August 16, 2018
Author: Susan Anderson
Organization: Hellmuth & Johnson
There are 2 types of trusts: Testamentary and Intervivos. Testamentary trusts, are trusts are formed upon the death of the creator (also known as the grantor). They are created and governed by the grantor’s will and do not come into existence until the death of the grantor. Testamentary trusts are the oldest form of trust, having been recorded as existing since the times of the Roman Empire. The second trust type, an intervivos trust, is the newer form of trust structure. This trust is created by the grantor during their life by executing a trust agreement. There are records of the existence of intervivos trusts, as far back as the 12th century in England in the period of feudal land ownership. During this time, there are records evidencing as system whereby land owners would transfer their ownership interests to trustees. The trustees were charged with maintaining and managing their affairs during their extended absences participating in the Crusades. The grantor would irrevocably gift over their ownership interests, to guard from enemy possession, either due to their capture or death in the Crusades, or from other invading marauders. Upon their, if they returned, the Crusaders could enter a plea to the Chancellor court with an appeal for the return of their lands and rights thereto. These arguments often being noted as the genesis of the modern legal theory for American arguments based on equity.
Today, in the U.S., a trust is a relationship whereby property is held by one party for the benefit of another. A trust is created by a settler (also called a grantor or trustor), who transfers some or all of their property to a trustee, oftentimes separating legal title from the equitable ownership and benefits. The beneficiary is the individual, or group of individuals, who may benefit from the assets, including receiving income and or the market value of the assets. The trustee are given legal title to the trust property but they are obligated to act for the good of the beneficiaries. The trustee may be compensated and have expenses reimbursed, but otherwise have a fiduciary duty to turn over all profits from the trust assets to the beneficiaries after expenses, as outlined in the trust document. This may be done for tax reasons, management efficiency, probate avoidance, or to assist in the transfer of rights and title during incapacity and/or death of the settlor.
B. Importance Of The Instrument - Uses
Once created, there are two overall trust structures based on the rights and powers which are either retained or relinquished by the grantor. The first trust type is a Revocable Trust, which allows the grantor to revoke or amend the trust at any time while the grantor is alive and has mental capacity. The second type of trust is Irrevocable. With this type of trust, the grantor relinquishes their right to amend most, if not all, provisions of the trust. Furthermore, the grantor cannot revoke the trust, or take actions to substantially control the administration and/or distribution of the trust.
A trust is a customized contract created between the grantor and the trustees. Each state has a general statutory framework governing the administration and distribution of trusts.
Furthermore, the Uniform Principal and Income Act and the Uniform Trust Code which serve as a model for states to follow when forming and amending state statutes. Finally, the Restatement of Trusts is a good resource for standard state and national laws and guidelines. While there are legal statutory and regulatory standards regarding trusts, a grantor can override laws and make their trusts completely unique. As a result, whenever a question arises with regard to the proper administration, investments and compliance of a particular instrument, the trust document in question must be examined. While form documents exist as guidelines for drafting trusts, because the grantor can and often does customize their particular trust for their own purpose. Outer limits do exist regarding certain trust provisions in that the provisions of a trust cannot be contrary to public policy.
C. Common Types Of Trusts Used For Estate Planning Purposes
Common reasons for establishing trusts include probate avoidance, tax minimization, asset protection, and controlling the purpose and use of funds for generations. We will now discuss some of the common types of trusts which are utilized to accomplish these purposes.
1. Revocable Trust
Among the many benefits of a revocable trust, there are three main benefits unique to this legal structure: probate avoidance, stronger creditor protection, by-passing ancillary probate, and springing incapacity management.
a. Avoid Probate
A revocable trust is an intervivos trust which is established by a grantor during their life. There are many goals which can be accomplished through the use of a revocable trust, the most common being probate avoidance. Probate is governed by state laws. In general, there are seven ways to by-pass the court probate system.
- Joint Tenancy
- Life Insurance and Annuities through beneficiary designation
- Qualified Retirement Plans: Such as 401k, IRA and profit sharing plans
- TOD/ POD (Transfer or Payable on Death)
- Transfer on Death Deed for Real Estate
- Contracts (including Buy Sell Agreements}
- Trust: Revocable and Irrevocable
Probate is a process which exposes the grantor’s assets to a court process. Depending on the types of assets held in the estate, and the clients’ family situation, this process can be more or less expensive and grueling. While it varies from state to state, the process usually entails listing your assets and heir’s names and addresses at the courthouse for public consumption. Sales organizations do buy lists of this information from the courthouse in order to solicit your heirs for business. The process can be lengthy, taking on average, a month to appoint a personal representative. Thereafter, some states require a waiting period before a personal representative may sell real estate (60 days in MN for instance). Then there is a creditor waiting period (around four months in Minnesota for example). If the estate has an estate tax, it cannot be distributed and closed until the return is filed and approved by the IRS. The return must be filed 9 months after date of death, and the IRS will take several months to issue a clearance letter that it will or will not be auditing the estate. This process takes a minimum of one year, and most probates take longer, usually 1 – 3 years to settle, if all goes well. Additionally, a probate will incur substantial legal fees, depending on your region, in the range of $4 – 10,000 for an estate, and going up from there. Finally, the public nature of the process tends to attract litigants, often exspouses, creditors, bankruptcy, or any other variant. An estate from a trust can be settled much faster, with none of the above waiting periods, requires potentially minimal legal fees depending on the type of assets involved, is much more private (not requiring publishing information about beneficiaries).
