Trust Fund Industry Roadmap – Past Present & Future
A trust fund owns assets in trust for one or more beneficiaries administrated by a trustee. Over the past two decades the trust fund industry has changed forever. Advisors and clients are the biggest beneficiaries of these changes. The evolution of this stodgy, roughly 700-year-old industry to the modern era, stems from independent corporate trustees and several states modernizing their trust statutes. The large traditional corporate trustee has adapted by mimicking these smaller independent corporate trustees. With the rise of the internet, the democratization of information, and the interconnectivity of information, the corporate trustee serving personal trusts is at a unique junction. The dependent variable remains the common thread of trust and fear that weaves through a client’s everyday financial life. The independent variables revolve around the need for innovation and collaboration in our information and technology age and retaining the trust and personal touch of corporate trustee services. Financial advisors who provide generational planning within the framework of their financial planning services should strongly understand the changes and opportunities in the corporate trustee industry. At stake for financial advisors and their clients alike, is the dependable execution of those generational plans and the $24 trillion of future bequest transfers (after taxes and charitable giving). Capitalist societies continue to evolve. Client’s want ease of use, innovative and collaborative financial solutions. This includes the trust industry. Advisors aware of these wants will have the roadmap and tools to continue to advise clients along their generational plans.
To know where trust law could evolve it helps to know where it began. The history and evolution of trust law and trust funds over the past 2,000 years of a trustee’s fiduciary duties and responsibilities, for both individuals and trust companies, has not gathered much media attention. The process has been slow and cumbersome. U.S. trust law follows the common law system established by the English, which our founding fathers integrated into our legal system. The English merged a few concepts and built on those legal principles from an old ancient empire. It began with the Roman Empire, which established the legal concept of a testamentary trust (created within a will). After the fall of the Roman Empire, and with the onset of the Dark Ages, any progress once achieved lay dormant for nearly 800 years. With the signing of the Magna Carta in 1215 in England, the re-birth of the law slowly began to re-emerge. With the re-establishment of the law, the principle of individual ownership of land was respected again by the Nobles, Church, and Crown. The concept of a living trust (also known as a revocable trust) emerged due to the Crusades. Men left England to fight in the Crusades and re-titled their property in “trust” managed by someone who they could trust should they not return home. The fear and trust that those men had heading off to war and to protect their assets did not always go according to plan. In a series of trust fund cases around the early 1300s, the establishment of a trustee’s legal responsibility for not fulfilling their fiduciary duties was codified into law. The basic tenets of those court cases are represented in any trust statute which trustees, today, are regulated to follow.
A trustee has two key roles and responsibilities—provide for the distribution and management of the trust fund assets. Those roles and responsibilities are described inside a trust fund document (testamentary, irrevocable, or living) which are essentially a contract between a trustee, beneficiary, and the creator (also known as the grantor or testator) of the trust. The past 20 years has seen drastic changes in the trust fund industry.
Before the past few decades, our parents, grandparents, great-grandparents, etc. all had the same experience with a corporate trustee. The trust officer of a local or large bank offered corporate trustee services to banking clients. Information on investments and trust law was not a commodity but a prized asset. Technology was limited to the speed of copier machines. Those trust officers’ duty was “to administer the trust solely in the interest of the beneficiary,” which began to be called the “sole interest rule.” The concepts of avoiding conflicts of interests, placing the needs of the beneficiary before the trustee, and other related fiduciary concepts were followed. There was no real leap of faith or trust for families dealing with their trust officer at the local and large bank. Decisions were made locally. The trust officers lived locally. Those banks custodied the trust fund investment assets hence why trust documents required large capital and surplus requirements. As an aside, very slowly, estate planning attorneys are recognizing the custodial power houses such as Schwab, Pershing, Fidelity, and TD Ameritrade to name a few that make the large capital and surplus requirements for corporate trustees irrelevant today. Independent financial advisors did not materially exist during this corporate trustee golden period, so families enjoyed a solid customer service from their trust officer at these banks. Clients of those banks felt comfortable having zero control over the trust investments and distributions. That was the environment roughly 20 years ago. Times have changed for the trust fund industry.
