Flexible trust planning has never been more important as a result of current and future health, political, economic and tax uncertainty. Modern trusts1 are drafted and existing trusts are modified to provide flexibility allowing a family the ability to navigate an unknown future and preserve family legacies intergenerationally. Many families will use their estate, gift and generation-skipping transfer (GST) tax exemptions2 to fund a flexible modern trust for important non-tax reasons. These non-tax reasons allow a family to deal with future uncertainties. Many of the more important non-tax reasons are:
- planning for future health, political, economic and tax uncertainty;
- family governance/succession/education;
- asset protection/wealth preservation;
- divorce protection;
- litigation protection;
- promotion of family values and social and fiscal responsibility in the family;
- privacy—documents sealed for court procedures involving trusts (reformations modifications and litigation);
- beneficiary quiet—ability to keep trust information quiet from one or more beneficiaries until appropriate;
- disability planning;
- special needs planning;
- caring for pets in the event of owner’s death or incapacity;
- preservation of treasured family assets and heirlooms—purpose trust;
- family’s ability to work with family members and family advisors as fiduciaries regarding trust investment management and distributions;
- ability to work with investment advisors and managers of a family’s choice;
- lessening family and family advisor personal liability as fiduciaries;
- ability to directly or indirectly hire and fire fiduciaries; and
- ability to change the situs and law of a trust
The combination of the modern directed trust and associated modern trust laws3 provide these desired non-tax advantages, thus positioning a family to flexibly deal with future family uncertainties. Families no longer ask the question how soon can they get the assets out of a trust; instead, they ask how long they can leave the assets in a trust. Consequently, most of these modern trusts are generation-skipping dynasty trusts with long term or unlimited durations.4
Directed Trusts
A modern directed trust allows individuals to establish a trust investment committee (IC) that directs an administrative trustee in a directed trust state5 regarding asset allocation as well as investment and asset management. The IC may choose multiple investment advisors and managers based on different asset classes/diversification. These may be traditional or more sophisticated investments based on a Harvard or Yale endowment-type asset allocation.6 Alternatively, individuals may select a large non-diversified single position in a public or private security. The directed trust is able to hold both financial and non-financial assets (that is, offshore companies, business interests, real estate, limited liability companies (LLCs), family limited partnerships, timberland, direct private equity (PE), alternative investments and more).
Historically, many events have caused uncertainty to both the U.S. and international economies. More recently, relations between the United States and China, COVID-19 and the enormous U.S. debt/deficit and inflation are all examples of this uncertainty. Many investors have switched from securities to U.S. government bonds as a result of uncertainty. Many others have transitioned to cash, gold and/or cryptocurrencies. Some feel safer with direct PE and other alternative investments. Other families desire a well-diversified portfolio of traditional investment assets. Each family and sometimes each generation within a family may have different investment philosophies to accomplish the desired trust investment goals.7 The modern directed trust provides the flexibility to accommodate the philosophies of all of these family generations.8 Additionally, the grantor and the beneficiaries have the ability to add and/or remove IC members.
Traditional trust laws9 (for example, the Uniform Prudent Investor Act (UPIA) and delegated trusts) may not provide families with enough flexibility and control to properly manage trust investments to navigate through future uncertainties. Most jurisdictions have enacted the UPIA, which provides for a general duty to diversify trust assets unless the purpose of the trust is better served without diversification. Diversification is usually limited to traditional asset classes. Some of the typical exceptions to this UPIA diversification requirement are low cost basis assets (sale would trigger large tax gains) and/or family business interests. Even with these exceptions, it may still be difficult safely to override the diversification requirement of the UPIA without risk.10 Consequently, the modern directed trust is usually a better alternative for most families.
The liability standard for fiduciary investment decisions by the directed trust IC is typically limited to gross negligence and/or willful misconduct.11 This is compared with the reasonable care liability standard12 associated with most traditional delegated (non-directed) trustee statutes. Many family trustees or co-trustees don’t generally have investment management expertise and are usually forced to delegate investment management. This delegation function requires that they conduct a due diligence analysis on the investment professionals to whom they’re delegating as well as conduct ongoing monitoring of these investment professionals and their investment management performance. They can delegate the duty, but not the risk. Consequently, depending on a family’s level of investment sophistication, the reasonable care liability standard for delegating may present a problem, particularly in times of economic uncertainty.13
In addition to an IC, the modern directed trust will also have a distribution committee (DC). The DC determines trust distributions and directs the administrative trustee accordingly. Family members and their advisors can generally serve on these DCs and determine trust distributions of income and principal. Any trust distributions over and above health, education, maintenance and support (HEMS) would be considered tax sensitive14 and require an independent fiduciary (for example, corporate administrative trustee, CPA, attorney or a combination thereof) to make the distribution decision as part of the DC. In the event of sickness, disability or incapacity, the DC, comprised of family and family advisors, can flexibly deal with unanticipated family needs. The grantor and the beneficiaries can add or remove DC members.
