Whether through hard work, intelligence, fate, fortune, or a combination of some or all of these, you have amassed substantial wealth and what you hope will be a lasting financial legacy for your children and succeeding generations.
To accomplish the goal of an orderly succession of your wealth, you opt to do a trust, which is, of course, one of the primary legal instruments (the other being a will) available to you for this purpose.
A trust is established by a settlor (or grantor or trustor) with a trustee to administer assets for the benefit of the settlor’s beneficiaries. A trust agreement serves as the official roadmap for a trustee in making vital decisions about distribution of property from the trust to beneficiaries, as well as about many other issues.
However, there is another instrument - one having no legal effect, but nonetheless significant – called a letter of wishes, which settlors may use to supplement their trust agreements. This informal piece of writing can play an outsized role in assisting the trustee to administer the trust in accordance with the settlor’s intentions. It’s not surprising, then, that legal counsel and wealth advisors consider it important to inform their clients of the availability of letters of wishes and the benefits of including them with trust agreements.
| WHAT IS A LETTER OF WISHES AND WHY IS IT USEFUL?
A letter of wishes is a statement by the settlor to the trustee and any other power holder in the trust who may decide whether and when to make distributions to the beneficiaries, how to invest trust assets, as well as a range of other decisions regarding the trust. A settlor typically uses general language in a trust agreement to provide the trustee with the necessary flexibility to adapt to social, legal, and economic changes over time. A letter of wishes is intended by the settlor to fill in any gaps between what the trust agreement expressly says and the settlor’s intentions for the trust.
For example, when a settlor outside the United States creates a trust for beneficiaries who live in the United States, the trust provisions on how to distribute income and principal to the beneficiaries are formulaic across most trusts. For U.S. tax reasons, this is what a typical trust provides:
➊ The trustee can make distributions of net income and principal to the beneficiary and the beneficiary’s descendants for their health, education, maintenance, and support, in equal or unequal amounts.
➋ An independent trustee can distribute as much income and principal to the beneficiary and the beneficiary’s descendants for any reason whatsoever, in equal or unequal amounts.
Accordingly, a professional or an independent trustee is expressly authorized by the first clause to make decisions about distributions for health, education, maintenance and to support the beneficiary’s customary lifestyle. In most cases, that is straightforward enough. Yet that same trustee is authorized by the second clause to make distributions “for any reason whatsoever,” and therein lies the possibility of a Hamlet-like rub: to distribute or not to distribute? For example, what if a beneficiary requests a distribution of principal to start a business or a distribution to a beneficiary’s son to buy a vacation home? How should the trustee decide in view of balancing the needs of the primary beneficiary and his children’s needs as against the settlor’s intentions for the trust, particularly if a large distribution would put a big dent in trust’s assets that are supposed to last “in perpetuity,” as stipulated by the trust. Moreover, by using that word “perpetuity,” did the settlor want the trust to last for many, many generations or only intend to have the trust last for her children, grandchildren, and possibly great grandchildren?
With a letter of wishes, a settlor can clarify in such instances how the trust’s formulaic language about distributions should be interpreted by the trustee. Also, the settlor can explain at length and in detail her philosophy of wealth creation and preservation, and core principles and values that are important to her. The settlor can also provide guidance to the trustee about investment decisions. I'll look at each of these topics as addressed in letters of wishes in more detail below, as well as lay out current best practices for writing such letters.
"With a letter of wishes... the settlor can explain at length and in detail her philosophy of wealth creation and preservation, and core principles and values that are important to her"
Employing a letter of wishes, a settlor of a trust has an opportunity to think through and express alternatives for how trust funds should be enjoyed by trust beneficiaries.
Most trusts are set up as discretionary trusts where the trustee has discretion as to the manner and timing of trust distributions. The trustee typically has the power to decide to which beneficiaries and in which proportions to distribute income or principal of the trust.
By utilizing a letter of wishes, a settlor may provide guidance to the trustee as to how to exercise its discretion:
➊ Whether the trust is intended as a supplement to a beneficiary’s lifestyle or as potentially the sole means of support.
➋ Any specific wishes a settlor has for how distributions should be made. For example, a settlor may clarify that a trustee’s ability to make distributions to a beneficiary for his education isn’t indefinite and that the settlor expects the beneficiary to find gainful employment after completing studies.
➌ For larger distributions, a settlor may want to identify for the trustee what she would approve of. For example, a settlor may approve a distribution from principal for a lavish wedding, a down payment for a home, initial capital for a new business or purchase an existing business, purchase of an aircraft, or purchase of a vacation home.
