A critical issue parents wrestle with in designing Trusts for their children upon their deaths is how to balance providing the necessary resources for their children against providing "too much too soon" and thereby undermining each child’s motivation to lead a productive and meaningful life. My July 28th Post, reprinted below for your convenience, describes how "ascertainable standards" are the typical provisions utilized to achieve this balance. The ascertainable standards are "health, maintenance, support and education." These words are well understood in the Trust world and in the eyes of the IRS. They provide guidance to Trustees to accomplish the parents’ objective to protect the child with adequate resources but not sap the child’s incentive.
Some clients go beyond ascertainable standards by providing specific guidance that condition distributions on various targets, such as achieving a level of education or income, or marrying, or pursuing a particular profession. These "Incentive Trusts" strike some as trying to "rule from the grave," while for others they merely provide the necessary structure and guidance to help the child when they no longer are able.
My own bias is that parents are taking a substantial risk when they go beyond the parameters provided by ascertainable standards. For example, if an Incentive Trust conditions distributions on earning a high income, what happens if the child becomes a social worker or school teacher? The Incentive Trust could prevent distributions that would allow the child to live in a safe and convenient neighborhood. Instead, with Trust distributions tied to a high income level, the child could be forced to move to a less desirable location because of a limited salary. Also, an uncontrollable health problem may prohibit a child from working at all. Thus, at the time when Trust distributions would be most meaningful and important, a provision conditioning distributions on work or income could prohibit the child from receiving the necessary support.
Parents may believe Incentive Trusts will provide for their children precisely as they intend years after their deaths. However, in most cases, the typical ascertainable standards will provide the necessary parameters to protect both the Trustee and the children and accomplish the parents’ objectives. Further, the Trust designed with ascertainable standards will help the drafter, and ultimately the Trustee who must administer the Trust in the future.
July 28, 2008 Post Ascertainable Standards
July 28, 2008 Post Ascertainable Standards
Clients must carefully consider the design of the Trust they create to hold assets for their children and future generations upon their deaths. Trusts are necessary to hold assets until the children reach a certain age (e.g., typically between 21 and 40). Often times, because of tax planning, asset protection or special needs, Trusts continue for a child’s lifetime. In any case, Clients must consider this fundamental question: when I am no longer living, how do I ensure the trustee will manage and distribute the assets for my children as I would? (The choice of trustee, e.g., bank, professional or family member, is for a different Post.)
This question is typically addressed in large part with "ascertainable standards" in the Trust instrument. Ascertainable standards are designed to balance the needs of the beneficiary and the power afforded to the trustee. The ascertainable standards are "health, education, support, and maintenance" as provided under Section 2041 of the Internal Revenue Code. Ascertainable standards apply to the trustee’s discretion over the Trust assets and provide guidelines as to the permissible reasons for distributions to a beneficiary. When a Client deviates from these ascertainable standards, there is a possibility that the trustee will be given too much latitude in the distribution of the Trust’s assets. Another danger is that the distribution standards are not clearly quantifiable and lack sufficient definition to provide useful guidelines.
When attempting to understand the meaning of Section 2041’s ascertainable standards, the corresponding regulations provide helpful instruction. Treas. Reg. §20.2041-1. Under the pertinent regulations, "health" includes "medical, dental, hospital, and nursing expenses" as well as "maintenance in health and reasonable comfort." Therefore, the term "health" can be interpreted broadly to include distributions for reasons other than commonly accepted medical ailments. Unlike "health", "education" is more narrowly defined to encompass only college and professional education. If the Client wants to allow for other expenses, such as an allowance or travel costs related to school, then he or she may more specifically delineate that intent in the Trust instrument to ensure that the trustee is aware of the appropriate distributions which should be made to the beneficiaries. (Of course, while a beneficiary is a minor, Trust distributions to the Guardian to care for the child would be more lenient.) The terms "support" and "maintenance" are synonymous. Their meaning is not limited to the bare necessities of life but is instead much more expansive. Included under these terms is "support in reasonable comfort" and "support in his accustomed manner of living." The latter, though seemingly ambiguous, has been allowed by the court when it is able to make a concrete determination about the beneficiary’s prior living situation.
Though clarification provided by the regulations helps determine the meaning of the stated ascertainable standards, it does not remedy all interpretive conflicts which could arise between the trustee and the beneficiaries. The trustee will still be charged with making value judgments when determining whether a distribution from the Trust to a beneficiary is appropriate for a given reason. Though these standards are "ascertainable," meaning that they provide guidelines for administering the Trust, it is not possible to apply them with scientific precision. For example, what happens when the beneficiary sues because the Trustee buys him a Ford to drive to college instead of a Range Rover? Despite efforts to specify these ascertainable standards, there will always be a level of ambiguity inherent in them which can cause conflict. Later Posts will examine how some of these issues have been resolved by the courts.