Originally published in the Fall Edition of WealthCounsel Quarterly on December 8, 2021.
The saying “easily gained is easily lost” seems like a simple phrase to understand. Yet these words often fall on deaf ears. Andrew Carnegie, the great steel magnate of the nineteenth century, explained in his essay The Gospel of Wealth that “great sums bequeathed [often] work more for the injury than for the good of the recipient.”[1] The classic parable of the prodigal son, in which a man gives his child his inheritance early only to learn that his son had been reduced to eating with the pigs because he had quickly squandered it, illustrates this phenomenon perfectly. The takeaway: an immature beneficiary who suddenly receives wealth is prone to make poor financial decisions.
Although the beneficiary of substantial wealth will likely not end up eating with the pigs, the story of the prodigal son is not far from reality. Carnegie warned against giving heirs too much money outright, stating “the parent who leaves his son enormous wealth generally deadens the talent and energies of the son, and tempts him to lead a less worthy life.”[2] In fact, recent studies have found that wealth has the ability to influence thoughts and actions in ways that the recipients and grantors are unaware of, regardless of the recipient’s socioeconomic status.[3]
Moreover, Carnegie understood that the recipients of wealth, absent prior experience or proper instruction, seldom recognize the labor and effort it took for the previous generation to build it. As a result, the inheritor’s understanding of the purpose behind a bequest is limited, and they may not develop a strong work ethic. Similar to the prodigal son’s failure to achieve a better life, other prodigal heirs may fail to meet the potential that the grantor intended.
An estate planning attorney can better serve their clients by learning to recognize the presence of a potentially prodigal heir when working with a family.
One effective way is by inquiring about the lives of the clients and their beneficiaries during the initial client meeting. During the initial consultation, some clients will express their lack of concern about the transfer of wealth to their heirs because “they’ll be gone or dead when it happens.” Although clients may express this view, such expressions of apathy are often a defense mechanism that clients employ when they feel uncomfortable being transparent about their children or family dynamics.[4] The attorney conducting the meeting should seriously consider probing more deeply to move past these initial statements in an effort to gather as much information as possible. Almost every parent cares about what happens to their children. The fact that they are sitting in the attorney’s office (or in a virtual meeting) likely demonstrates that they care about the wealth they have created. Moreover, many clients do not know if their beneficiaries are responsible or able to manage wealth and are, at a minimum, uncomfortable or biased when providing answers.
It is essential that an intake form be completed and returned to the attorney in advance of an initial consultation. However, to recognize prodigal heirs, the initial estate planning consultation must involve more than simply reviewing the client’s intake form. At the end of the meeting, an estate planning attorney who has only identified dates of birth and residuary beneficiaries may have missed a critical opportunity. Rather, the meeting should be an in-depth and personal conversation about family dynamics.
Instead of simply asking clients how well their beneficiaries manage wealth, a practitioner might approach the question from other angles. For example, the question, “what would your daughter do if she was given $1 million tomorrow?” indirectly addresses the more essential issue. If the client answers that the child will likely spend $250,000 on a new sports car, the beneficiary may lack the ability or maturity to manage wealth and probably qualifies as a prodigal heir in most families. However, if the client explains that the beneficiary will place funds into a savings account or hire a wealth advisor, the attorney and the client may plan accordingly. Keep in mind that the heir who will receive the funds may not be the main source of concern. Rather, a client may worry that the beneficiary’s inheritance will fall into the hands of their spouse or creditors.
The beneficiary’s current financial situation is another critical factor to consider. Questions about the beneficiary’s current employment, income, creditors, and spending habits provide a window into their future use of an inheritance. A beneficiary who has experience in making or handling larger amounts of money will likely know how to manage a substantial inheritance. For example, a thirty-five-year-old physician making $400,000 is less likely to be a prodigal heir than an eighteen-year-old college student. However, as any experienced practitioner will attest, professionals are not exempt from such a classification. In the end, it is the attorney’s responsibility to help determine the presence of a prodigal heir, to assist the client in understanding the implications, and to find solutions.