The financial services lurch and continued slothful client-centric progress into the modern era began on May 1, 1975. Known as May Day, regulators removed fixed-rate stock commissions. Innovative and collaborative companies, such as Charles Schwab Corporation, were founded and began to offer faster, cheaper client-centric financial services from trading to custodial services. The democratization of information and spread of information around technology platforms has only increased the trust advisors and clients relay on independent parties such as Charles Schwab. On the banking side, with the Douglas Amendment to the Bank Holding Company Act of 1956 and a court case, banks were allowed to own banks in other states. This led to bank consolidations, which have continued to the present day. The effect on the “sole interest rule” was that decisions were no longer made locally. The trust officer at the large or regional bank trust company lost real decision power. Trust officer turnover began to rise at these banks. Trust committee decisions on distributions and investments were/are made far away in another state. Yet, the clients of these trust companies still placed their trust in these firms and while having zero control. Local banks offering trust fund services, not swept up in the consolidation, continue to offer good old-fashioned trustee services. As the consolidations put earning pressure on the banks, which continues to this day, the loyalty to the beneficiary became blurry through many court case examples. In the late 1980s and early 1990s, certain states beginning with Delaware and shortly thereafter followed by Nevada and South Dakota, began to offer “modern” trust fund laws. These modern trust fund laws allowed the fiduciary risk and responsibility of trust fund investment and/or distributions decisions to be made by noncorporate trustees. For example, financial advisors could now manage trust fund investments at the custodian of their choosing. These states also removed the law against perpetuities, added privacy and asset protection laws. Their innovation and collaboration on trust law continues to this date. Also, in the mid 1980s, financial advisors begin to leave the large national and regional brokerage firms and offer their services independently. The consolidation of banks, founding of new custodians, and implementation of modern trust fund laws created an opportunity. Roughly over the past two decades we have the emergence of independent trust companies that are custodian neutral and choose not to compete against financial advisors. They are the trust industry innovators and collaborators for clients and advisors.
Figure 1: Traditional and New Trust Fund Company Models
Clients, estate attorneys, and advisors today have more choices than ever before on the type of trustee and the state governing law of a trust fund. The following sections describe the present ranges and outcomes of those choices.
Picking a trustee generally gets less attention and time from all of us than choosing our new smartphone. In the first place, it is not a fun moment. Clients, and even you, when discussing the potential trustee choices of your trust funds, are sitting with an estate planning attorney or hopefully having the discussion with their financial advisor. Advisors see the whole financial picture and ask the questions on the “philosophy of a client’s money and their family.” For engineers and math people this is a logical emotional process. For everyone else it is a winding road of emotions and what-ifs. To sum up, in a client’s will and/or separate trust funds they have to pick a few key roles. A trustee is one of those key roles. A client should consider an independent trustee (e.g., an individual or corporate) when the beneficiary will have challenges with money, need an impartial advocate, needs asset protection, or want to keep the assets out of their future estate. Whatever the choice, all trust documents should allow for the trustee to be removed without cause and without filing with the courts and allow the trust fund governing law to be changed based on the location of the successor trustee. Trustees should not have the ability to stymie change or remove the choice of control from a trust fund beneficiary.
Figure 2: PICKING A TRUSTEE
When choosing a corporate trustee, the additional challenge advisors face is the dramatic rise in choices and differences of corporate trustees today for any trust fund.
Table 1: ADVISOR AND CLIENT CHOICES ON A TRUST COMPANY
Additionally, advisors can hire firms such as National Advisors Trust to private label trustee services under the name of the financial advisory firm. This brings a few extra complications and benefits. The benefits allow those advisory firms to show they offer a full suite of wealth management solutions including trust fund services. The complications involve clients not knowing who the ultimate trustee is and who makes all final trustee decisions, higher regulatory scrutiny, and risk of the financial advisory firm unknowingly acting in a trustee capacity (e.g., approving trust distributions). Setting aside that complicated solution there is one last issue for advisors to consider. The advisor’s decision on which corporate trustee to choose comes down to the three key principles:
- How do they really understand my business and clients;
- What legal and technological innovative solutions do they offer to make my daily workflow and client experience better; and
- Apart from making a profit, why are they offering these services to advisors?
