Charles M. Aulino

Family trust funds are all about wealth management and wealth preservation. Their roots are centuries old. For most of that history, two key characteristics have been limitation of the time period during which a family trust is permitted to continue and prohibition of the use of trust funds to protect wealth from claims against, and debts of, the original owner. The antecedents of trust funds were around before the most common modern forms of wealth, such as securities and other financial instruments, existed. The laws governing how trust funds could be invested evolved along with the evolution of modern vehicles of fortune and developments in these laws typically trailed. For most of history, trustees have been severely restricted in the selection and management of investments for trust funds and judged on their investments performance by what may reasonably be regarded as peculiar standards. In the United States, within just the last one hundred years an obstacle to wealth formation and wealth transfer has arisen in the form of taxes imposed on lifetime gifts as well as transfers taking place at death. For most of that time, many affluent American families have seen the largest share their estates pass to the government.

Viewed from this perspective, legal developments affecting personal trusts that have taken place within the last ten years seem revolutionary in a field that has been the antithesis of revolution. It is as if the world of family trust funds is expanding at the pace of the universe. A personal trust can now have potentially perpetual existence, to be held for the benefit of one’s descendants as long as any are living. While still in the early stages of metamorphosis, asset protection trusts have appeared on the scene, permitting those of financial means great latitude in insulating their wealth from claims that might arise against them in the future. Restrictions on a trustee’s choices about the selection and management of investments for trust funds are pretty much a thing of the past. Along with this development has come a re-thinking of the plan for the flow of distributions to beneficiaries. Instead of the traditional philosophy, “you can do whatever you want with the income, but the principal will be preserved,,” more sophisticated methods of determining the amount of periodic distributions have become popular. These are based on the total value of the fund and its overall potential to produce growth as well as ordinary investment income.

Perhaps the most amazing and bewildering development has been a change in the federal tax law enacted in 2001 that has, at its heart, the purpose of eliminating taxes on the transfer of wealth. Passed at a brief moment in history when the only other topic of interest in Washington, D.C. was whatever to do with mounting federal budget surpluses, this law includes provisions for reduction of estate tax rates and increases in exemptions with complete phase-out of the tax in 2010, only to re-emerge the very next year. Clearly, the expectation of legislators who supported passage of the law was to extend the phase-out and ultimately to make it permanent. Many observers question the fiscal wisdom and responsibility of proceeding toward elimination of estate tax in view of the gruesome world events that have taken place since the law was passed, the impact of those events on the US and world economies and burgeoning federal deficits. Beyond the numbers, others question the change in philosophy, pointing out that the original stated purpose of wealth transfer tax was grounded in the American work ethic, to prevent the formation and expansion of the class of idle rich, so that each generation has the need and motivation to be productive. Productivity, they assert, contributes to society in myriad ways, despite that it is inspired by the quest for personal fortune.

In any event, the uncertainty of the future of US wealth transfer taxes creates unprecedented challenges for the financial consultant who is forced to plan for two extremely different alternative possibilities: transfer of the client’s estate free of tax or a tax that consumes about half of the total estate value. Few, if any, advisers or their clients seem inclined to plan based on the former alternative.

Regardless of one’s political, economic and philosophical outlook, it must be recognized that phase-out of the estate tax, should it actually take place, has enormous implications for the formation of private wealth. Unimpeded by tax, a personal fortune accumulating within a perpetual trust can grow to enormous proportions within a century or so. Whether the outcome is for better or for worse remains to be seen and, if ever, not within most of our lifetimes, but the outcome will be determined by individuals who create these financial gargantuans.

Those who toil in this obscure field have witnessed more significant developments, more dramatic changes and the creation of greater opportunities within the last ten years than the cumulative effect of developments in all prior history. While what happens next may be difficult to predict, it must be recognized that we are certainly living in an interesting time.