A drawback with utilizing a revocable trust are the initial legal cost is often higher than a will plan. Furthermore, all of the assets must be titled in the name of the trust upon creation. Any assets which are not title in the name of the trust will create a probate, the very thing you drafted a trust to avoid.
b. Stronger asset protection: The issue of the possibility of the recharacterization of assets between “probate” and “non-probate” makes titling your assets into the name of your trust attractive from an asset protection standpoint. Many clients will attempt to distribute their estate, attempting to by-pass probate by utilizing probate by-pass vehicles which are cheaper than drafting and paying for a Revocable Trust. However, multi-party accounts can come under attack from creditors and feuding heirs, much more easily than a trust. Keep this in mind during the drafting phase. Depending on the state, common law has developed quite a bit of law allowing multi party and joint tenancy accounts to be redistributed pursuant to the will, rather than pursuant to the client’s designation on the statutory form. This is a reason to establish a Revocable Trust which clearly outlines a grantor’s intentions. Trusts can be used to increase the efficiency of transferring the legal title of assets upon death and manage assets during incapacity. They are often implemented to control to whom, how much, and for what purpose, beneficiaries receive benefits from the trust.
c. Avoid Multiple Probates: Probate is required in every state which an individual holds real estate, requiring that an individual often times must hire an attorney in another state in order to pass the asset and have clean title for resale. However, any asset, including real estate in other states, which is titled in the name of the trust, by-passes probate, as well as, by-passing ancillary probate.
d. Incapacity planning tool: For clients who are single, have no children, have few trusted relatives, or whose relatives need help with investment management and/or who are busy and wish to have a trustee handle the books with their oversight, using a revocable trust with a springing trustee upon the grantor’s incapacity can be convenient and/or advisable.
2. Tax Planning Trusts:
Tax Overview: On a federal level, the historical amount that an individual could pass to their heirs free of estate tax (i.e. the applicable exclusion) has increased through time from $600,000 in and around 1997 to the current amount of $5.34 million in 2014. In the 90’s the effective highest marginal rate of tax on assets over $600,000 was 55% Currently, the corresponding tax rate of 40% is assessed on assets over the current exclusion of $5.25 million. Currently, each spouse of a legally married couple may claim their respective applicable exclusions, basically doubling the $5.34 million exclusion to $10.68 million for a married couple. In order to avail themselves of this double exclusion, the surviving spouse must make a proper tax election called the Deceased Spouse’s Unused Exclusion (DSUE) at the time of the first spouse’s death. This automatic doubling of the exclusion for married couples, often referred to as portability, was not available until January of 2013. Temporary regulations in 20.2010-3T(a), 25.2505-2T(a), 20.2010-3T(c)(1) and §20.2010-2T(b)(1) require an executor to file an Estate Tax return at the first spouse’s death and include a computation of the DSUE. So while the amount is portable, it is only portable if the correct filings are completed.
In order to avail yourself of the portability for a married couple, the couple must meet the definition of a legally recognized marriage. More states have passed laws legally recognizing marriage between same sex couples. Furthermore, on June 26, 2013, the Supreme Court held, in US v. Windsor, that federal government benefits will be conferred on partners in a legally binding same sex marriage, just as they are for married individuals in more traditional heterosexual marriages. As a result, same sex married individuals may avail themselves of the same federal tax planning techniques available to all married couples. Note, however, that the marriage must have been performed in a state which recognizes such marriages legally and reside in a state that legally upholds that legally binding marriage. In other words, a couple who flies to the Mall of America to get legally married (which is recognized in Minnesota), but then returns to a home state that does not recognize same sex marriages, will not be able to use these federal tax techniques.
Regarding state estate taxes, roughly 29 states do not assess estate taxes. The remaining states have implemented their own separate estate tax regime. States with no estate tax include: Alabama, Alaska, Arizona, Arkancsas, California, Colorado, Florida, Georgia, Idaho, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Dakota, Oklahoma, Rhode Island, South Carolina, South Dakota, Texas, Utah, Virginia, West Virginia, Wisconsin and Wyoming.
The following states have the following applicable exclusion amounts and maximum estate tax rates. This information changes frequently, so be sure to consult the current laws of the state you are dealing with to ensure the latest information. For these states, taxes are levied against, and paid from the gross estate, with the net estate being distributed to the heirs, after tax.