It is also important to recognize the value in making the client feel comfortable when they are sharing details of their family dynamics. The attorney should take care not to communicate using a judgmental tone. Rather, the attorney should assure the client that everyone has faults and family issues. A practitioner’s failure to redirect the client’s negative feelings about their truthful answers may hinder a client’s willingness to communicate openly.
Once an attorney has recognized the presence of a prodigal heir, the attorney should be prepared to provide the client with solutions to protect the client’s wealth and, ultimately, the heir’s financial stability. A prodigal heir can be addressed using nonlegal means. For example, a practitioner can suggest that a client talk with their beneficiaries about the beneficiary’s financial situation and plan. Similar to how the two rails of a train track must be parallel for the train to move forward, it is important that clients know that their beneficiary’s financial goals parallel their own.
Another practical technique that clients can implement to prevent an irresponsible heir from squandering inherited wealth is to test the heir’s financial responsibility or have them practice wealth management in a controlled environment. For example, a client could provide each child with a gift of $10,000 with no instructions or rules. After a year, or a few weeks in some cases, the client can simply ask the child what they did with the funds. The child’s use of these funds often speaks for itself. These practical exercises can also help beneficiaries understand the parent’s financial expectations regarding the use of cash gifts.
However, practical techniques may not be the most effective tools for some clients. Some clients want the opportunity to provide for their beneficiaries without giving them control over their inheritance. Placing the assets in a trust for the beneficiary’s benefit is the most obvious and effective solution. Although there are various drafting strategies, the most popular strategy when dealing with a prodigal heir is the spendthrift trust. It is standard practice to include spendthrift provisions in trusts regardless of whether a client has identified a prodigal heir.
A spendthrift trust, first created in the late nineteenth century, “is a trust established by the trust creator for the benefit of a third party.”[5] It is called a spendthrift trust because of the risk that the beneficiaries will be “spendthrifts” and would spend their share of the trust assets within a short period of time. There is one important feature that is vital to this type of trust that differentiates it from any other: the spendthrift provision.
The Wealth Docx® drafting system includes an example of a well-drafted spendthrift provision:
No beneficiary may assign, anticipate, encumber, alienate, or otherwise voluntarily transfer the income or principal of any trust created under this trust. In addition, neither the income nor the principal of any trust created under this trust is subject to attachment, bankruptcy proceedings or any other legal process, the interference or control of creditors or others, or any involuntary transfer.[6]
Ultimately, a spendthrift provision will generally prevent a beneficiary from voluntarily or involuntarily assigning their interest in the trust.[7] Thus, creditors cannot attach a beneficiary’s interest in the trust, and a beneficiary’s spouse generally cannot either. Therefore, the spendthrift provision is a useful tool that allows a trust creator to set aside wealth for a beneficiary without worrying that it will be irresponsibly spent.
However, because of changes in the law in some jurisdictions, the inclusion of a spendthrift clause in a trust has become less effective. For example, in Carmack v. Reynolds, the California Supreme Court held that a spendthrift clause will not prevent creditors from attaching mandatory distributions that were due and payable.[8] In contrast, in Oklahoma, most creditors may not attach any present or future mandatory distributions prior to distribution.[9] Consequently, it is important that attorneys act to ensure that their client’s wealth is protected.
One legal remedy is for the trust to authorize discretionary distributions—for example, for the prodigal heir’s health, maintenance, education, and support—instead of mandatory distributions. As mentioned, when a beneficiary has a vested interest (i.e., is entitled to a mandatory distribution), a creditor may have a right to attach the distribution even before the beneficiary receives it. Further, as a practical matter, a creditor may be more likely to attach mandatory distributions made at regular intervals than distributions that are made at the trustee’s sole discretion.
The trust instrument should not include withdrawal rights. Providing withdrawal rights to a beneficiary counters the purpose of a spendthrift trust. Upon withdrawal by the beneficiary, the trust assets are vulnerable to attachment by creditors and also potentially available to divorcing spouses. The strategy providing better protection is to allow only discretionary distributions with no withdrawal rights in a spendthrift trust.
