In the old days, trusts departments were backwaters in which investment programs had to conform to the most conservative of standards. Servicing the trust market was hardly a business that generated much excitement. But baby boomers and their parents are expected to pump more money — and life — into the trust market over the next decade while the definition of “prudent investing” for trusts continues to evolve in a broker-friendly manner. Brokerages are taking notice — and so should you.
“The more sophisticated brokers are looking for trust assets,” says Susan Hirshman, vice president of planning strategies at J.P. Morgan Fleming Asset Management and columnist for Registered Rep. “With the country's great transfer of wealth, there will be more and more trusts.”
High-profile examples of brokerages sailing into harbors historically blockaded by banks are now commonplace. The nation's wirehouses, for instance, today tend to feature trust arms as part of their “one-stop-shop” pitches to wealthy clients. Discount brokers and mutual fund firms like Charles Schwab have added trust services through firm acquisitions (U.S. Trust, in Schwab's case). Even solo financial planners are wading in as part of efforts to minimize asset loss when their wealthy clients die.
The reasons to add trust assets are compelling. They can expand your customer base and provide a reliable income stream, moving you closer to a holistic, rather than a transaction-based, business model. And, frankly, the money stashed in trusts is very sticky. “The average life of an investment account is three to four years, whereas the average life of a personal trust is nine to 17 years,” says Peter Welber, managing executive for personal trust services at Wachovia Trust Co.
Becoming knowledgeable about trusts requires dedication, persistence and an ability to endure longer sales cycles. In pursuing this specialty, keep in mind that trust accounts aren't for just the elderly or the super rich. The most popular trusts today, in fact, are living trusts. These trusts, which allow estates to avoid the potentially high costs of probate court, are attractive to baby boomers as well as their parents. Living trust documents permit the owners to name, in advance, who should handle their financial and legal affairs if they become incapacitated. They also are revocable, which means the holder of one can change the terms at any time or get rid of it; in contrast, irrevocable trusts can't be broken and are often created to minimize estate taxes.
Trust experts at Edward Jones advise its investment representatives on what types of client might need trust services, says Ken Cella, the firm's principal in charge of trust marketing. Its prime candidates include the recently widowed who relied on a spouse for financial guidance; people in poor health who have no relatives living nearby; and parents with irresponsible or disabled children. Trusts can also be used to pass along money to a charity, to stretch out an inheritance for more than one generation or to ward off creditors and court judgments.
The Prudent Investor Act, promulgated in 1994 and now adopted by 37 states so far, is also dramatically changing the way trust money is invested. Prior to this act, managers were legally charged with determining whether each investment in a trust portfolio was “prudent” (that is, conservative). This process eliminated myriad legitimate investing options and left trust portfolios top-heavy with Treasurys, corporate-grade bonds and dividend-paying blue chips.
The Prudent Investor Act changes the trust-investing landscape by allowing trust managers to evaluate risk-returns of an entire portfolio instead of requiring an evaluation of each individual investment within a portfolio. Today, an array of new trust investment options including small-cap and foreign stocks, junk bonds, real estate, hedge funds and derivatives is available to trust managers.
The fact that vast numbers of trusts still adhere to the old rules is an opportunity for advisors to “give more meaningful advice to clients,” says Joan Bozek, an attorney and senior fiduciary consultant with Merrill Lynch Trust Co. “From a business perspective, [the act has] created sales opportunities that weren't there before.”
It's also important to appreciate a revolutionary development in how trust money is dispersed. Trusts, which are designed to last for two generations, can arouse enmity between those who get first crack at the money (income beneficiaries) and younger relatives (remaindermen), who must sometimes wait decades before pocketing any cash. In this classic arrangement, income generated by bonds and dividends goes exclusively to the income beneficiaries; when they die the trust terminates, and what's left is handed to the next generation.
That's where the conflict of interest often arises. Income beneficiaries generally favor bonds, because they generate the most cash. Such conservative investing strategies, however, can short change the next generation, which might benefit from a portfolio invested for growth.
Many legal experts suggest something called a total return unitrust to help mitigate these types of conflict. In a unitrust, which is permitted in all 50 states, a portfolio is invested for growth, but income beneficiaries get to skim a portion of the portfolio (usually between 3 and 5 percent).
If you are interested in learning more about trusts, look to start your education in-house if possible. If it offers trust services, your firm should be able to provide you with materials as well as access to trust specialists. You should also speak with estate planning attorneys, who can provide client referrals as well as guidance. On the Web, try leimberg.com, which is operated by Leimberg & Associates, a nationally recognized publishing and software company serving the fields of estate, retirement and financial planning.
Lynn O'Shaughnessy is author of Retirement Bible (John Wiley & Sons, New York), has been writing about personal finance for nearly a decade.