➍ Payment of the beneficiary’s life insurance or kidnapping insurance policies.
➎ A settlor may recommend that the trustee communicate to the beneficiary that a prenuptial agreement would be a good idea before getting married and condition future distributions on same.
➏ Any cautionary examples to the trustee for when not to distribute trust funds to a beneficiary. For example, if the trustee knows that a beneficiary is in the middle of a divorce, has substance abuse issues, or gambles assets away.
➐ A settlor may also clarify how a trustee should resolve any conflicts between generations of beneficiaries. Should a trustee give primary consideration to the needs of a current beneficiary or treat the current beneficiary and his children the same? Should a trustee consult with a beneficiary-parent about making any distributions to his children?
➑ And, finally, how long the trust should last? A trustee of a perpetual trust may be particularly desirous to know the settlor’s wishes for how long to sustain expected levels of distributions to trust beneficiaries, even if that meant all the trust assets would eventually be distributed out.
Needless to say, to the extent a letter of wishes addresses points as above, it can save a trustee from much difficult deliberation, and ultimately result in distributions from the trust more in line with settlor’s intentions for creating the trust.
| PRINCIPLES AND VALUES
A letter of wishes also provides a great opportunity for a settlor to spell out his values, philosophy and vision related to family wealth. Given that a trust agreement is a legal contract between a settlor and a trustee, there isn’t much leeway to express the settlor’s holistic vision regarding wealth and its uses without running a risk of introducing potential ambiguities into what should otherwise be clear and definite expressions of legal effect. Happily, a letter of wishes avoids these constraints because it is a separate and informal expression of settlor’s wishes apart from the trust agreement, and, while it is intended to be informative and influential, it isn’t legally binding on the trustee.
Beneficiaries of a dynasty trust may never have had the opportunity to meet and get to know the settlor of the trust who is benefiting them. A letter of wishes is an opportunity for the settlor to reach across time to these future generations, to “imprint” the settlor’s values, principles, and beliefs regarding how the family can continue to flourish.
"A letter of wishes is an opportunity for the settlor to reach across time to these future generations, to “imprint” the settlor’s values, principles, and beliefs regarding how the family can continue to flourish"
Accordingly, a settlor may wish to explain the following:
Family history and anecdotes about family’s successes – what allowed the family business to grow and be successful.
Most cherished values and core principles – what is most important to preserve and maintain in the family.
Charitable activities – how a family may reconcile its family values and business values in fulfilling its obligations to the family and the community.
Future aspirations – what goals may help achieve financial security for future generations and ensure their happiness and productivity.
In short, this section of a letter of wishes, while short on directing a trustee’s specific decisions with respect to distributions and other issues, can go a long way in providing an ultimate context for those decisions as well as a narrative structure that imparts meaning and inspiration for future generations of the family.
Absent specific instructions in the trust regarding investments, a trustee would look to the governing law and purposes of the trust in determining how to invest trust assets. The governing law may provide that a trustee must invest as a reasonable, prudent person would, diversify trust investments, and balance competing needs of current beneficiaries for income generation with competing interests of future beneficiaries for capital preservation.
"The governing law may provide that a trustee must invest as a reasonable, prudent person would, diversify trust investments, and balance competing needs of current beneficiaries for income generation with competing interests of future beneficiaries for capital preservation"
On occasion, a settlor has very specific wishes on how trust assets should be invested. When these wishes are different from how a trustee would normally invest trust assets under applicable law, it’s critical that the trust agreement itself spell out the settlor’s intentions and any restrictions on investments. A letter of wishes may help explain settlor’s specific intentions as stated in the trust agreement.
For example, a settlor may provide in the trust agreement that the trustee, to the greatest extent possible, invest in ESG investments. A letter of wishes accompanying the trust agreement could then specify what causes are of special importance to the settlor. As the ESG investment offerings grow in their sophistication, it may be possible for a trustee to adhere to all the settlor’s wishes regarding ESG, and prudently invest trust assets for maximum return for the benefit of the beneficiaries.
"As the ESG investment offerings grow in their sophistication, it may be possible for a trustee to adhere to all the settlor’s wishes regarding ESG, and prudently invest trust assets for maximum return for the benefit of the beneficiaries"
| BEST PRACTICES FOR LETTERS OF WISHES
If a settlor decides to write a letter of wishes to accompany a trust agreement, he may want to consider the following best practices.
