by Julia L. Cronin, JD
Many clients worry about the “shirtsleeves to shirtsleeves in three generations” adage, fearing the dissipation of the wealth they worked so hard to build. The concern is that descendants may be unable to effectively manage the wealth passed down to them from one generation to the next. According to one study, 70% of wealthy families lose their wealth by the second generation, and 90% of families lose their wealth by the third generation.[1]
Clients come to us with the goal of positioning their family and their legacy to flourish for generations to come. Often, we accomplish their objectives, at least in part, through the use of irrevocable trusts. One decision clients face when designing their irrevocable trusts is: Who will serve as the trustee of their trusts?
The trustee acts as the legal owner of trust assets, and is responsible for investing assets held in the trust, distributing the assets according to the terms of the trust, and performing the administrative functions of the trust (such as record-keeping, filing taxes, and communicating with beneficiaries). Given the amount of control a trustee has over a settlor’s hard-earned assets, it can be daunting trying to figure out how to choose the right person or institution to serve as trustee.
Who can serve as the trustee? Every lawyer’s favorite answer is – it depends.
We often counsel clients about the benefits of choosing a state with favorable trust and tax laws, as well as administrative flexibility, as the situs or “home” for a trust. If they choose a situs with favorable laws such as Nevada, South Dakota, or Wyoming, they must choose a trustee in that location, as well. If a client has a trusted family member or friend in the state of administration, that person could serve as trustee. Otherwise, the clients need to retain a trustee in the chosen situs – that could be either a professional trustee such as a lawyer or an accountant, or a trust company or corporate trustee.
It can be difficult to decide whether a trusted individual or an institution is a better choice for trustee. Trusted individuals may be familiar with family dynamics, and may have a long and deep relationship with the settlor, giving the settlor peace of mind about the trusted individual’s judgment. But, eventually, even the most trusted advisors retire, become incapacitated, or pass away. Trust companies or corporate trustees can be a good option to ensure that assets will be professionally managed. But, they may not be familiar with family dynamics, and once they are hired to administer the trust, family involvement may be somewhat limited.
Enter the Private Family Trust Company.
A Private Family Trust Company (PFTC) is an entity authorized to act as a fiduciary under state law, but it is owned entirely by members of the same family and may serve as trustee of trusts held for the benefit of that family only.
Originally, private trust companies were regulated under state or federal law and subject to the same laws and regulatory requirements that governed any state-chartered trust company serving the public. For those reasons, private trust companies were generally only considered worthwhile for families with a net worth of at least $200 million. [2] However, some states now permit the creation of unregulated PFTCs if the entity is limited in its purpose to serving as trustee of trusts held for the benefit of a single family. [3] Accordingly, an increasing number of wealthy families elect to create a PFTC to serve as the trustee of their irrevocable trusts.
The PFTC fulfills the same activities as any other trustee. But the family designs how those roles will be fulfilled – so no two PFTCs are exactly alike.
At a minimum, the PFTC is a governance body that must perform certain operational and regulatory functions. But, a PFTC can also be focused on how to help beneficiaries live happy, fulfilling lives – in a way that traditional institutional trustees probably cannot.
The governance structure of a PFTC typically includes a Board of Directors, Officers, an Investment Committee, a Distribution Committee, and an Amendment Committee. It may also include a Philanthropy Committee.
The founding family member of a PFTC can appoint the Board of Directors, and family members always maintain at least majority control of the Board. The Board also frequently includes experienced non-family members who are trusted advisors, and they establish the trustee presence in the “home” state of administration and guide the family in drafting policies and procedures, forming committees to fulfill the fiduciary obligations of the PFTC, and structuring the organization to suit the family’s needs. Ideally, the Board includes trusted advisors with differing ages and tenures, to create and preserve “institutional memory” over time. The PFTC is a permanent trustee, but the Board can add or remove members over time. This creates both stability and flexibility for the trusts generation after generation. In addition, because the family is intimately involved in the PFTC, the family has more control over the disbursement of information, resulting in increased privacy for family issues and concerns.
In a PFTC, committees, either comprised of family members or selected by family members, act to fulfill fiduciary obligations.
For example, consider the duty to invest trust assets. The Investment Committee of a PFTC, likely comprised of both family members and investment professionals, has broad discretion to make a variety of investments informed by more intimate knowledge of family assets and more narrowly tailored to appropriate risk tolerance than institutional trustees, which have, historically, been inclined to invest trust assets conservatively, sometimes foregoing opportunities for outsized returns when the investment might put trust assets in jeopardy (but otherwise be within the family’s risk tolerance). Many families perceive the ability to participate in the investment management of their wealth as one of the primary tools for preservation and growth of family wealth inside of irrevocable trusts. The flexibility and tailoring available in a PFTC is appealing to many wealthy families, as is the opportunity to provide “heir conditioning” (estate-planner-speak for preparing beneficiaries to inherit wealth and passing on the family’s values and philosophy for making investment decisions).
However, family members cannot participate in all PFTC committees. The Distribution Committee and Amendment Committee exercise powers that can have tax and asset-protection consequences, so most cautious families make the prudent choice to limit Distribution Committee and Amendment Committee membership to independent third parties who are not related or subordinate to the settlor or beneficiaries of the trust. Although the Distribution and Amendment Committees are comprised of independent third parties, in most instances the family can still remove and replace the individuals serving on those committees – so the family is not entirely without influence. The Amendment Committee gives long-standing advisors to the family who are familiar with the family’s goals, values, and interests an important role to play as they balance evolving needs with enduring values. The Distribution Committee, long seen as a committee that gathers information about a beneficiary’s circumstances, determines whether a distribution is permitted under the terms of the trust instrument, evaluates the tax consequences of a distribution, and determines whether distributions were used for their intended purpose, is now frequently expanded to be a “Distribution and Mentoring Committee.” In doing so, families are building Distribution Committees focused on supporting beneficiaries to become the people they aspire to be and nurturing strong family relationships among fulfilled individuals, not financially supported but isolated individuals.
A PFTC fulfills the role of a fiduciary – but its function need not be narrowly viewed as maintaining control over investments and distributions. Rather, a PFTC accomplishes those objectives while developing and sustaining cohesive relationships among family members so that families can preserve and grow their wealth – in all its forms – from generation to generation.
If you would like to discuss whether a PFTC will help you accomplish your family’s legacy planning goals, we would be honored to speak with you.
[1] Roy Williams and Vic Preisser, Preparing Heirs: Five Steps to a Successful Transition of Family
Wealth and Values , p. 17 (San Francisco: Robert D. Reed Publishers, 2003).
[2] Pierce H. McDowell III, Family Owned Private Trust Companies, ABA Tr. & Investments, May-June 2008, at 42, 44.
[3] See Carol A. Harrington & Ryan M. Harding, Private Trust Companies and Family Offices: What Every Estate Planner Needs to Know, in Sophisticated Estate Planning Techniques 675, 689 (ALI-ABA Course of Study, Sept. 4-5, 2008) (discussing recent changes, uses, advantages, and disadvantages of family trust companies), available at WL SP020 ALI-ABA 675.