1 experience the right partnership dynasty trusts: long term trust design r. hugh magill executive...
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1 EXPERIENCE THE RIGHT PARTNERSHIP
EXPERIENCE THE RIGHT PARTNERSHIP
Dynasty Trusts: Long Term Trust Design
R. Hugh MagillExecutive Vice President & Chief Fiduciary Officer
© 2013 The Northern Trust Company - Rev. 10/2/2013
Community Foundation
November 14, 2013
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A C C E S S . E X P E R T I S E . S E R V I C E .
Today’s Agenda: Long Term Trust Design
Introduction
Financial Sustainability
Planning for Unique Assets
Statements of Intent
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A C C E S S . E X P E R T I S E . S E R V I C E .
Wealth Transfers After ATRA*
Introduction Under current law, 2013 represents a continuing opportunity to transfer substantial wealth by
gift to family members, particularly through long term trusts designed to be exempt from the Rule Against Perpetuities.
The Tax Reform Act of 2010 unified both exemptions and rates under the Federal Estate, Gift, and Generation Skipping Transfer Taxes. ATRA preserved the unified exemption and rate structure, with a modest marginal rate increase.
2011 20122013
Exemptions $5,000,000 $5,120,000$5,250,000
Rate on Excess 35% 35% 40%
Leveraged wealth transfer strategies such as the use of valuation discounts for unmarketable and minority interests, short-term grantor retained annuity trusts, defined value clauses, installment sales, and self-cancelling installment notes, among others.
The ability to obtain grantor trust treatment for fiduciary income tax purposes. See Revenue Ruling 85-13, 1985-1 Cum. Bul 184. See also Sections 671 et seq. of the Internal Revenue Code.
*American Taxpayer Relief Act of 2012
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A C C E S S . E X P E R T I S E . S E R V I C E .
Wealth Transfers After ATRA
Rule Against PerpetuitiesApproximately 29 states have either repealed, optioned or extended the permissible
period under the common law Rule Against Perpetuities (See Table A) making these states a logical choice for the situs of a long-term family (or “dynasty”) trust. Threats to perpetual trusts exist on several fronts:
President Obama has proposed, in the General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposals (commonly referred to as the “Green Book” that the Federal GST exemption to be limited in duration to a period of ninety years.
The American Law Institute’s Restatement Third of Property (Wills and Other Donative Transfers) – Volume 3 proposes limiting long-term trusts to no more than two generations below the transferor. This approach is explained and amplified in the “The American Law Institute Proposes a New Approach to Perpetuities: Limiting The Dead Hand to Two Younger Generations.” Lawrence W.. Waggoner, University of Michigan Law School, Public Law and Legal Theory Working Paper Series, Working Paper 200 (Revised July, 2010).
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A C C E S S . E X P E R T I S E . S E R V I C E .
State Perpetuities Statutes
RULE** STATESPermits Perpetual Trusts Alaska, Delaware (for trusts of personal property), District of
Columbia, Idaho, Illinois, Kentucky, Maine, Maryland, Michigan, Missouri, Nebraska, New Hampshire, New Jersey, North Carolina, Ohio, Pennsylvania, Rhode Island, South Dakota, Virginia, and Wisconsin
Permits Very Long Trusts Alabama (360 years), Arizona (500 years), Colorado (1,000 years), Florida (360 years), Nevada (365 years), Tennessee (360 years), Utah (1,000 years), Washington (150 years), and Wyoming (1,000 years)
Follows USRAP Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, District of Columbia, Florida, Georgia, Hawaii, Indiana, Kansas, Massachusetts, Minnesota, Montana, Nebraska, New Jersey, New Mexico, Nevada, North Carolina, North Dakota, Oregon, South Carolina, South Dakota, Tennessee, U. S. Virgin Islands, Utah, Virginia, Washington and West Virginia
Follows Common-Law RAP Iowa, Mississippi, New York, Oklahoma, Texas, and Vermont
Termination at Later of Death of Last Income Beneficiary or 20 years after Grantor’s Death
Louisiana
**January, 2013
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Financial Sustainability
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A C C E S S . E X P E R T I S E . S E R V I C E .
Financial Sustainability
Financial SustainabilityFinancial Modeling
Many financial models used to illustrate the asset accumulation in long-term trusts inadequately assess the impact of the two critical phenomena in trust management:
– The expansion of beneficial interests through generations– The timing and extent of trust distributions tied to beneficiaries’ life stages
Reproductive DataThe mean age of a mother at first birth is 25.2 years in the United States.
Significant differences in age at first birth exist among U. S. States and among racial and ethnic groups:
– Massachusetts has the highest average maternal age at first birth – 27.7 years
– Mississippi has the lowest average maternal age at first birth – 22.6 years– Asia Pacific Islander women had the oldest maternal age at first birth - 28.5
years– Alaskan native women had the youngest maternal age at first birth - 21.9
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A C C E S S . E X P E R T I S E . S E R V I C E .