The remaining states have an inheritance tax regime. Some states have both an estate tax (above) and an inheritance tax system. So, unfortunately for residents of those states, it is not a mistake if you see a state listed in both places In fact,for the states that you see a state listed above, some states have both types of regimes.
On a federal level, any gifts over the $14,000 annual exclusion amount, per donor and donee, are deducted from the $5.34 million amount that can be gifted during an individual’s life or at death. There are two states which also have their own unique set of gift tax rules, namely Connecticut and Minnesota. A few other states who previously had their own gift tax regimes, repealed them, citing a heavier expense burden than realized profit.
Connecticut has an estate tax exemption of $2 million. It taxes lifetime gifts totaling more than $2 million at a rate of 7.2 – 12% for anything over and above the $2 million. The $2 million gifted during life counts against an individual’s $2 million exemption which can pass estate tax free at death. CT requires that the value of the gross estate add back in, any gifts made at any time during your life. CT also exerts a long-arm estate tax on any non-CT resident who owns real estate in CT, levying them pro rata amount of the CT state estate tax associated with the real estate as if the decedent had been a resident of CT.
In May of 2013, Minnesota passed a new gift tax regime. Minnesota has an estate tax exemption of $1 million. There is no portability (no automatic doubling) for a couple like there is on a federal level. Therefore , without specialized legal planning, the exemption for a married couple remains at only $1 million. This can be increased to $2 million with proper legal drafting in advance of the first spouse’s death. Individuals who gift more than $1 million during their life will now experience a gift tax on the amount over $1 million at a flat rate of 10%. One favorable aspect of the new law is that MN does allow an individual to gift $1 million gift tax free during life in addition to passing $1 million estate tax free at death. For those who are willing to gift during their life, they are effectively increasing the amount they can pass estate tax free from $1 million to $2 million. Additionally, any gifts made within three years of the date of death are pulled back into the estate. So don’t wait until the last minute to gift your $1 million inter vivos. Furthermore, like CT, MN exerts a long arm tax authority on non-Minnesota residents who die owning MN real estate, who have an estate which would have been taxable if they had been a MN resident, will be required to file and pay the pro rata amount of tax due on the MN real estate to the MN Department of Revenue.
a. Marital Trusts:
Individuals have the unlimited ability to leave your assets to your spouse with no tax effect if in a legal married and your spouse is a US citizen with no federal estate tax.. However, this can result in unnecessary accumulation of taxable assets in the survivor’s estate, such that the exemption for the first spouse’s death is lost. As result, estate planners use marital deduction planning to capture the first spouse’s exemption in a trust, allowing the surviving spouse to have access to the trust for HEMS (health, education, maintenance and support) with the remainder passing to the ultimate heirs of the grantor’s choice, or the survivor’s choice within a class of beneficiaries using a limited power of attorney. This planning is referred to in many ways as:
credit shelter planning (sheltering the estate tax credit amount), A/B trusts, by-pass trust plan, materialized planning, and marital deduction planning. The drafter, depending on the client’s situation, will often draft the trust to fund a Family tax exemption trust with an amount up to the amount of the current state exemption with the remainder going to the surviving spouse, or into a Marital Trust (see QTIP Trust below). Upon the surviving spouse’s death, these assets are often drafted to distribute to the grantor’s children, whether they are children of a previous, or the current, spouse. This is important because if your spouse remarries after your death, and you did not fund a Family trust, then all of your assets could go upon your spouse’s death to her new spouse and/or family, rather than to your children (whether they are the children of your current or previous marriage).
b. Disclaimer Trust. This trust is a variation on the Family tax exemption trust above. Rather than tying the amount that goes into a Family tax exempt trust to state legislation which can be unpredictable, a disclaimer trust is more flexible. The decision as to whether and how much to fund into a Family trust is left to the survivor to decide after the grantor’s death. In this situation, if the state, for instance, increases their estate tax exemption and/or completely abolishes their estate tax, so that marital tax planning is no longer needed, then the surviving spouse can calibrate whether and how much needs to go into a family / disclaimer trust for maximum tax efficiency. This is a good option for stable long term marriages where all of the children come from the joint marriage and where the judgment and financial acumen of the surviving spouse can be trusted. Additionally this type of drafting lends itself to not requiring multiple amendments due to sometimes frequent legislative changes during your lifetime. The drawback to a disclaimer trust, is that if the spouse is a second spouse and there are children of a first marriage, the grantor will want to consider whether the someone or some professional, other than the surviving second spouse, should make the trust funding decisions. Leaving this with the second spouse creates a conflict of interest with the children of the first marriage. May require less amendments because surviving spouse has latitude to decide how much to fund in the trust given the laws as they exist on the date of the first spouse’s death.
