Is silence golden - The good and the bad of keeping your trust a secret

It’s common for parents to set aside money or other assets in trust for their children or grandchildren. At the same time, many parents agonize over the impact this wealth may have on their heirs. One potential solution is a “silent trust.” These trusts, which are permitted in many states, limit the amount of information shared with beneficiaries or, in some cases, keep the existence of the trust a secret. This article explains the benefits and drawbacks. A sidebar looks at an alternative to the silent trust: a principle trust.

Is silence golden?

The good and the bad of keeping your trust a secret

It’s common for parents to set aside money or other assets in trust for their children or grandchildren. At the same time, many parents agonize over the impact this wealth may have on their heirs. Will the promise of a significant inheritance encourage financial irresponsibility or recklessness? Will it provide a disincentive to higher education and gainful employment?

One potential solution is a “silent trust,” sometimes referred to as a “quiet trust.” These trusts, which are permitted in many states, limit the amount of information shared with beneficiaries or, in some cases, keep the existence of the trust a secret. Silent trusts offer several benefits but, as discussed below, they also have a few drawbacks. And in some cases, there are other strategies for achieving the same objectives.

What are your options?

The duties of a trustee are governed by state law, which varies from state to state. Most states require trustees to keep beneficiaries (at least those who’ve reached the age of majority) reasonably informed about the existence of a trust as well as its terms and administration. Typically, at a minimum, trustees must provide beneficiaries with a copy of the trust agreement and an annual accounting of the trust’s assets and financial activities.

Most states allow you to place limits on the information provided to beneficiaries, but they accomplish this in different ways. Some states, for example, allow the trust agreement to waive the trustee’s duty to inform the beneficiaries. Others allow the trust’s settlor (the person establishing the trust) to limit the trustee’s duty by executing a separate waiver document. In some states, a settlor can limit the disclosure of information by appointing a third-party surrogate (a trusted advisor, for example) to receive notifications and other information from the trustee on the beneficiaries’ behalf.

Eventually, beneficiaries must be given information about a trust. Some states require disclosure after a specified time or upon the occurrence of a specified event (such as the beneficiary reaching a certain age). Others allow the settlor to determine when beneficiaries will be informed.

What are the benefits?

The ability to keep a trust’s terms or existence a secret offers several important benefits, including:

· Maintaining confidentiality over the settlor’s financial affairs and estate planning arrangements,

· Avoiding beneficiary scrutiny of the trustee’s investment and management of trust assets,

· Preventing the disclosure of information about the trustee’s management of family business interests, and

· Potentially reducing disincentives for beneficiaries to behave in a financially responsible manner, pursue higher education and gainful employment, and lead a productive life.

A secret trust may also help protect beneficiaries from becoming targets of fraud, identity theft or other nefarious schemes.

What are the drawbacks?

The most significant drawback of a secret trust is that it defeats one of the key purposes of keeping beneficiaries informed: to enable them to monitor the trustee’s activities and ensure that he or she is acting in their best interests. Without anyone “policing” the trust, there’s an increased risk of litigation years or even decades down the road, when beneficiaries learn of decisions by the trustee that they believe breach the trustee’s fiduciary duty. This may be less of a concern, however, in states that allow a third-party surrogate to monitor the trust.

Another drawback is that secret trusts may not be effective in discouraging irresponsible or destructive behavior. It’s nearly impossible to keep your wealth a secret from your children, so they’ll likely expect to share that wealth one day, regardless of whether they know about a trust. But failure to explain the details of your estate plan to your children can lead to hurt feelings and disputes when they learn about them years later.

Is an incentive trust an option?

Instead of avoiding disincentives to positive behavior, which may or may not be effective, a better approach for many families is to provide incentives for such behavior using an “incentive trust.” Rather than keeping the trust a secret, an incentive trust provides positive reinforcement by informing beneficiaries of the trust’s terms and by conditioning distributions on behaviors you wish to encourage. Examples include obtaining a college or graduate degree, maintaining gainful employment, pursuing worthy volunteer activities, or avoiding alcohol or substance abuse.

Another alternative, which offers greater flexibility, is a “principle trust.” (See “A flexible trust for encouraging good behavior.”)

To tell or not to tell

If you’re concerned about the impact a trust will have on your children or grandchildren, talk to your estate planning advisor about the pros and cons of silent trusts. There are many strategies you can use to accomplish your estate planning objectives while helping your heirs to lead productive lives.

Sidebar: A flexible trust for encouraging good behavior

A disadvantage of incentive trusts is that by setting specific goals — such as finishing college or maintaining a certain income level — they may discourage alternative, but equally worthy, lifestyles. Examples include being a stay-at-home parent, doing volunteer work or starting a not-for-profit organization.

A principle trust offers the flexibility to accommodate these choices. Rather than condition trust distributions on specific behaviors, the trust outlines general principles for distributing funds to beneficiaries who demonstrate responsible behavior, providing the trustee with broad discretion to apply these principles on a case-by-case basis.

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