Financial Sustainability
Fertility rates in the United States have declined over the last three generations, from a high of 3.0 births per women, for women born in 1935, to 2.0 births per woman, for women born in 1960.
– The total fertility rate (TFR) for the United States in 2009 was 2007.0 births per 1,000 women.
Statistical data on the average age difference between siblings are difficult to interpolate from census data. I have assumed a three year gap between first and second children for modeling purposes.
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A C C E S S . E X P E R T I S E . S E R V I C E .
LONGTERM TRUST DESIGN9
Family Tree
Husband (70) Wife (70)
Daughter (45) Husband Son (40) Wife2012
Grandson (15) Granddaughter (12)
Granddaughter (10) Granddaughter (7)
G-Granddaughter G-Grandson G-Grandson G-Granddaughter G-Granddaughter G-Grandson G-Grandson G-Granddaughter
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
GGG Child GGG Child
2027 - 2038
2057-2068
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A C C E S S . E X P E R T I S E . S E R V I C E .
Modeling AssumptionsFamily Size – See Table
Distribution Rates (Annual)
Years 1 – 10 0
Years 10 – 12 1%
13 – 14 2%
15 - 17 3%
18 – 20 4%
21 – 26 5%
27 – 38 6%
39 – end 7%
Special Principal Distributions
– $100,000 in each of years 15, 18, 20, 23 (inflation adjusted)
Financial Sustainability
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A C C E S S . E X P E R T I S E . S E R V I C E .
Financial Sustainability
Capital Market Assumptions – See ModelsTax Assumptions
– Taxable TrustOrdinary Income
2012 35%
2013 to end 43.4%
Capital Gains
2012 15%
2013 23.8%
– Defective Grantor Trust
No tax for years 1 – 13
2013 rates thereafter
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
$5.12 Million Trust Subject to Fiduciary Income Taxes
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model I
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
$5.12 Million Trust with Grantor Trust Status until 2026
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Long-Term Trust Model II
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A C C E S S . E X P E R T I S E . S E R V I C E .
Financial Modeling: Implications for Estate Planning & Trust Design
Role and Design of Financial Models
Trust Design IssuesTrust DesignBreadth of Beneficial InterestsDifferentiation of Discretionary StandardsTrust Termination
Asset Allocation/Asset Selection
Family Expectations
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Planning for Unique Assets
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A C C E S S . E X P E R T I S E . S E R V I C E . Long Term Planning for Unique Trust Assets
Recurring Fiduciary ChallengesControl and Management: Fiduciary ResponsibilityLiquidity, Cash Flow & ExpensesRetention and the Duty of Diversification
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility
Conventional Trusts v. Directed (Administrative) Trusts
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility – Conventional
Trust
General Asset
Management
DiscretionaryAdministration
SpecializedAsset
Management
BeneficiaryCommunications
Tax Planning and
Compliance
Custody and
Reporting
TRUSTEE(s)
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility – Directed Trust
DiscretionaryAdministration
Beneficiary Communications
GeneralAsset
Management
Tax Planningand
Compliance
SpecializedAsset
ManagementCustody
andReporting
Administrative Trustee
InvestmentAdvisor
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A C C E S S . E X P E R T I S E . S E R V I C E . Changes In Trust Design – Enterprise Trust
ValuesMissionGoals
Discretionary Administration
Beneficiary Communication,
Custody, Reporting, Oversight
Asset
ManagersInvestm
ent
Consultant
SpecialAsset
Management
Tax Planning& Compliance
Trust ModificationFiduciary Removal
InvestmentAdvisor
Tax Advisor
Disc.Committee
SpecialAssetsAdviso
r
AdminTrustee
TrustProtector
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility
Delaware Administrative Trust (12 Del. C.§3313(b) & (e))The directed trustee under a Delaware administrative trust has no duty to:
Monitor the advisor’s conduct;
Provide advice to or consult with the advisor;
Warn or apprise beneficiaries about the advisor’s directions
The directed trustee, under the Delaware statute, following an advisor’s direction is liable for losses only for the trustee’s own “willful misconduct.”
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility
Directed Trusts Under the Uniform Trust Code or the Common LawSettlors may allocate trust functions among the primary trustee and advisors as
they provide in the trust document (UTC §808).The primary trustee’s standard for review of the advisor’s actions will depend on
local law or the trust terms.Uniform Trust Code: the trustee must act as directed unless advisor’s action is:
– Manifestly contrary to trust terms– A serious breach of fiduciary duty
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A C C E S S . E X P E R T I S E . S E R V I C E . Fiduciary Responsibility
Drafting to Allocate Responsibility to an AdvisorDefine the scope and terms of the advisor’s responsibility;Set the standard of review to which the advisor’s actions will be subjected by the
primary trustee.Specify whether the advisor’s power is fiduciary or personal in nature.