The ability to pass on family values intergenerationally is also very important to many families.15 The modern directed trust can provide for the promotion of both fiscal and social responsibility because family members and family advisors play such an important role as mentors on the DC. In addition, these non-charitable modern directed trusts may be drafted to allow for distributions not only to family beneficiaries but also to charitable beneficiaries.16 Distributions to charity from a non-charitable modern directed trust allows for the promotion of family social responsibility and results in an unlimited income tax deduction to the trust.17 The charitable deduction to the trust, however, is usually secondary to most families.18
It may also be helpful for a family to keep a trust quiet as to one or more beneficiaries until they’re ready or need to know about the existence of a family trust.19 Information is usually withheld from a beneficiary if they lack financial maturity or don’t understand family values. Other reasons are asset protection, divorce, ID theft, ransom and other related issues. In many modern trust states, the trust can also remain quiet even after the grantor’s death or incapacity.
Families may also desire to add a trust protector20 to their modern directed trust for additional future flexibility. A trust protector is generally an individual (or a committee of individuals or an entity) with specified personal and/or fiduciary powers over the trust. The trust protector can have powers to veto investment or distribution decisions, which act as checks and balances to IC and DC decisions. The trust protector may also have powers to amend the trust for administrative purposes, which can be very useful in the future. They may also have powers to add family beneficiaries. The trust protector is often a close family advisor and sometimes an extended family member. Thus, the trust protector provides the family with another trusted individual to oversee the family trust as well as added flexibility. The trust protector’s statutory standard of liability is generally gross negligence and/or willful misconduct. The grantor and family beneficiaries may also have the power to both add and remove the trust protector.21
Some modern trust jurisdictions also allow for the appointment of a family advisor,22 which is a non-fiduciary appointment. The family advisor (often a retired family lawyer or CPA) is authorized to consult or advise on fiduciary and non-fiduciary matters with the IC, DC and trust protector. Powers may include the ability to remove and appoint a trustee, fiduciary, advisor, IC member, DC member or trust protector. They also have the power to advise the administrative directed trustee and/or IC and DC regarding beneficiary matters such as distributions and beneficiary quiet status. The standard of liability is generally dishonesty or improper motive. This is an extremely low liability standard so that long-term family advisors (retired lawyers and CPAs) will want to serve.
Despite the gross negligence and/or willful misconduct fiduciary liability standards for the IC, DC and trust protectors of a modern directed trust, many families may also want to establish a trust protector company (TPC) or special purpose entity (SPE) to supplement this protection.23 TPCs and SPEs are typically LLCs that house the IC, DC and trust protectors who in turn provide direction to a qualified administrative directed trustee in a modern trust state. Consequently, individuals serving in these functions serve as agents or employees of the TPC or SPE. TPCs and/or SPEs aren’t private trust companies but are popular lower cost alternatives. These entities also provide a family and its advisors with both family governance as well as directors and officers and errors and omissions insurance for serving as IC, DC or trust protector fiduciaries. Additionally, unlike individual fiduciaries, the TPC and/or SPE as LLCs never die or become incapacitated.
Divorce
In addition to trust investment and distribution flexibility, many families also want to protect against future divorces. The divorce rate historically has been 50%.24 This has increased since COVID-19.25 Modern directed trusts provide great intergenerational divorce protection. Most trusts traditionally rely on the spendthrift clause to protect family trust assets from divorce.26 Generally, the spendthrift clause prevents the attachment or assignment of a beneficiary’s interest in an irrevocable trust before the interest is distributed. The spendthrift clause is generally the only line of defense with most traditional trusts. There have been many recent successful attacks on these spendthrift trusts,27 which are generally a result of the spendthrift clause exception creditors. Alimony is one of these exception creditors. Recently, cases around the country have illustrated that the courts may disregard a spendthrift clause with trusts set up by parents and/or grandparents for children and/or grandchildren (third-party trusts) when exception creditors are involved.28 Some of the modern directed trust jurisdictions have powerful asset protection statutes and case law that protects these discretionary trust interests. Such jurisdictions have codified the common law and Restatement (Second) of Trusts, which states that a trust discretionary interest isn’t defined as property or an enforceable right.29 This discretionary interest protection also includes HEMS distribution powers.30 It’s therefore difficult to garnish discretionary trust property in these states directly or as a spendthrift clause exception creditor.