Some clients want their beneficiaries to have some degree of control over their share at a certain age. Instead of including the right to withdraw at a certain age, a more protective strategy is to specify that the beneficiary be named a co-trustee with the successor trustee at a specific age. Establishing this co-trusteeship will allow the beneficiary to have some control over the trust principal, limit the beneficiary’s degree of control over the wealth, and allow the successor trustee an opportunity to teach and demonstrate successful wealth management.
The choice of a successor trustee for the spendthrift trust is crucially important and should be carefully considered. Many clients believe that “blood is thicker than water” and erroneously assume that appointing a family member as trustee is always better than an unbiased third party. Problems can arise when a client appoints cousin Eddie, who is not in a position to understand the family’s needs, in lieu of a more experienced or qualified trustee. Thus, it is critical for the attorney in the planning meeting with a client to explain the complicated tasks and issues involved in serving as a trustee, especially when a spendthrift trust will be used.
An attorney may consider recommending a corporate trustee to serve as successor trustee. Although a client’s initial reaction may be negative, the use of a corporate trustee is sometimes advisable. A successor trustee who is a family member may not recognize that a trustee’s primary duty is to protect and preserve the trust assets rather than to please other family members. Further, serving as successor trustee requires an in-depth assessment of the trust’s language, which corporate trustees, who generally have access to trust administration experts with substantial experience, are in a better position to handle.
However, some clients are adamant about naming a family member to serve as successor trustee. This may stem from the fear that a corporate trustee will not act in the beneficiary’s best interest when deciding whether to make discretionary distributions. Under these circumstances the estate planner may want to recommend that a corporate trustee be named as the successor trustee who oversees the management of all the trust assets, and that a family member be nominated as the distribution trustee whose sole power is to approve the successor trustee’s discretionary distributions.
Alternatively, a practitioner may recommend the use of a trust advisor or trust protector in addition to the corporate trustee. A trust advisor or trust protector has the ability to monitor the successor trustee and remove them and appoint a new trustee if appropriate and necessary.
Regardless of the degree of their wealth, many clients want to discourage their beneficiaries from carelessly spending their inheritances and do not want to negatively impact their beneficiaries’ financial potential. Using the strategies outlined, an attorney can help protect the client’s wealth and, ultimately, the beneficiary’s financial wellbeing. An estate planning attorney can provide an invaluable service by helping clients recognize the presence of a prodigal heir and implementing the most prudent solutions for transferring wealth to them. Ultimately, no client wants to see their children eating with the pigs.
[1] Andrew Carnegie, The Gospel of Wealth, N.Y.: Carnegie Corp. of N.Y., (2017, first published in 1889), https://media.carnegie.org/filer_public/0a/e1/0ae166c5-fca3-4adf-82a7-74c0534cd8de/gospel_of_wealth_2017.pdf.
[3] Carolyne Gregoire, How Money Changes the Way You Think and Feel, Greater Good Magazine (Feb. 8, 2018), https://greatergood.berkeley.edu/article/item/how_money_changes_the_way_you_think_and_feel.
[4] Dr. Leon F. Seltzer, The Curse of Apathy: Sources and Solution, Psychol. Today (Apr. 27, 2016).
[5] Jeramie J. Fortenberry, JD, LLM., Drafting Third-Party Spendthrift Trusts after U.S. v. Harris, WealthCounsel Insight Brief (July 19, 2017), https://member.wealthcounsel.c...; Jay Adkisson, A Short History Of Asset Protection Trust Law, Forbes (Jan. 26, 2015), https://www.forbes.com/sites/jayadkisson/2015/01/26/a-short-history-of-asset-protection-trust-law/?sh=4f3c98923fb4.
[6] Jeramie J. Fortenberry, JD, LLM, Drafting Third-Party Spendthrift Trusts after U.S. v. Harris, WealthCounsel Insight Brief (July 19, 2017), https://member.wealthcounsel.c....
[7] Id.
[8] Carmack v. Reynolds, 391 P.3d 625 (Cal. 2017).
[9] 60 Okla. Stat. § 60-175.87 (2021).