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A C C E S S . E X P E R T I S E . S E R V I C E . Northern Trust Revocable Trust Form - 201
If non-marketable assets (e.g., partnership interests, closely held stock, real estate, loans) or investment concentrations of marketable securities may be included in a trust, this should be discussed in advance with the corporate trustee. If these assets are to be retained, clients usually want to relieve the corporate trustee of investment responsibility for them. If this is desired, add to the end of SEVENTH:
SECTION 20: A Trust under this agreement may hold some or all of the following assets, which shall be known as “special assets:”
_____________________________________________________________
_____________________________________________________________
_____________________________________________________________
Notwithstanding the general investment powers of the trustee, the following provisions shall apply to the special assets in the trust:
a) I appoint the following individuals who are willing and able to act (singly, and in the order listed) to act as manager for the special assets in the trust:
i. Myself
ii. The remaining individual cotrustees or cotrustee of the trust (if any)
iii. _____________________________________________________
iv. _____________________________________________________
b) While a manager is acting, the manager shall have sole investment, voting and management responsibility (and the trustee shall have no such responsibility) for the special assets in the trust. The trustee shall sell the special assets, and deal with them, only upon the written direction of the manager. The trustee shall be under no obligation to review the special assets, make any investment recommendation with respect to them, solicit any direction from the manager, or value special assets which are non-marketable. The trustee need not review whether the manager is satisfying his or her responsibilities hereunder, and the trustee shall not be liable for any action or inaction of the manager.
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A C C E S S . E X P E R T I S E . S E R V I C E . Northern Trust Revocable Trust Form - 201
c) The powers of the manager (other than myself) shall be deemed to be and exercised as fiduciary powers. Special assets may include stock or other interests in a corporation, partnership, limited liability company or other entity (herein called a “company”). The manager’s fiduciary powers shall not preclude the manager from holding office in a company, accepting remuneration from it, voting any interest in favor of himself or herself as director, manager or officer, or purchasing or selling interests in the company. The trustee shall make tax elections with respect to a company only as the manager directs. If a firm succeeds to part or all of the business or assets of a company by merger, consolidation, reorganization or otherwise, the trust’s interest in that firm (whether or not publicly traded) shall continue to be a special asset of the trust.
d) Special assets may include interests in real estate. The trustee shall have no responsibility, other than title-holding, for those interests and the tangible personal property associated with them. The manager shall have sole responsibility for managing, insuring, leasing and repairing the properties, collecting rents, and paying all taxes and expenses on the properties. The trustee shall deal with the properties only as and when directed to do so by the manager. If the manager asks the trustee to provide additional money for the expenses or improvement of a special asset, however, the trustee shall have responsibility for determining whether or not to provide funds. The manager may employ property managers at the expense of the trust or may manage the properties personally. The trustee need no review or inspect the properties, except that the trustee shall have the right (but not the duty) to exercise the trustee’s environmental powers under this agreement.
e) A manager shall be entitled to reasonable compensation, unless waived, and to reimbursement for reasonable expenses, include travel costs.
f) The statement of the trustee that it is acting according to this section shall fully protect all persons dealing with the trustee. The trustee shall have no responsibility for any loss that may result from acting in accordance with this section.
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A C C E S S . E X P E R T I S E . S E R V I C E . Liquidity Issues
Trust Assets Presenting Liquidity/Cash Flow IssuesReal Estate
Non Marketable EntitiesTangible Personalty and CollectionsIntellectual Property
Consider Endowing “Income Consuming” Assets to Facilitate Administration and Management
Non-Income Producing Held in GST Exempt Trusts Present the Risk of Tainting
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A C C E S S . E X P E R T I S E . S E R V I C E . Statutory and Judicial Pronouncements on
Diversification
Uniform Prudent Investor Act, Section 3. DiversificationA trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.
Restatement Third, Trusts §91FWhether and to what extent a specific investment authorization may affect the normal duty to diversify the trust portfolio (see §90, Comment g) can be a difficult question of interpretation. Because permissive provisions do not abrogate the trustee’s duty to act prudently and because diversification is fundamental to prudent risk management, trust provisions are strictly construed against dispensing with that requirement altogether. Nevertheless, a relaxation in the degree of diversification may be justified under such an authorization by special opportunities for the trust or by special objectives of the settlor.
Wood v. U. S. Bank, N.A. 160 Ohio App 3d 831, 2005A trustee’s duty to diversify may be expanded, restricted, eliminated, or otherwise altered by the terms of the trust. But this statement is true only if the instrument creating the trust clearly indicates an intention to abrogate the common law, now statutory, duty to diversity.
