Is The Money Ever Supposed to Come Out?

If you’ve ever set up a trust, served as a trustee, been a beneficiary of a trust, or helped anyone in connection with a trust, you may have wondered: how does the money come out of the trust? 

If no one has ever reviewed this question with you, you are not alone. Quite often, when a person sets up a trust, very little time is spent talking about why, when, and how money going into the trust will come out. Most people do not know much about trusts, so they don’t know to ask this question. Professionals who help set up trusts emphasize how to get the money into the trust, and how to manage it once it’s there. As for how the money will be paid out to the trust’s beneficiaries, not much is said.

Why is this so? Because when setting up a trust, both client and advisor tend to focus on the client’s tax planning and the client’s control over the assets. They may also consider asset protection for the client. But tax planning and control tend to be the main considerations. In addition, both client and advisor tend to view setting up and funding a trust as a business transaction, a discrete project, which does not have an immediate connection to distributions. Distributions from the trust are seen as an issue that will arise later, probably far in the future.

In addition, both client and advisor tend to see the act of distributing money from a trust as a danger, a risk to be managed. It is as though the money is a problem, and the client must place the money in a trust to contain the problem.

This approach to trust distributions weakens an enterprise-owning family. Avoiding the question of distributions draws the trust’s creator, the trustee, and the beneficiaries away from important conversations about the purpose and use of assets in a trust.  This is true for any family. But it is especially true when those assets include ownership stakes in a family enterprise. Consider the following.

First, in a family business, from year to year the question arises: do we reinvest the free cash in the business, or do we pay it out to the owners? Those who work in the business tend to be in the first camp (the “retained earnings owners”). Those who are passive owners tend to be in the second camp (the “value out owners”). This is understandable. Those who work in the business may have a closer view of what the cash can do to increase the value of the owners’ investment. Those who do not work in the business may think more in terms of what they can do with the cash outside of this particular investment.

Introducing a trust into this scenario compounds the possibility for disagreement among the business’s owners. The trust beneficiaries are beneficial owners of an interest in the business. They are a type of passive owner. But if no one – not the trust creator, not the trustee, not a family advisor – has talked to them about how cash from the business turns into distributions from the trust, the passive owners are more apt to feel isolated from what happens in the business. From the vantage point of efficient management of the business, this may not seem like a problem. But ultimately the owners are where the buck stops. If the owners feel disconnected from the business, eventually serious problems in managing the business will develop.

Second, when families avoid the distribution question, trust beneficiaries tend to be viewed as owners who, simply because they are passive, do not contribute anything to the good of the enterprise or the family. This is especially true if the beneficiaries do not work in the business.  Of course, this raises a most important question: in this particular family, to be qualified to be an owner should you be required to work in the business? Every family holds its own opinion about this issue. Every family needs to come to its own consensus about this. But not talking about the issue – because no one has thought much about how money comes out of the business-owning trusts – impedes consensus. Not talking about it visits excessive tension and difficulties upon the family. Life in a family enterprise does not need to be this way.

Third, the problem of distributions becomes more complex, and the difficulties in the family’s decision-making more severe, when the family’s enterprise has multiple divisions or multiple layers. If the family runs divisions as stand-alone silos, or if there is a holding company atop multiple operating companies, and family trusts own interests in the divisions or the operating companies, the effect of how the trusts make distributions becomes at once both more central and more wide-ranging. Nor is ownership by a trust the only issue connected to distributions. There is also the question of the trust as a source of financial capital. What happens, for example, when a family trust loans money to one division or one operating company? Do the trust’s beneficiaries become less “passive,” relative to ownership of the business, than they were before? These are not issues to push into the background.

Fourth, where does this leave the trustees? They, after all, are the legal owners of the interests in the family’s enterprise. They must walk the narrow, precarious line of staying on good terms with the enterprise’s CEO and board of directors, and maintaining serviceable relationships with the beneficiaries. Is avoiding the question of discretionary distributions really in the trustee’s best interest? How does avoidance help a well-meaning individual family member serve as trustee?

We all know a family enterprise is better off, and its family stronger, when the owners of the enterprise are engaged in what they own. With respect to trusts, engaged ownership means a trust that has not only excellent administration and investment of its assets, but also excellent distribution. How, when, and why distribution happens is a hidden but important component of engaged ownership. Let’s not hide it any more. 

(A version of this article appears at MoreAtStake.com, a subscriber-based Web portal that addresses family ownership issues.  Amelia Renkert-Thomas manages the portal.  To subscribe, see MoreAtStake.com.)