In our previous blog post, Silent Trusts Have Come to Michigan, we shared some situations in which a settlor and their beneficiaries could benefit from the creation of a “silent trust.” In this type of trust arrangement, the trustee is not required to disclose information about an irrevocable trust or its existence to the trust’s beneficiaries during a non-disclosure period of up to 25 years.
While a silent trust could solve issues for some settlors, this trust arrangement comes with some complexities that must be considered. Additionally, even with the best-laid plans, there is the potential for an inadvertent early disclosure of the trust’s existence, which can create anger and hurt feelings for beneficiaries.
Silent Trust Issues to Consider
- Beneficiary Skills – Some beneficiaries will never care enough, be mature enough or have enough financial savvy to manage wealth. For these beneficiaries, delaying the inevitable with a silent trust doesn’t make sense. It is better to set up the trust terms and choose the right trustee now to work with the beneficiary’s situation.
- Disclosure Issues –
- Prenuptial Agreements and Divorce Judgments – It is currently unclear if a prenuptial agreement is valid if a silent trust is not disclosed, or if a judgment of divorce can be challenged due to a silent trust that was disclosed after the entry of the judgment.
- Distributions – Making distributions directly or indirectly may prompt questions about the source of the money. Even distributions made indirectly for the beneficiary’s benefit, instead of directly to the beneficiary, may require that revealing tax forms be provided to the beneficiary to fulfill the trustee’s tax reporting obligations.
- Increased Taxes – If the trustee chooses not to make distributions to avoid inadvertent disclosure to the beneficiaries, any income that stays in the trust is taxed at the highest tax bracket very quickly, which may be higher than if it had been distributed out to the beneficiaries.
- Effect of Notices for Other than Trust Law Purposes – Appointing a protection power holder to stand in the place of the beneficiaries for purposes of trust notices raises additional issues. For example, are certain trust notices (such as “Crummey” notices) effective for federal income tax purposes if they are provided to someone who is not the beneficiary?
- Litigation Risks – For several reasons, including these below, trustees and protection power holders might be anxious about these trusts and not want to serve.
- A fiduciary loses their best protection against litigation when they cannot provide beneficiaries with trust information.
- Decisions made by the trustee or protection power holder can bind the beneficiaries without their input or knowledge. This potentially opens the trustee and protection power holder to legal challenges later if the beneficiaries are not happy with the decisions made.
- Claims against the trustee must be filed within one year after the beneficiary or the protection power holder receives trust information that adequately discloses a potential claim. The trustee can thus limit their liability by providing information to the protection power holder. Such a limitation of liability is less clear for the protection power holder.
- If a trustee is working with unusual assets in the trust (e.g., holding a concentrated portfolio of family business stock), not being able to involve the beneficiaries in the discussion and decision-making process when planning with those assets increases the chance of dissatisfied beneficiaries.
- Trustees not operating under oversight from a protection power holder may have to fight the perception that they are cheating the trust. Additionally, without the ability to provide information to a protection power holder, trustees are far more open to a future challenge from a beneficiary.
- A fiduciary loses their best protection against litigation when they cannot provide beneficiaries with trust information.
- Loss of Flexibility –
- If a trust needs to be modified or decanted to respond to changes, beneficiaries cannot participate during the quiet period (unless trustee is given discretion to violate the quiet period for certain purposes or in trustee’s discretion). This makes it more difficult for the trustee to accomplish these modifications.
- Silent trusts are not recognized in all jurisdictions, which may restrict the trustee’s ability to make a change in situs for better tax benefits/savings.
- Delay in Preparing the Next Generation to Manage Wealth – If trust settlors know they have many years before the beneficiaries learn of the trust and its value, settlors could feel they can delay preparing the family's next generation members to manage the wealth that is coming their way. Such a delay gives the beneficiaries less time to accustom themselves to the wealth and learn how to effectively manage it. The delay also deprives the settlor of the time to watch the beneficiaries learn with and enjoy the wealth.
Silent Trusts are Tricky But Now Possible
While a silent trust might be more challenging to administer, it could be an excellent solution for a trust settlor in the right situation. If you are interested in exploring the creation of a silent trust, contact your Warner estate planning attorney or Sara Nicholson.
