How Wealthy Families Use Trusts to Protect and Grow Their Wealth and Pay Less Taxes
Introduction to Trusts
Perhaps you have heard a bit about Trusts and know that wealthy families and their highly paid advisors know when and how to set up trusts to protect and grow their wealth and save on taxes. If you are curious about how trusts work and how they might benefit you and your own family read on as we reveal a lot of the “inside baseball” on how trusts work and some key ideas related to their pros and cons and situations in which using them can be beneficial.
To start, a trust is simply a legal entity through which property or assets such as cash, real estate, or other investments can be protected, invested and set aside to provide for specific people or causes you care about with certain conditions or guidelines as established by the grantor (the person setting up the trust who generally contributes assets to create the trust in the first place).
Generally, a trust names certain beneficiaries - the people or organizations the trust is intended to help - often subject to the conditions attached to the trust. Trusts usually also have one or more Trustees - who can either be professionals or other individuals (or a combination of both) who are charged with controlling and managing the trust by making decisions on its behalf.
Trustees are accountable to manage the trust in a way that meets the original objectives of the Trust grantor and takes care of the beneficiaries in the ways intended by the people who set up the trust. They typically need to take actions that a “prudent” person would do if they had been charged with the same responsibility.
A trust is generally created by writing and signing a Trust agreement - this is a legally binding document that can be created during a person's lifetime or stipulated to be established after their passing by their will. An attorney is often hired to help draft the trust document or the will that creates a Trust. Although hiring an attorney to create a trust is not a legal requirement, trusts can be complicated and subject to some complex rules so having an expert help in creating a trust is usually a good idea to make sure it is done correctly and works as intended.
In summary, a trust holds assets and property in a fiduciary relationship by one party for the benefit of another (for example a charity or a person’s heirs). Once assets are put into the trust they belong to the trust itself, not to the trustee or the beneficiary or the creator of the trust and remain subject to the rules and the instructions of the trust document that created it.
Examples of Wealthy Families Who Have Used Trusts
The Rockefellers are perhaps one of the most famous and wealthy families to use trusts to pass on their wealth. John D. Rockefeller made his fortune in the early days of the oil business, setting up Standard Oil Company of Ohio - the predecessor of today’s Exxon Mobil.
The first Rockefeller trusts passed the bulk of his wealth to his heirs when he set them up in 1934. Now entering its seventh generation of beneficiaries, with more than 170 heirs, the Rockefeller family was estimated to have still enjoyed an $11 billion fortune in 2016 - so many years after the founding Rockefeller established the initial corpus from his vast holdings and wealth.
Here’s another, more contemporary example. In 1945 Sam Walton bought his first retail store. From this humble beginning, the great Wal-Mart business empire ensued creating over $170 billion for the Walton family. Sam Walton died in 1992 and his wealth at the time was estimated at around $10 billion.
Due to his smart planning, and use of a Trust his family continue to benefit from his legacy as Walton Enterprises and the Walton Family Holdings Trust own half the retailer, he successfully established a structure that has continued to preserve and grow one of the world's biggest family fortunes well after his passing.
As illustrated by both of these examples, one of the reasons to set up a trust is to protect wealth on a multi-generational basis. Instead of giving money or wealth directly to the next generation of the family, founders create trusts and give some or a substantial portion of their wealth to a trust instead.
This can have many benefits, including protecting that wealth from dissipating more quickly through mismanagement by heirs who may not be as sophisticated as the founder. Depending on their terms trusts can also protect the beneficiaries from losing assets to subsequent lawsuits or divorces.
Trusts can also allow the founder to establish some guidelines and conditions to when and how the beneficiaries are to be assisted. These “strings” can help the founder to establish some requirements from the beneficiaries to receive support or guidelines as to when and how much support from the trust is to be provided. This approach can help to prevent wealth left in the trust from becoming a negative that enables frivolous expenditures or an unproductive lifestyle. It also can help the wealth left in a trust to last much longer and be helpful to multiple generations of the founder’s descendants.
Finally by putting wealth into a trust and appointing one or more sophisticated Trustees to oversee the wealth in the trust, founders can actually increase the likelihood that the Trust assets will be managed in a way that preserves and grows that wealth so that one or more generations of beneficiaries also gets maximum support if so desired by the grantor. Done correctly, a good trust can, over time, distribute far more to its beneficiaries than the initial amount contributed into the trust through a combination of prudent stewardship and intelligent investing of the assets.
Different Types of Trusts
There are many different types of trusts. While a detailed discussion of the various types is beyond the scope of this article, we touch on some of the main types below.
Which types are appropriate in any given situation varies based on your own specific needs and goals, the type of assets you’re trying to protect, and your desired outcome for the assets in the trust.
Some of the most common types of trusts are:
- Living Trusts
- Testamentary Trusts
- Life Insurance Trusts
- Charitable Trusts and Charitable Remainder Trusts
- Asset-Protection Trusts, and
- Special-Needs Trusts
In addition, all of these trust types can be revocable or irrevocable, depending on how and why they are set up. Revocable simply means that the trust can be dissolved and the assets returned if so desired. An irrevocable trust is a more permanent structure and once it is set up it cannot be undone by the grantor or trustees later.