c. Qualified Terminable Interest Property (QTIP). Once the Family or Disclaimer trust is funded, the remaining assets of the decedent’s trust are taxable to the spouse in the spouse’s estate. Depending on whether you wish to exert control over these assets, you may either have them pass directly to your spouse, or into a Qualified Terminable Interest Trust (QTIP), otherwise referred to as a Marital Trust. From such a trust, the survivor may receive income and principal for HEMS (health education maintenance and support) during their lifetime, with the remainder passing to the decedent’s children or other heirs of the decedent’s choice. Passing the assets directly to your surviving spouse makes sense if the grantor is in a long term marriage, and all the children existing are from the union of the grantor and the surviving spouse. What if the surviving spouse remarries, however, and their assets to their new spouse and the new spouse’s family? There is no requirement that the remainder of your assets would go to your children rather than to other heirs or organizations. What if your surviving spouse becomes elderly and is exposed to undue influence by outsiders wanting access to her and your assets? These may be reasons to put the assets into a Marital Trust, otherwise referred to as a QTIP (Qualified Terminable Interest Property Trust). The survivor will still have access to the trust assets during their life, but upon your death, it is assured that your children will receive your assets upon your spouse’s death, protecting them from your survivor’s creditors, predators, and the like.
d. Gift Trust. A gift trust is utilized where the grantors wish to make a gift to heirs, but do not want the heirs to receive all of the assets directly into their name outright. Some reasons why they may gift into a trust may be as follows:
Keep the asset in the family blood line. If an asset is gifted outright to an heir, the asset is exposed to the heir’s divorcing spouse, to the heir’s creditors in bankruptcy, and to the heir’s litigation (whether the lawsuit has merit or not, for instance if your heir is a doctor who is targeted by lawsuits), etc. If the assets are in trust, the heir receives the benefit of the assets during their life, and then the assets are there for successive generations. Whereas, if the assets are accessed by a divorcing spouse for instance, the ex-spouse is not obligated to give funds back to your children upon their death.
Provides guidance and investment management for the heir. In the case of younger heirs, providing their gift through a trust vehicle, rather than outright, allows the heir to mature and grow into their wealth. Money can either propel an heir into success or demotivate them from striving for their own success. Allowing the money to be there for support, but providing funds over time with the guidance of a trustee can be help avoid disastrous consequences from obtaining too much wealth too soon. Regarding investment management, regardless of the heir’s age, it can be beneficial for an heir to go through several market cycles and take the “helm” of the investments, if they were not previously involved, in order to gain the appropriate acumen for making good decisions.
e. Generation Skipping: Individuals may pass up to $5,340,000 to a “skipped” generation – that is, to a grandchild or further removed without incurring a federal generation skipping transfer tax. The generation skipping transfer tax also applies to transfers to someone who is not a descendant of the transferor but is 37 1/2 years or more younger than the transferor. This could include younger spouses. In addition, many states that collect state estate taxes also collect state generation skipping transfer taxes. Check with your state taxing authority to be aware of your state’s laws.
Under the provisions of the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010, the federal generation skipping transfer tax was repealed for 2010 but came back in 2011 with a $5,000,000 exemption and 35% tax rate. In 2012 the federal generation skipping transfer tax exemption increased to $5.12 million and the tax rate remained the same. In 2013, under the provisions of the American Taxpayer Relief Act, the exemption increased to $5.25 million and the tax rate increased to 40%. In 2014 and future years, the exemption amount will continue to be indexed for inflation and the tax rate will remain at 40%
f. Irrevocable Life Insurance Trust (ILIT): Another form of tax planning trust is an Irrevocable Life Insurance Trust. Because the death benefit amount of a life insurance policy, owned by a decedent on their date of death, is included in the decedent’s gross estate for estate tax purposes, this trust us designed to own insurance. The grantor is the insured on the underlying insurance policy. Since the insurance is held in an ILIT, the decedent’s estate is reduced by the value of the death benefit of the insurance policy. The grantor may make annual additions to the trust to cover administration costs and insurance premiums. With those funds, the trustee pays the premiums on the underlying policy. The premium payments are considered gifts of a present interest, to the beneficiaries. The death premium amounts are calibrated to equal the amount allowable for annual exclusions for the number of beneficiaries on the trust. In the Crummey case, the IRS allowed the premium payments to be considered a gift of a present interest, thereby allowing the death benefit of the insurance to be excluded from the decedent’s estate, if certain procedures are followed. Namely, each year, when the grantor makes a contribution to the trust to pay the premiums, the trustee must send a notice to each beneficiary, notifying them that a gift has been made and that by the terms of the trust, the beneficiary has a right to withdraw the gift.