1 Consider what’s critical to the settlor.
A letter of wishes is not binding on the trustee. The trustee need not follow it. The trustee is only required to follow what’s written in the trust agreement. If the settlor absolutely wants to ensure that her wishes are followed, the settlor should incorporate those wishes into the trust agreement itself.
2 Consider when to do a letter of wishes.
A trust can be revocable or irrevocable. With a revocable trust, a settlor can amend and revoke it. Conversely, a settlor cannot amend or revoke an irrevocable trust.
For a revocable trust, settlor’s legal advisors typically would be fine with the settlor providing a letter of wishes to the trustee when the trust is initially created or later, as well as amending and updating the letter of wishes from time to time. If the settlor’s specific wishes for distributions change, amending the letter of wishes may be a less costly alternative than amending the trust. For example, in a letter of wishes the settlor may recommend specific sums to be distributed to a beneficiary at stated ages. The settlor can adjust the recommended sums and the ages for distributions as he wishes without needing to amend the trust.
Not so with an irrevocable trust. When a settlor creates an irrevocable trust, he parts with the assets funding the trust for the benefit of beneficiaries. The assets no longer belong to the settlor and he may not continue to direct how they ought to be used. Most legal advisors recommend that if a settlor wants to provide a letter of wishes to the trustee of an irrevocable trust, he should do so only at the time of setting up the trust, and not after. Settlor’s legal advisors may also caution the settlor against amending or supplementing the letter of wishes later. Under U.S. tax law for example, amending a letter of wishes by a settlor of an irrevocable trust may cause adverse tax consequences.
3 Have the letter of wishes reviewed by legal advisors.
It’s best if the settlor herself were to write a letter of wishes to communicate how a trust should be enjoyed by the beneficiaries, or alternatively provide detailed directions to her legal advisors to compose a letter of wishes. Authoring the letter of wishes herself would be particularly impactful if the settlor would like the contents of the letter of wishes to be shared with trust beneficiaries.
On the other hand, it’s highly advisable that the settlor’s legal advisors review and adjust the letter of wishes as needed. First, the legal advisor would make sure that the non-binding nature of a letter of wishes is expressed clearly therein. Otherwise, language that appears binding may interfere with the trustee’s exercise of discretion as expressed in the trust agreement. Second, review by the legal advisor who drafted the trust agreement would ensure that any emotional or imprecise language included in the letter of wishes doesn’t conflict with the terms of the trust agreement. Third, the legal advisor may recommend that some of the settlor’s wishes as expressed in the letter be incorporated into the trust agreement to safeguard that they are carried out by the trustee.
And, as noted above particularly in the context of irrevocable trusts, the settlor would be well advised to consult with her legal advisors any time she wishes to amend or supplement an existing letter of wishes.
4 Consider who should see the letter of wishes.
Ordinarily a letter of wishes need not be disclosed to the trust beneficiaries by the trustee in its normal course of business. But a settlor may want the beneficiaries to read it when they reach adulthood or a certain age. In that case, the settlor should clearly say in the letter of wishes that the trustee may share it with the beneficiaries and when to do so.
Other settlors may want the exact opposite and instruct the trustee not to show the letter of wishes to the beneficiaries. Normally, a trustee can abide by such a wish, but such an outcome isn’t necessarily guaranteed. For example, a letter of wishes with a “no show” clause may also express the settlor’s specific wishes for when not to distribute funds to a beneficiary. If a trustee denies the beneficiary’s request for a distribution pursuant to the settlor’s wishes and the beneficiary challenges the trustee in court, the trustee may need to disclose the letter of wishes to the beneficiary to justify its decision. The upshot: it may be best for the settlor to keep in mind that a beneficiary may eventually see the letter of wishes and thus abstain from overly negative or disapproving language about the beneficiary in the letter of wishes.
With all the legal formalities inherent in trust agreements, the availability of letters of wishes is often a welcome and crucial way for settlors to express many important considerations about their legacy. Moreover, when a trust is accompanied by a well-written letter of wishes, the trustee can be more effective in its role and confident in the propriety of its decisions as to distributions from the trust and investment of trust funds. A letter of wishes providing settlor’s firm convictions and vision about the meaning of family success and the uses of wealth might be cherished by beneficiaries, particularly by those members of succeeding generations who never had the opportunity to meet and know the settlor. Of course, as with anything else, there are best practices to be considered before composing a letter of wishes, but, following those guidelines, settlors may well prefer to compose a letter of wishes to accompany their trusts.
Managing Director and Wealth Advisor, J.P. Morgan Private Bank.