with a mother who experienced a marital event (divorce, death, marriage or remarriage) within the year. Ibid. While only 62% of children live with two married parents today (an all-time low), 15% are living with parents in a remarriage, and 7% are living with parents who are cohabitating. Only 46% of children living with two parents are living with parents who are both in their first marriage, a significant drop from 73% in 1960. Pew Research Center report, supra note 7, at fn. 7. 

10. The comments to Uniform Trust Code (UTC) Section 803 provide that “[t]he differing interests for which the Trustee must act impartially include those of the current beneficiaries versus those of beneficiaries holding interests in the remainder; and among those currently eligible to receive distributions.” See also Restatement (Third) of Trusts (Restatement Third) Section 79.

11. Uniform Prudent Investor Act (UPIA) Sections 2(a) and (b); Restatement Third Section 90. 

12. UPIA Section 2(c).

13. Restatement Third Section 90, general cmt. (c).

14. UPIA Section 2, comments. 

15. UTC Section 814(a). See alsoEstate of Wallens, 9 N.Y.3d 117 (2007) (trustee granted broad discretion must act “reasonably and in good faith in attempting to carry out the terms of the trust”).

16. Treasury Regulations Section 25.2514-1(c)(2).  

17. For example, the College Board reports that from 1989-1990 to 2019-2020, inflation-adjusted average tuition and fees tripled at public 4-year institutions and more than doubled at public 2-year and private 4-year institutions, https://research.collegeboard.org/trends/college-pricing/figures-tables/average-published-charges-2018-19-and-2019-20.

18. For a comprehensive discussion, see Bridget A. Logstrom Koci, “Discretionary Distributions: Trust Decanting and Consideration of a Beneficiary’s Other Resources,” ACTEC Fiduciary Litigation Committee Meeting (Fall 2014). 

19. Restatement (Second) of Trusts (Restatement Second) Section 128, cmt. e. 

20. For example, see NationsBank of Virginia, N.A. v. Estate of Grandy, 450 S.E.2d 140 (Va. 1994) (trustee with “uncontrolled judgement and discretion” was entitled to consider a beneficiary’s other assets and to deny a discretionary distribution request where the beneficiary had substantial wealth outside the trust).

21. Restatement Third Section 50 comments. 

22. Guaranty Trust Co. v. New York City Cancer Comm., 144 A.2d 535, 547 (1958) (while the governing instrument authorized the trustee to invade principal, the court saw no reason to obviate the general rule requiring that the beneficiary’s other resources, both capital and income, be substantially exhausted before principal distributions were made). See also City of Bridgeport v. Reilly, 47 A.2d 865 (1946); Brennan v. Russell, 52 A.2d 308 (1947).  

23. Restatement Second Section 173, cmt. d provides, “[o]rdinarily the trustee is not under a duty to the beneficiary to furnish information to him in the absence of a request for such information.” John H. Langbein, “Questioning the Trust Law Duty of Loyalty,” The Yale Law Journal, Vol. 114:929, 931 (2005), at pp. 949-950, comparing the Restatement Second Section 173, cmt. d and UTC Section 813(a). 

24. Charles D. Fox IV and Thomas W. Abendroth, “Trustee’s Duty to Account and Disclose,” American Bankers Association Briefing/Webinar (April 5, 2018).  

25. UTC Section 813(a) provides that a trustee must keep the beneficiaries “reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests.”  

26. The Connecticut statute is one example. See Pub. Act 19-137, Sections 1-80, effective Jan. 1, 2020.  

27. N.Y. S.C.P.A. Section 2309(4) permits a trustee to retain annual commissions provided he gives an annual statement of the principal on hand, receipts and expenses to the income beneficiaries and to other beneficiaries on request.

28. Restatement Third Section 78, cmt. i. 

29. Certain states, such as Delaware, allow for “silent” trusts for at least some period of time and for a “designated representative” to be appointed to receive notice on behalf of and to bind the beneficiaries. For more information, see Jocelyn Margolin Borowsky, William Lunger and Gregory J. Weinig, “Silence is Golden—The Best Way to Set Up a Quiet Trust, Roadmap to Navigating the Issues and Pre-Mortem Validation,” 11th Annual Delaware Trust Conference (Oct. 25-26, 2016).