If however, the beneficiary does not withdraw the gift within a certain time period, then the right to withdraw lapses, and gift is considered a completed gift of a present interest. Due to the IRS case, these notices to the beneficiaries have been coined “Crummey” notices. This trust is irrevocable.
g. Charitable: Several forms of trusts can be utilized to reduce the grantor’s estate tax, provide income tax deductions, retain a current benefit for themselves or a charity, provide a future benefit for themselves or a charity, provide diversification of assets with deferred capital gains, and redirect funds otherwise escrowed for government taxes to benefit a specific cause of the decedent’s choosing.
Charitable Remainder Annuity Trust (CRAT): A CRAT involves a gift of certain assets into an irrevocable trust, whereby the grantor receives payments during his/her life, with the remaining assets going to a qualified charity. The grantor receives scheduled payments back, either in a fixed dollar annuity amount, or a fixed percentage based on the initial contribution to the trust. The grantor receives a current income tax deduction equal to the present value of the remainder interest gifted. The present value rate used by the IRS is found in I.R.C. 7520. This is the interest rate which the Code requires us to use to determine the present value. One of the values of the CRAT is that to the extent that the trust property outperforms the 7520 rate, the gift actual made to the charity is larger than what the grantor had claimed as their lifetime gift exemption.
The IRS has curbed abuse of these vehicles requiring that the annuity amount cannot be too large (i.e. the annuity payments are considered too large if the probability exceeds 5% that the charity will not receive some portion of the assets after the term of the trust). The trust is created for a term of years or can remain in existence for the lifetime of the grantor and several other beneficiaries’ lifespans. The grantor can serve as trustee.
Charitable Remainder Unitrust (CRUT): A CRUT is similar in most ways to a CRAT, except that instead of a fixed payment coming back to the grantor which is based on a flat amount or percent based on the original funding amount, the unitrust amount is calculated as a fixed percent of the annual market value as recalculated every year.
Charitable Lead Trusts (CLTs) are funded by a grantor to provide payments to a charitable organization during the lifetime of the grantor, with the remaining assets being distributed back to the grantor’s family/heirs. Rather than being an income tax reduction vehicle, CLTs are primarily an estate and gift tax reduction vehicle. These can be created as in intervivos or testamentary vehicle. Similar to CRATs/CRUTs, a grantor transfers an initial funding amount into the trust. The CLT pays an annuity or unitrust interest to a qualified charity for a term of years or for a life/lives. Unlike a CRT, there is no minimum or maximum payout rate and no minimum nor maximum term of years. The CLAT pays a fixed percentage of the initial value of the trust to the charity for the term of years. A CLAT is sensitive to changes in the I.R.C. 7520 rate (IRS’ assumed rate of return). The lower the 7520 rate, the larger the value of the lead charitable interest and the smaller the gift to the noncharitable remainder beneficiaries. This vehicle will typically be more desirable than a CLUT (below) if the goal is to maximize the value of the assets eventually distributed to the noncharitable remainder beneficiaries. Charitable Lead Unitrust (CLUT): The CLUT pays to the charity, a percentage of the value of the assets recalculated annually, for the term of years The CLUT is not sensitive to the changes in IRC 7520.
h. Grantor Retained Annuity Trusts (GRATs)
A Grantor Retained Annuity Trust or “GRAT” is one of the most powerful and tax efficient wealth transfer tools available today. A GRAT allows a person to share the future appreciation of an asset with the next generation with virtually no gift tax. A GRAT is a trust with a specific life or term, i.e., 5 years, 8 years, etc. The grantor transfers assets to the GRAT and retains an interest in the trust. This income interest will be stated as an annuity percentage of the original assets transferred to the GRAT. Each year the GRAT will pay the grantor the required payment.
At the end of the GRAT term, any remaining assets will be distributed to the named beneficiary or beneficiaries. The gift will be calculated using the subtraction method. The present value of the annuity payments to the grantor will be subtracted from the original value of the assets placed into the GRAT.
Example: Dad holds $1,000,000 of a stock that pays a 10% dividend. Dad establishes a GRAT with a 13 year term and transfers the $1,000,000 of stock to this GRAT. Each year the $100,000 dividend is paid to the GRAT and the GRAT then pays the required $100,000 annuity to Dad/grantor. The value of the gift may be as low as $13,710. This is a gift of the future interest and does not qualify for the annual exclusion. Dad/grantor must use part of his $1,000,000 lifetime gift exemption or pay a gift tax.
At the end of the GRAT term or 13 years, Dad would have received $1,300,000 ($100,000 per year x 13 years) in annuity payments. The remainder value in the GRAT is the stock and would still be valued at $1,000,000 assuming no appreciation. The stock would then be distributed to the remainder beneficiaries, usually Dad’s children. In this case, the children will have received an asset worth $1,000,000 but Dad only had to report a gift of $13,710.
