The role of a side letter in trust planning

Side Letters – helping your trusted advisors step into your shoes

Every day, individuals and couples ("clients") walk into their attorney's office to execute estate planning documents that subsequently create trusts as part of their estate plan.

For many, these trusts can be the vehicle that carries on a client's wishes when they are no longer able or alive to do so themselves. Embedded within trust "documents" are details that specify how clients have chosen who will make certain decisions about their assets when they are gone. This person—whose job it is to carry out the instructions in the document and decide whether or not to make distributions to the beneficiaries—is called a trustee.

Once the creator of the trust (the "grantor") dies or becomes incapacitated, the grantor is no longer available to consult when a family's circumstances change: children grow up, choose or change career paths, start businesses, get married or even divorced. As a result, the trustee's decisions may become more complicated. Due to these changes in circumstances, the trustee is often left with vague trust language that does not easily apply to the current situation.

A side letter, also known as a letter of intent, is a non-binding letter from the grantor to the trustee that gives guidance to the trustee by providing additional context and guidelines to help the trustee make decisions, particularly as time passes from the initial drafting of the document and the circumstances of beneficiaries have changed.

For example, a grantor could offer insight into what types of distributions should be prioritized, such as health or education, or what sort of beliefs and legacy the grantor hopes to pass on to future generations. The grantor could also provide guidance to the trustee for types of requests that may not fall under the grantor's work ethic, such as refusing to find a job. Another purpose of the side letter is to offer grantors the opportunity to explain why specific language may exist in a will or trust. If a grantor chooses to use a side letter, it is very important to consider the following:

• The side letter cannot conflict with or expand upon the terms of the trust itself. For example, if the trust includes language that allows distributions to be made for health or education, as noted above, the side letter cannot encourage distributions for the purchase of a home or starting a business.
• The side letter should be drafted or reviewed by an attorney to help ensure that there are no conflicts or inconsistencies between the side letter and the trust document.
• Side letters should be used to supplement and add context to existing documents and should not be used as a way to avoid amending or restating existing documents.
• If the grantor feels that it is important that a distribution be allowed for a particular reason, such as purchasing a home, it is better to include this in the trust itself rather than in a side letter.

An example of a side letter

Let's look at a hypothetical scenario. Jason and Maggie want to protect the assets they've accumulated after they are gone, but also want to provide their descendants with the ability to live extraordinary lives.

After multiple conversations, their financial advisor and attorney both suggest their assets remain in trust for their family, allowing a trustee discretion to distribute assets.

"Our children and grandchildren are all so different. How do we know the trustee will make the kinds of distributions we would?" Maggie asks.

The attorney responds, "Write a side letter telling the trustee about yourselves, your hopes and fears for your family and the kinds of distributions you want the trustee to make. In other words, give the trustee guidelines to follow." The advisor adds, "You may also consider speaking to the members of your family and hearing what they might want distributions for. A mapping exercise might help guide you in writing the letter and your family in understanding how you hope your assets will enhance their lives."

Jason and Maggie spoke to their children and took the time to prepare a side letter with the help of their attorney. One copy resides with the original trust at the attorney's office; they left a second copy of the letter in a safety deposit box for their children.

Here are some examples of requests that trustees face:

1. A child requests a distribution from a trust to start a business.
2. A child wants a substantial distribution from a trust to build or purchase a house.
3. A child requests $100,000 for a trip around the world.
4. A child wants to follow their passion, which might not be financially lucrative, and looks to the trust to supplement their lifestyle.

What many clients may not fully comprehend is how vague and subjective the language in estate planning documents may be to their trustee. Kerri Scharr, Chief Fiduciary Officer of Fidelity Personal Trust Company, says, "When a trust uses vague terminology, the trustee is often tasked with interpreting the trust language."

"For example, if the trust states that distributions may only be made for a financial emergency, does the beneficiary have to suffer job loss or bankruptcy to receive assistance—or simply request funds for a larger than usual purchase, such as a new roof? Any guidance the grantor can offer the trustee, such as definitions or examples of acceptable distributions, offers context and direction for situations that the grantor may not have anticipated," she added.