Key Steps In Setting Up A Trust
At a high level, the steps needed to establish a trust are as follows:
- Collect key details and information
- Seek out professional assistance from a trusted financial advisor and attorney
- Draft and execute the governing Trust Agreement
- Register the trust with the Internal Revenue Service by obtaining a tax identification number
- Transfer assets into the trust
- Administer the trust in accordance with the trust's legal guidelines.
- Invest the Trust assets intelligently
- File tax returns and follow the proper procedures on an ongoing basis
Trusts: Main Uses
Trusts can be created for a variety of reasons. Here are some typical situations:
- To manage and control spending and investments to protect beneficiaries from their own lack of experience, poor judgment, immaturity or tendency to waste or spend excessively
- To reduce income taxes and to shelter assets from estate and transfer taxes
- To provide a vehicle for charitable giving
- To avoid court-mandated probate and preserve privacy
- To protect assets held in trust from beneficiaries’ creditors
- To hold, preserve and manage unique assets such as timberland, art, mineral interests and vacation properties
- To hold life insurance policies, pay premiums and hold insurance payoffs to care for beneficiaries
- To hold assets while planning for business succession
- To hold assets to provide for beneficiaries with special needs such as physical or mental incapacities
These are but a few of the most common reasons behind the establishment of a trust. Once you realize their versatility, you may find that a trust may be beneficial for your own personal situation. A discussion with a trusted financial advisor may be a particularly good idea if you think you may be a good candidate for setting a new one up or already have a trust that needs to be looked at and perhaps improved in one or more respects.
Pros and Cons of Trusts
Trusts are not magic, but they are extremely powerful and versatile and can help you solve a wide variety of financial concerns or objectives. For example, a simple revocable trust can enable you to pass your property to your heirs without going through probate, which can streamline asset disposition and preserve privacy in your estate plan.
An irrevocable life insurance trust can remove ownership of your life insurance policy and proceeds from your estate thereby saving your heirs tens of thousands or even millions on your eventual estate tax bill down the road.
On the downside, the biggest difficulty with trusts can be the cost and complexity of getting them set up in the first place. Moreover, besides the preparation costs they will generally require that you retitle your assets in the name of the trust. This is an important step because its not uncommon for people to create wills or trusts and then delay or forget to properly retitle their assets on a timely basis so that the trust actually works as intended.
Are Trusts Only For The Wealthy?
Trust funds have long had a reputation of being a tool used primarily by the wealthiest families. Although many ultra-wealthy families use trusts, others may benefit from them as well.
Indeed, certain types of trusts such as life insurance trusts, asset protection trusts, trusts to benefit disabled or handicapped beneficiaries, or trusts set up to avoid probate are more common and useful for a wider range of families. In these cases, families with wealth ranging from as little as $500k to $5 million in assets might be good candidates for setting up certain types of trusts.
On the other hand, other types of trusts are more applicable only to families with $5m or more in wealth (sometimes much more).
Working With a Sophisticated Financial Advisor Experienced with Trusts
Because trusts are binding legal contracts and can be created to cover a wide variety of situations, it is best to consult with a knowledgeable financial advisor when thinking about the right trusts applicable to your own specific situation.
Also the way the trust is managed and invested can be a large determinant of whether or not the Trust succeeds in the purposes for which it was established in the first place. Investing the trust assets properly is key to preserving and growing the assets placed into a trust. This means that most trusts should have at least one trustee who is extremely capable and experienced when it comes to making investing, business and financial decisions.
Unfortunately, many trusts name professional corporate trustees such as banks or trust companies that are sometimes rather bureaucratic, overly restrictive or stodgy and constrained in their administration of the trust and especially its investments. These corporate trustees may bundle the three responsibilities of a trustee which are administration, investing, and distributions.
In contrast naming a professional independent registered investment advisor - sometimes referred to as a investment advisor trustee can add tremendous value to existing or new trusts by bringing much needed energy and superior investment options to the management and growth of trusts.
In such cases, its even possible and often a very good idea to separate the mundane day-to-day administration of the trust and its distributions which can be handled by a professional corporate trust company or other responsible professional or individual from the task of investing the assets in the trust intelligently which can be assigned to an expert investment advisor, whose focus and responsibility is to bring investment acumen and skill to the team working on preserving and growing a particular trust.
Ridgewood Investments is experienced in managing and investing trusts in a way that maximizes their value for the intended beneficiaries. If you have been considering setting up a new trust or have an existing trust that could benefit from an upgrade, Ridgewood Investments can advise you
Benefits of Working with Ridgewood
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Ridgewood Investments is experienced in managing and investing trusts in a way that maximizes their value for the intended beneficiaries. If you have been considering setting up a new trust or have an existing trust that could benefit from an upgrade, Ridgewood Investments can advise you through all the steps needed to maximize the power and versatility of this powerful tool.
We can work with your existing attorney and accountant or help you find and assemble the best professionals on your team along with our investment and financial structuring expertise to get it done right and efficiently on the first try or even improve the trust(s) you already have in place so that they create the maximum benefit for you and those you care about.
About the Author
Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.
Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.