The term of a GRAT can be as short as two years or as long as the grantor chooses. However, if the grantor dies during the GRAT term, the IRS says “the technique fails and the assets inside the GRAT are included in the taxable estate”. For this reason, most GRATs are kept to shorter term. If the GRAT term is shortened, the annuity payout rate must be increased or a larger reportable gift will occur. It is important to note that the GRAT annuity payment does not have to be made from income. The annuity payment can be satisfied with principal or the assets that were originally transferred into the GRAT.
Example #2: To illustrate both a short term GRAT and using principal to satisfy the annuity obligation, consider the following. Dad transfers $1,000,000 of non-dividend paying stock into a two year GRAT. Dad retains a 53.17167% annuity interest. If the stock grows 10% each year, the GRAT must pay $531,716.70 of value to Dad each year for two years. This payment can be made by distributing the appreciated stock to Dad. If the trust does this for two years, the trust will have $93,395 of stock remaining after the last payment to Dad. According to the Walton Tax Court Decision, Dad made a taxable gift of under $1.
i. Dynasty Trust: A dynasty trust is a type of asset protection trust, where the trust continues into perpetuity. Where permitted by state statutes, dynasty trusts can be utilized as a way to keep family funds within your bloodline for generations while paying less taxes. In theory, the trusts can last forever. Many states however, have a Rule Against Perpetuities, which makes a trust, even if it purports to be a perpetual trust, terminate. Such a clause and/or statute contains language stating that a trust must terminate twenty-one (21) years after the death of the last life in being at the time of the grantor’s death. The following are the states which allow perpetual and/or dynasty trusts by operation of law.
These trusts can offer benefits and disadvantages. Some benefits are the following: spreading wealth over many generations rather than simply giving all to your children; promoting the grantor’s values for generations to come; minimizing attrition of wealth at each generation, protecting the assets from future generations’ creditors, litigants and divorcing spouses. Drawbacks can include the irrevocable nature of creating such a trust (once created, it cannot be terminated). Also terms of art can sometimes be difficult to draft, not knowing unforeseen conditions of future markets, and society in general. Needless to say, a drafting attorney will need to somehow provide maximum flexibility, all within the constraints of an “inflexible, ” rigid, tool. One way drafters have addressed this is to appoint a Trust Protector, in addition to a trustee. While trustees may be constrained by fiduciary statutes and case law, a trust protector, can be nominated for a grantor that wants a safety-net option to keep their trust from becoming obsolete because of unanticipated changes in the law or facts after the grantor’s demise.
Examples of such situations can include amending the trust to do the following:
Comply with substantial law changes such as the Tax Reconciliation Act of 2001 or HIPAA changes;
Accommodate unforeseen circumstance of a beneficiary. Examples might be incapacity, substance dependency, mental illness, etc. One would hope that things like this are drafted for, however, depending on states and families and the drafting counsel, and societal changes (such as the legalization of same sex marriage, etc.),
- Comply with Medicaid spend down changes.
- Correct drafting errors
- Move situs for tax or other reasons
- Create or limit a power of appointment
- Veto or direct investments. The world of investments in the 1940’s, for instance, looks quite different than today’s landscape. Many companies who would be the best investment advisor/trustee might not be eligible to serve due to new company affiliation regulations, for example. Allowing a trust protector to amend a trust for issues such as this, benefits the grantor and the beneficiaries.
Who should serve? Much literature states that a Trust Protector should appoint an individual of sophisticated technical ability. This is correct, however, while a grantor can nominate specific individuals to serve, which s/he knows and trusts at the time of the creation of the trust, by the very essence of a perpetual trust, such individuals will likely not be around for hundreds of years. Therefore, another option is to appoint an institution and/or an advisory board elected by certain classes of beneficiaries who will vote on the appointment and/or removal of a particular individual or corporate Trust Protector.
3. Asset Protection
Irrevocable Asset Protection Trusts (APT). Regardless of the assets of an individual’s estate are comprised of business shares, stocks or other, the formation of an LLC still leaves open to attack, the individual’s stock or membership interest. For instance, if an individual debtor receives a judgment in connection with personal assets, stock ownership in his/her business is subject to attachment in a proceeding for bankruptcy, creditor attachment, frivoulous litigation and/or by a divorcing spouse. For this reason, many asset protection structures will utilize a stand-alone trust structure to hold the assets, or trusts in combination with corporate entities, to protect the assets therein.
A revocable trust on it’s own, without creditor protection drafting, will not protect assets. However, many individuals, depending on the level of wealth of a family, and/or the circumstances, may incorporate these provisions into their revocable trusts to keep the wealth within the family blood line, upon the grantor’s death when the trust becomes irrevocable. In general, a trust can act as a shield for the beneficiary if it is determined that the beneficiary does not have an enforceable right to a distribution from the trust. If drafted properly, it can be shown that the beneficiary only has an “expectancy” of receiving funds.