The present state of trust fund law in the United States rests in the roots of the common law which was adopted from England. The establishment and maintenance of trust fund law was left to individual states in the U.S. federal legal system per our founding fathers. Throughout the past century, with U.S. society more mobile, there were strong calls from attorneys, judges, and beneficiaries to create a standard for trust fund laws that states could adopt or use as a base for their own versions. The Uniform Trust Code (UTC) was established in 2000 and has been established by a large majority of states. However, several states such as Delaware, Nevada, and South Dakota believed the UTC was not vibrant enough and have created trust fund laws that are industry leading. The key areas separating the top trust states revolve around the following: decanting laws, directed trusts, perpetual trusts, no state income or capital gains tax, privacy laws, self-settled trusts, and community property trusts. Clients can now choose, within their trust fund documents (testamentary, living, and/or irrevocable), the best trust fund jurisdiction or at the very least, allow the governing law of their trust fund documents to be changed based on the location (e.g., situs) and administration of the trustee (individual or corporate). The top trust fund states desire to attract high-paying jobs, which ensures their continued thought leadership as well as the vibrant trust fund industry community in those states pushing for cutting-edge trust law.
A hallmark occurred in 1994 for present day clients, advisors, and attorneys with the passing of the directed trust law in Delaware. This allowed for the distinct fiduciary separation of trustee duties from a corporate trustee. Advisors today in all the top trust states have the flexibility to manage trust investment assets independent of the trustee guidance or oversight. They bear the fiduciary investment risk, not the corporate trustee. This raises a legal issue—should the advisor be formally informed that they have this fiduciary investment risk and not the corporate trustee. Currently, very few independent or even traditional trust companies offering independent trustee services have procedures in place to inform advisors of this fact. The current groupthink, not shared by this author, rests that advisors are professionals and are aware or should be aware of the trust statutes governing a trust document. The process to change or to modify a trust to enjoy the directed trust statutes is straightforward in the leading trust states. Delegated trusts, formally known as discretionary trusts in the trust industry, are the majority of trusts in existence today. They generally state that the trustee may delegate to an outside advisor the investment of the trust assets. Traditional trust companies elect not to delegate this investment authority and subsequently remove any current financial advisor when they are the successor trustee in a client’s will, revocable, and/or irrevocable trust. Independent trust companies delegate that investment authority to the advisor but retain the fiduciary investment risk. There are inconsistent risk management practices among advisor-friendly trust companies regarding how to monitor the investment actions of those advisors. The corporate trustee has the final decision on those risk management processes and not the advisor. Clients and advisors, whether choosing a traditional or independent corporate trustee, still embrace the fear of having to trust in the system delivering solutions, across multiple companies, for themselves and their future heirs.
The future of the trust industry and advisors needing a corporate trustee centers around time, technology, transparency, creativity, and demographics.
The demographic shifts in the United States are occurring in the general population and also in the advisor industry. Currently, 50 percent of all advisors plan to retire within 14 years and yet only 66 percent of advisor practice owners have a succession plan in place. At the same time the transfer of wealth from the World War II (also known as the Silent Generation) and Baby Boomer generations to the Gen X and Millennial generations are titanic in nature. In 2015, the Deloitte Center for Financial Services provided a research report of the mapping trends of generational wealth in the United States. They estimate gen X and millennials will control almost 34 percent of all household financial assets by 2030. It appears the largest pools of those assets bequeathed to future generations will be in real estate, individual retirement accounts (IRAs), and trust funds. Advisors focused on not being replaced by successor trustees (e.g., JP Morgan, Northern Trust, SunTrust, Wells Fargo, etc.) and beneficiaries of IRA accounts will experience the success of their client’s generational plans. There are two simple steps to accomplish this: (1) Consider the use of an advisor-friendly trusteed IRA; and (2) Review a client’s will and other estate-planning documents to suggest removing the traditional corporate trustee and replace with an advisor-friendly trust company. At stake is the $24 trillion in bequests and who will retain, lose, or earn those clients. Advisory firms of all sizes are making strategic and tactical decisions on which trust fund companies to consider to use and when.