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A C C E S S . E X P E R T I S E . S E R V I C E . Concerns About Diversification
Adverse Income Tax Consequences
Unfamiliarity with Other Asset Classes
Loss of Control
Performance Expectations
Impact on Portfolio Yield
Legacy Holdings
Fees
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A C C E S S . E X P E R T I S E . S E R V I C E . Reasons for Non-Diversification
Purpose of Trust
Legacy Holdings
Termination Date of Trust Interests of Beneficiaries
Step-Up in Basis
Illiquidity
Loss of Controlling Interest
Related Trusts
Beneficiaries’ Assets
Adverse Income Tax Consequences
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A C C E S S . E X P E R T I S E . S E R V I C E . Grantor Intent – Trust Terms on Retention
Silent Document
Retention of Assets Acquired from Grantor is Permissible
Retention of a Particular Asset is Permissible
Retention of a Particular Asset is Preferred
Retention of a Particular Asset is Mandatory
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A C C E S S . E X P E R T I S E . S E R V I C E . Retention Language
Identify the Asset
Explicitly Waive the Duty to Diversify
Articulate the Reasons for Retention
Address Asset “Conversion” Issues
Equities: Mergers, Acquisitions, Spin-offs
Real Estate: Sale, Reinvestment
Consider Modifying the Fiduciary’s Standard of Care
Conventional Trusts
Directed Trusts
Endow Operating/Holding Costs for Non-Income Producing Assets
Provide a Means for Dispute Resolution
Protect the Fiduciary
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A C C E S S . E X P E R T I S E . S E R V I C E . Asset Concentrations: Risk Management
Process
I. Policy
Follow trust terms or state Prudent Investor Rule
II. Process
The trustee must have a process for identifying and evaluating concentrations
III. Review
Determine grantor intent and fiduciary responsibility
IV. Evaluation
Evaluate retention and diversification strategies
V. Consultation
Consult with beneficiaries, their counsel, and trustee’s counsel
VI. Implementation
Implement appropriate strategies
VII. Documentation
Memorialize the process
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48 Long Term Planning for Unique Trust Assets
A C C E S S . E X P E R T I S E . S E R V I C E . Unique Trust Assets - Examples
Bolivian Tin Mine Emu Farm
Bombay Cement Factory Llama Farm
Sewage Plant Race Horse
Bingo Parlor ½ Race Horse
Las Vegas Casino Animal Reproductive Material
Animal Hospital
Pet Cemetery
Hemp Factory
Methadone Clinic
Nudist Colony
Indonesian Brothel
Motel with Hourly Rates
Las Vegas Wedding Chapel
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Statements of Intent
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50 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Statements of Intent
Repeal of the Rule Against Perpetuities and the Proliferation of Dynasty TrustsR.A.P. has been repealed, extended, or optioned in 29 states and the District of
Columbia.The continuing transfer tax window permits individuals to make substantial non-
taxable gifts to long term, GST-Exempt dynasty trusts.Threats to Dynasty Trusts
Limits on leveraged estate planning techniques
Discontinuation of grantor trust treatment
Limitations on length of the GST exemption
Reinstitution of the Rule/restoring the power of alienation
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51 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Statements of Intent
Dead Hand Control v. Beneficiary RightsTension Between Settlor Control, Flexibility, and Future InterestsMaterial Purposes and the Claflin Doctrine
Claflin v. Claflin
Restatement (Third) of Trusts
Uniform Trust Code
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52 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Statements of Intent
Settlor Intent…Into PerpetuityEstablishing and Adapting Settlor intentVagaries of the Future
Economic cycles
Capital markets and investment practices
Tax law
Trust law
Lifetime expenses (education, health care)
Demographics changes
Equitable Deviation Doctrine
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53 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Demographic Changes
Reproductive Variables
Blended Families Composition
Generational Overlap
Expansion of Marriage and Definition of Spouse Increased Life Expectancies
Conception
In UteroEx UteroInter VivosPosthumousHusband
His spermDonor sperm
Wife
Her eggDonor egg
Pregnancy
Wife’s wombSurrogate’s womb
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54 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Statements of Intent
Instructions to the Trustee (and Other Fiduciaries)Letters of WishesPrecatory LanguageStatements of Intent
Demonstrates unique grantor intent
Ties that intent to the trust (material purpose)
Expresses grantor’s view on modification and termination
Public Policy Limitations
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55 STATEMENTS OF INTENT
A C C E S S . E X P E R T I S E . S E R V I C E .
Statements of Intent
Communications to BeneficiariesWills and Trusts as a Form of Personal Communication
Ethical WillsFamily Mission StatementsStatements of Intent
Formulation
® Inductive Method® Deductive Method
Examples
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