You don’t need to be an attorney to bring up the subject of personal trusts with clients. No one from a bar association is going to rush in and tap you on the head with a judge’s mallet as long as you’re not giving legal advice. As an FA, you want to learn enough about trusts so you feel comfortable raising this issue with clients. So, I’ve written this article to give you a sample of a few fundamentals which might be useful.
For example, a trust can protect assets from a beneficiary who is a “shopaholic” or spendthrift. While we often dismiss this behavior by a relative as an eccentricity, it is actually a widespread mental health issue in the US. According to the US National Institutes of Health, the official medical diagnosis is Compulsive Buying Disorder or CBD and it is classified as mood or anxiety disorder.*
How does a trust protect assets from a beneficiary who struggles with CBD? Say that person receives a monthly allowance from the trust and they blow through that money in a week. Can they go to the bank and borrow money pledging their portion of the trust as collateral? No. Why? Because the beneficiary doesn’t own the assets. The trust owns the assets. By removing the ownership from the beneficiary, the grantor creates a legal barrier which protects a beneficiary from their compulsive habits.
What gives a personal trust one of its most useful qualities is this: when the person who funds the trust (known as the grantor) leaves this vale of tears, the trust as an entity continues. It doesn’t die. This allows the grantor to leave instructions about how that money should be spent. We have seen how important this is in the case of our compulsive shopper. But it is also important if one of the beneficiaries has struggled with alcohol or drug addiction, has a chronic physical or mental health problem, or has minor children and is unmarried. A charming swindler cannot marry that person and abscond with their money since it is locked up in the trust.
There are other reasons and other people for whom a personal trust could be ideal. Here are some examples: a person who cannot manage their own assets because they don’t know how, or don’t have the mental capacity; persons who don’t have the time or don’t wish to manage their own assets. The latter can include such clients as performers, business people who travel constantly, or an expatriate. Last, an individual of means who wants a trusted person or entity on standby to manage their affairs when they can longer do it themselves, thus avoiding an incompetency hearing in open court before a judge.
Another key attribute of a personal trust is it legally empowers the trustee to act in the place of the beneficial owner of the assets and make decisions about those assets. Whoever takes on this responsibility as trustee must manage the funds according to the “Prudent Person Rule” which simply means that the trustee must act in the manner they would act for themselves if they were in the same situation as the beneficiary.
A trustee is by definition a fiduciary. This means that under the law he or she must always act in the best interest of the beneficial owner of the property under every circumstance and be able to prove this with meticulous records and specialized trust accounting. To make this crystal clear: the trustee should not get in over his head with investments about which he is unfamiliar nor where there could easily be “self-dealing” or “conflicts of interest.”
A classic example of this is a trustee who is a realtor. He decides the trust should purchase an apartment building. As the trustee, he hires himself as the realtor and collects a real estate commission for selling the apartment building to the trust. This could easily be a very suitable investment for the trust. But the trustee can’t hire himself to carry out the transaction.
When choosing a trustee many people choose a spouse, domestic partner, or another family member. A family member will—at least most of the time—want to handle the assets in a way that is the best for you. Unfortunately, significant problems can occur if the family member chosen doesn’t know anything about the suitable investment options available. If you think about it, how many people in your family do you think would have the ability to manage a trust for your children or grandchildren? For many of us, the answer is, “no one.”
To learn more about this topic, register for our Cannon Trust I curriculum.
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Article citation: BLACK DW. A review of compulsive buying disorder. World Psychiatry. 2007;6(1):14-18.