There are two types of asset protection trusts under common law (1) spendthrift and (2) discretionary trusts. Trusts may contain both types of clauses if you feel the client situations warrants.
i. Spendthrift Trust. These trusts expressly provide that a beneficiary’s interest may not e alienated or attached by a creditor. Example clause: “Neither the income nor the principals of the trust property shall be assigned, anticipated, or alienated in any manner by any beneficiary nor shall it be subject to attachment, bankruptcy proceedings, or any other legal process, or to the interference or control of creditors or others.”
ii. Discretionary Trust. This trust type is arguable more powerful than a spendthrift trust because the beneficiary’s interest is tenuous and has, at best speculative value due to being subject to the discretion of the trustee. The trust makes any discretionary distribution decision 100% within the discretion of the trustee. Example clause:
“Our trustee shall hold and administer the trust for our descendants upon the following terms: our trustee may distribute to any one or more of our beneficiaries as much of the net income and principal of the trust as such trustee may, in the trustee’s sole and absolute discretion, determine advisable for any purpose.” Critical to this type of trust working is to make sure that the trustee appointed is not a beneficiary. A beneficiary may be a co-trustee with an independent trustee, but then the document must specifically state that the beneficiary has no right to be involved in the decision as to whether s/he shall receive discretionary distributions. Example clause: No person shall participate, directly or indirectly, in the exercise of any discretion of the Trustee (whether or not such discretion is limited by a standard) to distribute income or principal to himself or herself, or to discharge a legal support obligation of such person, and such discretion shall be exercised solely by the other Trustee acting hereunder.
State law: All of the above is very dependent on state laws as to whether and how much protection the state will provide. Individual statutes and case law must be reviewed as changes and differences exist for family law, for instance, regarding the protection or lack thereof, that such a state will afford a beneficiary. See asset protection survey in Appendix. Age based distribution provisions. One thought to be highlighted is whether, how much, and at what age should future beneficiaries be given their assets outright. Many practitioners tend to give the assets out to their client’s children, outright, at certain ages. There tends to be an attitude that the clients don’t want their children to think that they didn’t “trust them,” or that the grantors were attempting to unduly control distribution “from the grave.” A frank discussion with your clients about the benefits and drawbacks of keeping a portion or all of the assets in a trust for their lifetime, is warranted in many cases, especially given today’s divorce rates, the advent of uncontrollable economic circumstances such as the Great Recession, and the litigious nature of our society. Your clients may still decide against it, but oftentimes they simply hadn’t thought it through. Also, if your client intends for the trust to offer asset protection, the earlier the ages and the larger the amounts that a beneficiary will receive, tends to make the trust an easier target and makes for a better argument for access to the funds, rather than protection of the funds.
2. Special Needs Trusts
A special needs trust is utilized for a beneficiary who has been determined by the Social Security system to be “disabled” and therefore, eligible to receive government benefits. Funds received by such a beneficiary typically will disqualify a beneficiary for government benefits on a need based analysis. That being said, the Medicaid system does not pay for all of a beneficiary’s needs, and/or will only pay for the most basic needs of a beneficiary. In certain instances, putting inherited or received funds into a trust for such a beneficiary’s benefit can allow the beneficiary to qualify in the needs based analysis for government funds, while still having the trust funds available for “quality of life” items during the beneficiary’s life, items not covered by Medicaid. Examples can be life enrichment items such as dental care, companion services, a handicapped equipped vehicle, newer or non-approved treatments, mental health treatment, private rooms, reasonable handicapped access remodeling for a home, Camp Courage, travel to visit family, trips for enjoyment of life, etc.
In general, US Federal Law 42 USC 1396p(d) and the corresponding state law of the beneficiary/grantor controls. Each state has their own laws regarding establishment and creation of these trusts. However, generally, there are two types of trusts based on the source of funds: Third Party or Self-Settled.
a. Third Party Funded: Trust funded by funds from anyone other than the beneficiary, usually their family. An individual can create a trust for their loved one, which will cover the quality of life items discussed above. Upon the beneficiary’s death, the grantor controls where the funds are distributed: in many cases to the beneficiary’s descendants, back to the grantor’s descendants, and/or to other heirs of the grantor’s choice. This trust can be created either during the grantor’s lifetime or at their death (testamentary). Furthermore, individuals other than the grantor can contribute to the trust at any time through lifetime or testamentary gifts. Take care with a testamentary trust in that some states have laws where the trust cannot be created after beneficiary turns the age of 65.
ii. Self – Settled Trust: Trust funded with the beneficiary’s own funds. An individual can fund a special needs trust, only if the funds are coming to them from a third party source. The usual situation is where an individual becomes disabled due to accident or injury and receives funds as a settlement in a lawsuit. If an individual, who already owns significant assets, becomes disabled, s/he cannot specifically impoverish themselves by putting their funds into a trust in order to qualify for government benefits. It is important to note that upon the beneficiary’s death, the trust must first pay the county back for services received during life. Only the remaining assets will then pass pursuant to the trust provisions to third parties. This is an important wealth preservation tool for wealthy families who know they have special needs descendants. Furthermore, many trusts are being drafted with provisions for a special needs trust if needed in unforeseen circumstances for future generations.