Capturing your true intent

Clients may wish to discuss the intent of their estate plan with their children while they are still living. In these cases, the side letter can work to memorialize the conversation and provide a history for future individuals or generations unable to participate in the conversation.

On the other hand, these conversations can be challenging, so a client may prefer to provide a written explanation of the choices they made in their estate plan. For example, grantors might use a side letter to explain why they are choosing to leave assets outright to one child but in trust for another. Perhaps at the time the document was drafted, the child was a very immature teenager, or the child was in a questionable personal relationship or had financial issues.

If circumstances have changed and the beneficiary no longer exhibits the concerning behavior, the trustee may be more inclined to make distributions. However, without the side letter to provide the context for the grantor's thinking when the trust was executed, the trustee is only left with the language in the document and may not be as inclined to make certain distributions.

It is also important to note, as mentioned earlier, that the side letter is not binding on the trustee. The side letter's purpose is to help guide the trustee when making discretionary distribution decisions and to help both the trustee and the beneficiary better understand the grantor's goals and wishes. "A side letter that is consistent with the trust itself has the potential to explain to the trustee the true purpose of the trust. Although it is not intended to be binding, it may offer examples of what the grantor considers desirable or undesirable distributions," says Scharr.

There is no one way to write a side letter. Whether one should be written, and what it should say, depends on your circumstances. You should consult with your lawyer regarding the best way to communicate your wishes.

It may be helpful to provide clear statements and examples, if possible. While a single letter to the trustees and beneficiaries may be appropriate, it may be helpful to write separate letters if there is different information you wish to share with each. If separate letters are written, it is important to help ensure that they do not contradict one another. Although it may be implied that the trustee's letter is confidential, do not assume that it may never be discoverable by the beneficiaries.

Where to begin? Some ideas on side letter topics to consider

The following is a compilation of scenarios to consider when preparing a side letter. Not all considerations apply to every family and clients should not attempt to answer all the questions in a side letter; an attorney can help in this regard. It should be noted that if side letters are too long, or too detailed, they may be deemed a codicil to a will or amendment to a trust. If you choose to write a side letter, you should have your attorney review it to help avoid any unintended consequences. This list is also helpful as you consider what you may wish to include in your documents and discuss with your heirs as you put your estate plan together. With these items in mind, here are some potential considerations.

