I don’t play the lottery. But if I did, here are three numbers I would not put on the same ticket: 30, 90, 80. Together, and in this order, they signify not a trifecta of instant riches but an abiding challenge that requires a lifetime of commitment to overcome.
30. About 30% of all families who own significant assets together survive intact to the third generation. Three generations is not long – from grandparent to grandchild. The rest of the families, at least 70%, go into a slow decline. Perhaps they spend too much, or they don’t work, or they bicker about how to use what they have. They never find a common purpose for shared ownership. Their financial capital deteriorates because they pay insufficient attention to developing their non-financial capital. In terms of how the family makes decisions together about assets they own in common, either they have no system for doing so, or if they have one, it does not work when they need it most. Down the drain they go.
90. During this same three-generation period of time – again, not a long time; from grandparent to grandchild – there is a change in how the family’s assets are owned. Rather than being owned by individual family members, the assets become owned by trusts. By the second generation, a majority of the assets are held in trust. By the third generation, about 90% are.
There are good reasons for this shift. Trusts are smart protection in case a parent dies before a child turns 18. Trusts can help people of all ages become accustomed to making significant decisions with money. Trusts are useful ways to deal with creditors, bankruptcy, divorce, and drug and alcohol illnesses. Tax-wise, trusts are nearly essential for transferring assets out of a person’s taxable estate and maximizing the use of federal estate and gift tax exemptions. Trusts help preserve what a person has.
80. Informal studies over the years have shown repeatedly that 80% of all trust beneficiaries view their trusts as a troubling thing, not a good thing. Specifically, when asked whether they view the trust as a burden or a blessing, 80% of beneficiaries say the trust is a burden.
Why does this happen? The answer seems to lie in how a trust operates. Every trustee is responsible for performing three functions: administration, investment, and distribution. The trustee administers the trust assets – keeps track of what the trust owns, how much the trust generates in interest, and how and when taxes get paid. An investment professional, usually in a firm the trustee hires, manages investment of the money. The investment advisor uses the advantage of a long time horizon and other features to draw a good return on the trust’s assets. Lastly, periodically the trustee distributes some of the money in the trust to the beneficiary. Depending on what the trust says, the trustee may distribute money quarterly, annually, or very seldom.
The distribution function seems to be where trusts break down. Almost never does a trust fail for administrative reasons. Most trustees are conscientious and do not intentionally violate their duties. So too a trust usually does not fail for investment reasons. Of course, a trust can run out of money. But usually, the investment professional is doing his or her best to generate a return that accomplishes the trust’s purposes.
So how does the distribution function cause a trust to fail? The root of failure is the trustee’s inability or unwillingness to base distributions on a human relationship with the beneficiary. After all, each beneficiary is a human being, and so the trustee-beneficiary relationship is necessarily a human one. The trustee’s challenge is to get to know the beneficiary as a person. If the trustee does not know what makes the beneficiary tick, what the beneficiary aspires to, what the beneficiary is really good at, and what weaknesses the beneficiary is prone to, the trustee is not really able to perform the distribution function. Notice the function at issue here: distribution. The trustee might be performing the administration and investment functions excellently. But to perform the distribution function well, the trustee must know the beneficiary – in the same way, the trustee knows colleagues at the office or people in the trustee’s community.
According to recent research by The Family Enterprise Office, most trusts don’t hit this standard. There are many reasons why not: commodification of investment services; unclear or confusing trust agreements; inexperienced individual trustees; a decline in service by outside professionals; complexity of managing illiquid assets; and of course, unrealistic expectations.
This sounds like a big mess, right? Perhaps it is. But as the saying goes, “To untie the knot, first one must learn how the knot was tied.” Having sorted the problem, one is now in a position to address it. And that’s what The Family Enterprise Office will be doing. For trusts to be good owners, both trustees and beneficiaries must be good at what they do. Stay tuned for more from us on this subject in the next few months.