1. What are Trustee’s Duties
The duties of a trustee vary by state law, however, the Uniform Trust Code, upon which many states’ laws are based, lays out nine fundamental fiduciary duties:
- Duty to Administer the trusts solely for the benefit of the beneficiaries, following the terms and purpose of the trust in good faith. In so doing, they must take into consideration, reasonable care for the current beneficiaries, as well as the future remainder beneficiaries.
- Duty of Loyalty: The trustee may be paid for services, however, profits flow to the trust and the beneficiaries. The trustee must refrain from transactions of self dealing which can be construed to unduly benefit the trustee due to the trustee’s position and influence.
- Duty to Account: To keep clear and detailed records and report such to all appropriate parties
- Duty to Provide Information: A trustee is require dto provide beneficiaries with all relevant information regarding trust transactions, assets, the legal document itself and the procedures used in managing the account.
- Duty to Exercise Reasonable Care: The trustee is expected to exercise the highest level of care and skill in managing the trust. The law requires a fiduciary to follow the America “prudent person” rule, where the trustee must actually step into the shoes of the beneficiary and make all decisions for the best benefit of the beneficiary.
- Duty to Control the Assets. Self explanatory, yet sometimes difficult to execute when there are multiple authority holders/managers, and various asset vendors, involved.
- Duty of Impartiality. This pertains to objectively and fairly treating all beneficiary classes fairly.
- Duty of Co-Trustee Accountability: Fiduciaries have a duty to use care to prevent or redress a breach by another trustee.
2. Who should serve as trustee?
It is important to consider who you will appoint as trustee. The following can be a trustee
- Any individual who is 18+ years of age
- No residency requirement, but note that the trust may be subject to the income tax laws of the trustee’s residence
- Any bank or trust conmapny qualified by state and/or federal regulatory authorities to carry on such business.
- A nonprofit corporation can be trustee of a trust where the corporation or related organization has a vested or contingent interest in the trust
- Grantor can be their own trustee. The draftor must pay attention however if attempting to limit incidents of ownership for tax purposes.
- A beneficiary may be a trustee. However, the draftor must be aware not to allow the beneficiary to have power over the decision to distribute discretionary income to themselves, if the draftor is attempting to preserve spendthrift aspects and limit incidents of ownership for tax purposes.
The benefits and drawbacks of choosing an individual or corporation as trustee. The answer to this question depends largely on the client’s family situation and their pool of available individuals to serve. The advantages of an individual are
- Familiar with family background
- Present in beneficiaries’ lives frequently to assess validity of requests
- Emotionally care about and connected to beneficiaries
- Lower cost
Disadvantages of an individual trustee
- Perceived or real bias on part of beneficiary
- Unfamiliar with correct trustee standards and duties
- Might not have funds available to pay if they mismanage trust assets
- Depending on age and health of trustee, there may need to be a higher frequency in turnover requiring continual appointment of new trustees.
Advantages of a corporate trustee
- Knowledge of the fiduciary framework. More creative options
- Objectivity which may be welcome to a beneficiary that feels as though they are dealing with a biased family member
- “Deep pockets,” in case of mismanagement of assets, they have funds to pay damages.
Disadvantages of a corporate trustee could be
- Feeling that the organization isn’t personal enough, or isn’t located locally
- Might have turnover in staff depending on the organization
- Perceived costs
3. When to serve. A trustee will likely be appointed to serve upon any number of events or provisions enumerated in a trust document, including but not limited to the following, for example:
- Appointment due to death or incapacity of a grantor or beneficiary
- Upon the occurance of a beneficiary attaining a certain age
- Appointed by beneficiaries pursuant to a vacancy
- Appointed by a court of law by petition
4. Delegation to Outside Investment Advisors. Historically speaking, the delegation of duties in general by the trustee was frowned upon. However, the increased environment of complexity in managing trust assets throught time has been recognized by drafting attorneys, such that they have added the power to employ agents and delegate to the agents in the trust documents. Furthermore, the modern recognition of the increasing complexity of the investment arena has resulted in the increasing activity where a trustee delegates investment responsibility.
Reasonable care in the selection and supervision of agents in all cases is always required. Minn.Stat. sect,.501B.152.
5. Situs – state survey.
6. Activating the Trustee: Execute resignation and/or acceptance of trusteeship.
- Proactive Resignation of current Trustee.
- Incapacity or death of current trustee: Refer to trust document as to requirements regarding definition of incapacity. Does the document refer to one doctor’s opinion or two? Does it require a doctor’s opinion at all?
- Complete vacancy