1. Consider sharing stories of family heritage to display the values that should drive distributions.
2. Consider sharing your view on life and your own personal philosophy.
   1. Providing this information may provide additional perspective as the trustee decides whether to grant distribution requests.
   2. What role should the trust provide in shaping the beneficiary's life?
3. Consider sharing why you set the trust up and your hope/intent for the assets.
   1. If you were alive, what types of gifts would you have made to your children/grandchildren?
   2. What is your goal for the beneficiaries?
      1. For example, perhaps the grantor wishes her children to be productive members of society by obtaining a higher education, having a job, and/or volunteering.
   3. If the beneficiary is a minor and is living with a guardian's family, when should the trustee make distributions, as permitted by the trust document, that directly or indirectly benefit the guardian's family?
      1. For example, should the trust pay for an addition to the guardian's family home or a larger car to accommodate the grantor's child?
   4. Is the hope for the trust assets to be used for people who are alive now, or should the trustee's goal be to keep the trust in existence for as many generations as possible?
      1. If the grantor chooses longevity, the trustee may limit the amounts given to current beneficiaries.
4. Consider some reasons beneficiaries will request distributions, and address how you would like the trustee to consider these requests.
   1. A child requests a distribution from a trust to start a business.
      1. Should the trust primarily focus on the child's personal life rather than supporting a child's business endeavors?
      2. Does the grantor want the trust to provide ongoing support for the business or just make a one-time distribution?
      3. Does the grantor require a business plan from the child?
      4. What types of parameters should the trustee follow?
      5. Should the trustee match funding that the business receives from professional investors (angels, venture capital, etc.)?
   2. A child wants a substantial distribution from a trust to build or purchase a house.
      1. Assuming that a residence is considered to be a prudent trust investment, should the trust own the house, or should the distribution be made so the beneficiary owns it?
      2. Should trust funds be used for a down payment or to buy a home outright?
      3. If the child is married, should the spouse contribute to the purchase?
      4. What if the child already owns 1 or 2 other houses, should the trustee weigh any additional considerations?
      5. What about distributions for the beneficiary to purchase investment property?
      6. What range or percentage of distribution of trust assets should be considered?
      7. Should the beneficiary be expected to pay ongoing maintenance for the home purchased or should the trust pay these expenses? What if housing expenses are charged to the trust but paid by the beneficiary? How should housing expenses and liabilities be assigned and are these payments deductible by anyone? Such as:
         1. Real estate taxes
         2. Mortgage payments
         3. Homeowners/umbrella insurance
         4. Home repair
         5. Landscaping and/or pool maintenance
      8. Other expenses to consider:
         1. Furniture
         2. New appliances
         3. Renovations
         4. Moving expenses
   3. A child requests $100,000 for a trip around the world.
      1. How does the grantor feel about extravagant purchases?
      2. Does it matter whether the child earns an independent living?
      3. Should the trustee pay for the full trip if the child has access to other funds?
      4. Should the trust pay for all family members accompanying the child even if they are not related? (stepparents, unmarried significant others)?
   4. A child wants to follow their passion, which might not be financially lucrative, and looks to the trust to supplement their lifestyle.
      1. Does the grantor have any concerns if the trust can fully support the child?
      2. If the child moves in with a significant other, should the trust pay for all the expenses or only one-half of the expenses, such as utility bills, rent, and food.
   5. Education:
      1. If the trust is for more than one beneficiary, how should the trustee balance varying education expenses between the beneficiaries?
      2. Private vs. public universities?
      3. Pre-college private vs. public?
      4. Tuition only or are transportation, books, rent and other living expenses okay?
      5. Trade schools?
      6. Graduate schools or internships?
      7. Preschool?
      8. What about summer opportunities such as camp and/or travel experiences?
      9. School trips?
   6. Luxury transportation
      1. Is it permissible to pay for and/or maintain extravagant transportation such as luxury cars, private planes, or yachts?
         1. Would this apply to the beneficiary's spouse?
      2. If a plane or yacht is purchased, should the trust be responsible for maintaining this property?
   7. Travel/vacation
      1. What range or percentage of distribution of trust assets should be considered?
      2. How often can a beneficiary request funds for travel (annually, semi-annually, etc.)?
      3. Should the trustee consider how many people are going?
      4. Should distributions only be for family members?
         1. What if a child wants to bring a friend?
   8. Gifts to charities and/or family members
      1. Should making large contributions to charities and/or family members be a permissible use of trust funds?
      2. Is it more important to make gifts than to preserve the principal for the use of the current or remainder beneficiaries?
   9. Restrictive/substance abuse provisions
      1. Is there a reason that restrictions were included in the trust?
         1. For example, the trust was intended to be preserved for the grandchildren, so children were limited to distributions for health or education.
      2. If there are distributions restrictions if the beneficiary suffers from substance abuse, is it appropriate to pay for a professional intervention?
         1. Can the trustee pay for inpatient care?
         2. Any limit to the number of times?
   10. Special needs
       1. Do any of the beneficiaries have special needs?
       2. What types of distributions may be appropriate to make?
       3. Is it more important to continue government benefits or to make the beneficiary as comfortable as possible?
       4. Since special needs planning is a specialized area, consultation with an attorney may be especially important.
   11. Priority of beneficiaries
       1. Is there one person or group of people who should benefit from the trust funds the most (e.g., surviving spouse)?
       2. Is there one person or group of people who should be prioritized over any other beneficiary even to the point of completely exhausting the trust assets?

Conclusion

Generally, when clients go to an attorney to create estate planning documents, they have an intent for their assets and underlying wishes for their beneficiaries. It is important to share this intent and the underlying wishes with your attorney so the attorney can include these in the documents in a clear and concise manner. This helps ensure that the documents are not drafted using vague terminology that is open to interpretation by trustees. Working with their attorney, clients can then prepare a side letter written in their own words to supplement the guidelines for their trustees when the grantor is no longer available to be consulted.