The Directed Trust: Advisors and Clients Win

Competition among wealth managers for high-net-worth clients is fierce. In order to attract and retain such clients, wealth managers must offer a wide range of sophisticated services, including a directed trust.

For years, two of these services — trust administration and investment management — came as a joint package. When a client came to a bank and was referred to its trust department, services were offered in the form of a trustee who would retain decisions about asset choice, arguing that both services were not wise to divide.

As a wealth advisor, you can furnish the very powerful tool of a directed trust to allow your client to retain the services of an independent trustee, while you, their trusted financial advisor, maintain full control over investment decisions and the management of your client’s assets.

What is a Directed Trust?

In the simplest sense a directed trust removes investment management responsibility from the trustee. With a directed trust, the terms of the trust typically will designate an investment advisor who will direct the trustee, regarding all investment-related actions taken on the account. The trustee will not take action without direction from the appropriate party authorized by the terms of the trust. This in effect splits responsibilities; the trust company or the trustee administers the trust but the client’s financial advisor keeps control over investment choices and assets.

The Directed Trust: Advisors and Clients Win

The evolution of many trust companies into broad-based wealth management firms has put financial advisors serving the high-net-worth market in the unenviable position of having to cede control of a portion or all of their clients’ assets to a competitor whenever they suggest that a trust be created.

But with the advent of directed trusts, the grantor can direct the trust company to follow the investment choices of an outside advisor. In these arrangements, control over the assets (and the investment fees they generate) remains with the advisor, while the trustee administers the trust itself.

With a directed trust, both the trustee and investment advisor are free to do what they do best, aligning the interest of all parties with the grantors and beneficiaries themselves, while minimizing potential conflicts.

The key point to remember about directed trusts is that someone other than the trustee manages the underlying assets. In a traditional common law trust, the trustee is responsible for both the administration of the property held in trust and how it is invested. In a directed trust, these functions are split up between the trustee, the advisor and possibly other professionals.

The practice of directed trusts began with the Uniform Prudent Investor Act of 1994, and the first families to benefit from these arrangements used them as a vehicle to consolidate control over various family-held business entities.

Since the family had much greater understanding of how the business operated than any outside trustee could ever achieve, directed trust arrangements allowed them to form a family LLP or LLC and transfer the ownership units into the trust. A trust company served as trustee while the manager of the partnership maintained control over the enterprise. Everyone won.

Over the last few decades, the directed trust concept has expanded to focus on more conventional asset classes such as stocks, bonds, cash or other marketable securities.

As before, the person managing that wealth — the legacy advisor — is logically the best positioned to go on managing it. Again, a trust company serves as trustee, but the advisor continues running the investments and everyone wins.

Enter the Directed Trust Company

In the last 20 years, a vibrant industry of independent trust companies like Peak Trust Company have emerged as specialized directed trust vendors.

The best directed trust company can support custody platforms that are truly open in architecture. They can support their trust clients’ portfolios across the universe of asset classes — cash, stocks, individual bonds, mutual funds, exchange-traded funds, and exotic instruments — all, of course, as you direct.

Fees for administration and custody at directed trust companies are typically in the 0.50% to 0.80% range for the first $1 million, which is roughly half the normal fee that all-inclusive firms tend to charge for bundled wealth management plus trust administration. As with any other financial service, fees vary widely and the trade off between value and expense can be precarious. Advisors should be prepared to shop around on behalf of their clients.

Naturally, the investment manager directing the way the trust assets are invested retains the right to set his or her own management fee and, where appropriate, performance fees as well.

While full-service trust companies normally adjust their fees to pass on the cost of working with unusually complex or non-liquid assets, directed trust companies can avoid this surcharge because they are passing on the responsibility (and liability) for managing those exotic assets.

Learn more about Peak Trust's Directed Trust Services.

Choosing the Right State

Location is everything. Various U.S. jurisdictions support over 50 types of trusts and dozens of legal codes that determine what protection your clients are entitled to receive — and what your rights as directing advisor are. Many states do not allow directed trusts at all.

Fortunately, there are no rules forcing wealthy families to work with a trust company in their own state. Many cross state lines in order to get the strongest protection available, and many advisors are there helping them make the best choice.

Family office providers generally begin by narrowing their search to a favorable state or group of states, then look further to find a good fit among the trust companies doing business there.

Even if a particular tax benefit or class of protection is not required as of yet, these advisors know that their clients’ situations or needs may change. Since multiple generations may be part of the equation, the trust must be able to evolve with the family’s needs. Many advisors look for some combination of the following factors when searching for a directed trust company:

Perpetuities. Perpetual trusts, or dynasty trusts, are very popular techniques used by planners and clients today. Alaska, for example, allows property to remain in trust in perpetuity, Nevada can continue for 365 years.
Avoidance of State Income Taxes. Avoiding state income tax is another key objective for planners to achieve for their clients. Alaska and Nevada do not impose an income tax on trusts.
Asset Protection. Some states offer varying degrees of protection for locally domiciled trusts from the trust creator’s creditors. The language can be vague in some jurisdictions that theoretically support these “asset protection” trusts. Nevada and Alaska, however, specifically state how long assets must be in trust before they become protected from creditors and what claims may be exempted from protection.
Total Return Trusts and Power to Adjust. Many states have enacted total return trust or power-to-adjust statutes. Trustees in these states can invest based on a total return approach and satisfy beneficiaries who receive either a share of current income or the principal at a later date. Most states with total return trust legislation have the ability to convert a trust to a unitrust percentage between 3% and 5%.
Delegation. Directed trusts are common today where a third-party investment advisor manages the assets of the trust. It is important to review state statutes permitting segregation of duties. Trustees who delegate investment management to an outside investment advisor may still be responsible since the trustee selected the investment manager. This is an important distinction between directed trusts versus delegated trusts.
Privacy. Most directed trust states have methods for ensuring that fiduciary matters will not be a matter of public record, although some are stronger than others. Alaska and Nevada both provide for a high degree of confidentiality to grantors and trust beneficiaries (e.g., grantors can elect to keep the trusts existence confidential form beneficiaries for a pre-determined period of time.)

How To Gather More AUM with Full Control Directed Trust

Remember, trusts give wealthy families:

Control over disposition of assets.
Effective tax planning.
Protection from lawsuits.
Flexibility to respond to changing family needs.

Every single one of your clients — not to mention the clients of competing advisors — would like to achieve at least one of these goals, if not all of them.

In other words, an advisor who can help set up trusts has a key differentiating factor that all clients and prospects appreciate.

Like any other differentiator, trust services can be used as either a competitive weapon to capture clients and assets held elsewhere, as a defensive moat to keep your clients from straying, or both.

Highlight your expertise in this area in your brochure, website, and other marketing materials.
Prospect your existing book by reviewing client documents for trust assets that could be moved or “decanted” into a directed trust under your management.
Remind all clients that you will effectively be “fired” when they die unless their trust documents name you as the ongoing advisor of record and names a successor trustee that is advisor friendly.
Network with estate planning attorneys. You are a valuable referral source for them and, in return, many are actively searching for investment advisors to suggest to their own clientele who are contemplating a directed trust arrangement.

The ideal time to raise the issue is during a regular client review meeting or when new estate planning concerns arise. Simply lay out how directed trusts work and how they allow you to keep providing the same level of service you currently offer your client — even after the wealth moves into the trust.

Be ready to describe the advantages that all forms of trust provide wealthy individuals and families, as well as the differences between directed trusts and traditional trust arrangements. Not all trusts are created equal.