Rob, a well-mannered, intelligent 25-year-old beneficiary to his grandfather’s trust came to me with a question. “My father told me that I can’t have any of granddad’s money until I’m 35 years old because that’s what’s in the trust,” he said, handing me a copy of the document. “I understand granddad’s wishes but I took a job in Atlanta, and rather than rent I’d like to buy a condo. There’s plenty of money to do that, but Dad says I can’t.”
I skimmed through the trust document and found the provisions for a staged distribution, the first to occur upon Rob’s 35th birthday, the second at his 40th and the last upon Rob attaining age 45. “Does your father think it’s unwise to buy the Atlanta condo you’re looking at?” I asked.
“No, actually,” Rob said, looking a little exasperated. “He thinks it’s a wise investment and that the condo is a good deal. It’s near Piedmont Park and needs a little work, but I’m capable of reflooring and painting the place, which would add a lot of value right away.”
“So, what’s the holdup?” I asked.
“Dad says the trust can’t distribute anything to me until I’m 35.”
“That’s not what the trust reads,” I stated, pointing to the applicable section in the legal document. Your father’s the trustee, so he’s in charge of determining how the trust funds are invested, and whether distributions should be made and when. It doesn’t say that you can’t have any of the trust proceeds until age 35, only that upon that age you can demand that one-third of the principal of the trust be distributed out of the trust to you, so that you can control that amount. You can also demand one-half of what is left at age 40 and the entire remainder by age 45.”
Rob furrowed his brow. “I’m not sure I understand, What you’re saying is that Dad can make a distribution to me even though I’m only 25?”
“Yes!” I replied. “The trust funds aren’t locked up until you’re 35. It’s just that your father can decide whether he believes a distribution is appropriate. Your trust share is known as a ‘discretionary trust’. In other words, your father, as trustee, can exercise his discretion over the trust funds for you. Earlier you told me that he thinks you purchasing the condo is a good idea. So if he wants, he can make the distribution to you and you can buy it.”
“What if the purchase price is more than one-third of the value of the trust?” Rob asked. “When I turn 35, have I forgone that one-third distribution?”
“Your father has the discretion to distribute the entire trust to you if he feels it’s appropriate,” I informed, adding, “When you turn 35, you may still request a distribution of one-third of the remaining balance, even though your father let you use trust funds to buy the condo.”
“Wow, I never knew that,” Rob said.
“I’ll add one more thing,” I said. “The trust is earning interest and dividends each year. At a minimum your father should consider distributing those out to you since your tax bracket is lower than the trust tax bracket, and the income tax paid will be less.”
“Wait a minute!” Rob exclaimed. “I earn more than the trust does! Why would I be in a lower bracket?”
“Because when a trust accumulates income, it becomes the taxpayer. The trust income tax bracket is so compressed that when it has income around $13,000 it is in the highest marginal income tax bracket. You won’t reach that bracket unless you make several hundred thousand dollars.”
“There’s so much to know with all this.” Rob said.
“Yes, there is. But that’s why you came to ask me.”
The above is a real-world conversation with the facts changed so as to protect confidentiality. If you have a question about a testamentary (after death) trust established under a will or a revocable trust, make sure you ask a qualified attorney. It’s not uncommon for lay people to misinterpret trust language, losing opportunities.
Hope this helps you help others!
©2020 Craig R. Hersch. Learn more at www.sbshlaw.com