Don’t Silent Trust Funds Constitute a Massive Loophole in Financial Aid Calculations?

My morning was spent reading the New Hampshire Bar Journal, Winter 2010 edition because I was interested in a piece by Joseph F. McDonald, III called Migrating Trusts to New Hampshire: The “Why” and the “How“.  New Hampshire, along with a very few other states, allows the existence of something known as a “silent trust” or “quiet trust”.  These trust funds, the distribution rules, the total assets, and much more can be kept from the beneficiary.  Theoretically, you could leave $10,000,000 in a silent trust to a child, who would only learn of the inheritance and begin receiving payouts on her 35th birthday.  Alternatively, you could put $100,000 in a quiet trust to be paid out as a lump sum when a grandchild graduated from college and got his first real job to help setup a home or payoff student loans.

What immediately occurred to me, however, is this seems to present a massive loophole in the government regulations of financial aid for colleges and universities.  I can’t see how they could possibly stop it.  A scenario will help you understand my point.

Imagine you are a successful heart surgeon.  You have a niece whom you love.  Her parents never saved any money, so you decide to setup a trust fund to help her once she’s an adult, independent, and moved away from home.  You put $500,000 into a quiet trust that, over the decades, grows to $2,000,000.  Once she turns 30, the trust will begin distributing 3% of its net value to her per year.  The beneficiary, your niece, never learns of the existence of the silent trust until she is an adult in the midst of her career.  She has no idea how much money is in it, that she is entitled to any of it, or even how much she will receive.  For all intents and purposes, the money doesn’t exist until that first check shows up and she meets with the trustees.

The FAFSA form requires trust fund assets to be disclosed and factored into financial aid using a discounted net present value formula, even if the money isn’t available to help pay for college.  With a silent trust, however, the parents don’t even know of the existence of the trust fund.  They, and your niece, can’t commit perjury on the financial aid forms because they are unaware that the trust fund was ever established!  How can they disclose something of which they are unaware?  Even if they did become aware of the silent trust fund, they have no standing to request disclosure of the assets, meaning they can’t even guess how much is in it to complete the financial aid forms.

Likewise, what would stop you from maintaining plausible deniability as your parents setup silent trust funds for the grandchildren?  You could even hide the assets further by naming the child as a contingent beneficiary only entitled to the funds if he or she graduates from college, while in the meantime, someone else was (temporarily) the “real” beneficiary.  It would only be useful in a certain limited number of circumstances, where the parents themselves weren’t rich but the family members were.  Still, it seems blatantly obvious that with a little tweaking, you could drive a Mack truck through the FAFSA rules by taking advantage of trusts domiciled in certain states.

People wonder why the rich get richer.  It’s not that the system is unfair, it’s what I’ve said many times already: Being rich is a symptom of behavioral patterns, such as maximizing efficiency or structuring investments in tax advantaged ways.  Anyone can sit here and research this stuff; it’s publicly available, free, and not that hard to understand if you have at least a 12th grade reading level.

I’m guessing at this point, silent trusts are still so new, and so novel, having been on the scene for only 6 or 7 years, that no one has tried a lot of these techniques.  If you did it right, no one would ever even know to challenge them, though, because they would remain ignorant of the trust fund in the first place.

I need to research this further … for some reason it intrigues me to spot vulnerabilities in the system.  I’ve long made it known that I think trust funds should be used even by those with only $50,000 or $100,000 in wealth they want to pass on to their heirs.  You can avoid a lot of folly when you lock the money away and only let the dividends, interest, and rents be spent; never the principal.  You could use a trust fund to amass a lot of wealth for future generations.