Figure 3: Bequests forecasts to be received, all generations ($ billion)
Time, technology, creativity, and transparency are the pivotal points for the future of the trust fund industry. Trust companies delivering on all these points in an easy to use, innovative, and collaborative process will gain the trust and confidence of the advisor community. The majority of clients and advisors demand a perfect blend of user experience, technology, and human touch.
For example, today with a traditional trust fund company the process of a beneficiary requesting a trust distribution involves the following four steps:
- Beneficiary calls or emails trust officer explaining reason for distribution
- Trust officer reviews requests and sends to trust committee in another state
- Trust committee reviews distribution request and approves, denies, or requires more information
- Trust distribution made to beneficiary personal account
Best practices involve collaboration and communication between advisors and trust officers. Today trust companies have automated the collection of the manual distribution request and communication between parties. The time between steps, communication gaps, and approving the distribution request has shrunk dramatically. Another example is the administrative reviews all trust companies perform on trust funds. Currently this is a manual process of collecting information from trust fund transactions, required trust document actions, trust committee decisions, advisor notes, and beneficiary notes. In the near future the collection and initial annual administrative review will be completed using machine learning. The back office of any trust company will shrink, and trust officers’ time on this manual process will almost disappear. Trust officers will now have more time to solve issues in creative ways. That takes time. That is a great use of time. Some trust companies and/or financial service companies will give in to the temptation of using this extra time differently. They will use technology to take away the creativity of their key employees so that extra time can be spent on sales. That is a misaligned use of extra time given by technology. The transparency of trust fund fees and providing a fast and accurate quote on those fees to advisors also will change for the benefit of everyone. All trust fund fees are based on risk and time. Those can be broken down into the following seven factors:
- directed or delegated trust
- number of beneficiaries
- number of annual distributions
- number of trust(s)
- size of trust(s)
- type of trust assets
- custodian selection
Using algorithms and data across all trust fund accounts, trust companies will provide consistent and transparent trustee pricing based on those seven factors. As those factors change over time, a trustee will change pricing. The future demand of advisors and clients on their choice of a corporate trustee will center around their prioritization of time, technology, creativity, and transparency.
As much as the trust fund industry has changed and will continue to change, one tenet must remain doggedly paramount, the duty and responsibility to follow the “sole interest rule” for the beneficiary(s) of a trust.
. W.S. Holdsworth, “A History of English Law”, Volume 4, pages 414-417
. Val Srinivas and Urval Goradia, “The Future of Wealth in the United States”, Page 6, Deloitte Center for Financial Services, 2015
. Bracton’s Note Book
. Restatement (Second) of Trusts §170(1) 1959; accord UTC §802(a) 2000
. See Northeast Bancorp v. Board of Governors, https://www.oyez.org/cases/1984/84-363
. See Ashby Henderson vs. The Bank of New York Mellon, https://docs.justia.com/cases/federal/district-courts/massachusetts/madce/1:2015cv10599/167967/72
. Chuck Sharpe, Sharpe Law Group
. Stewart Jay, “Origins of Federal Common Law: Part Two”, University of Pennsylvania Law Review, July 1985, Vol. 133, No. 6
. Tenth Amendment of United States Constitution, Ratified December 15, 1791
. See http://uniformlaws.org/Act.aspx?title=Trust%20Code
. Daniel G. Worthington and Mark Merric, “Which Trust Situs is Best in 2018”, Trust & Estates Magazine, Dec 13, 2017
. As of July 2018 only in Nevada, Alaska ,and South Dakota
. Directed Trust Statute, Delaware Code, Ann. 12 §3313
. 2018 Edelman Trust Barometer, Financial Services Edition, page 28
. State Street Global Advisors, The Advisor Retirement Wave, 2017; State Street Global, Prioritizing Succession Planning, 20177
. Val Srinivas and Urval Goradia, “The Future of Wealth in the United States”, Page 9, Deloitte Center for Financial Services, 2015
. Internal Revenue Code §408(a)
. 2018 Edelman Trust Barometer, Financial Services Edition, page 33
. See https://finance.yahoo.com/news/wells-fargo-automated-high-net-worth-wealth-management-advisors-faced-sales-pressure-151535558.html