Families may also want to name in-laws as beneficiaries.31 In some instances, an in-law spouse may be named as a “floating spouse” beneficiary who’s defined as the spouse the beneficiary is living with and married to at the time of the distribution. Such clauses are very important because many in-law beneficiaries aren’t even born, and thus, the in-laws are unknown. Consequently, protecting against future divorce is very important. Additionally, the trust may require that beneficiaries sign prenuptial agreements to be eligible for trust distributions. Other trust provisions may require that beneficiaries remain married to their spouses while their children are young to maximize their trust distributions. This requirement ensures that two parents will raise the children in the same home. In many of these instances, distributions are subject to some type of vesting schedule based on the length of the marriage while the children are young. This schedule can result in some miserable, but well compensated, married couples. Lastly, many modern directed trusts may purchase homes with trust funds instead of giving cash outright to children and/or grandchildren. The children and/or grandchildren as trust beneficiaries can then use the home tax free as well as protect it from divorce. These are all important planning strategies providing flexibility to deal with the uncertainty of future divorces.
Litigation
Litigation, like divorce, is also very difficult to anticipate. Future lawsuits may come from any direction, particularly in uncertain times. Families need to plan accordingly. Modern trusts provide excellent asset protection and wealth preservation as a result of trust discretionary interests not being defined as property or an enforcement right.32 Additionally, many modern directed trust states have statutes that provide that a court may award attorney’s fees and costs to the prevailing party. Consequently, the trustee can be reimbursed for attorney’s fees if the plaintiff loses.33 All of these factors discourage lawsuits by providing barriers to litigation against a modern trust, thus protecting a family’s wealth. Also important is that many modern trust jurisdictions seal court records with the exception of the names of the parties and any other interested parties as determined by the court.34
Family Heirlooms
COVID-19 has caused many individuals to recognize their own mortality, resulting in a desire to provide for their families intergenerationally. This is also important with family assets and heirlooms. Purpose trusts are a great vehicle to preserve these items.35 Purpose trusts don’t have beneficiaries; rather, their sole purpose is to care, protect and/or preserve an asset for a period of years or in perpetuity. They have a trust enforcer to enforce the purpose as well as a trust protector to oversee the trust and the directed administrative trustee. If the trust purpose is served, the trust protector can then convert the trust to a beneficiary trust. Many types of family assets, such as grave sites, antiques, cars, art, jewelry, memorabilia, royalties, digital assets, land, property, buildings and vacation homes are typically best suited for a purpose trust.
Pets are also valued property and another important reason to establish a purpose trust. There’s always a concern by a pet owner about predeceasing their pet, and COVID-19 has caused many individuals to be concerned about their pets’ futures.
Purpose trusts are also popular with families who desire cryonic suspension for family members and/or pets.36 The hope is that they can be brought back to life at some point in the future.
Defining the Future Family
Future family members are also a very important future uncertainty.37 It’s important to plan regarding future family members. The definitions of “children,” “grandchildren,” “issue,” “stepchildren,” “foster children” and “spouses” and their recognition as beneficiaries are all very important. These definitions have now moved beyond family births and adoptions to surrogacy, in vitro fertilization, artificial insemination and other definitions of “children” and “issue.” Generally, it’s helpful to draft a trust specifically to match the grantor’s intent regarding who the grantor wants to be a beneficiary.
Change of Situs and Law
A change of situs/change of law clause is usually recommended for all newly drafted or reformed long-term trusts. This provides the option to change the situs and the law of a trust, thus providing enormous flexibility.38 A state other than the client’s resident state may have the more favorable trust laws (for example, directed trusts, asset/wealth protection, dynasty or privacy) or tax laws (that is, no state income tax and low insurance premium taxes). Additionally, trust situs in a jurisdiction with a strong economy can be beneficial relative to future trust and tax legislation. Additionally, courts in some trust jurisdictions may be more likely to be open than other jurisdictions in times of crisis and uncertainty. Also, some courts have more experience with modern trust laws. Some states also allow for the ability to notarize or witness remotely. All of these benefits may be important in times of crisis and uncertainty but may not be available in the grantor’s resident state. Change of situs clauses should allow for change of trust situs not only to another state but also offshore to another country or even to another planet if desired. Flexibility to change the trust situs to the moon or some other planet is the utmost flexibility.
Modernize Existing Trusts
Clients with existing trusts may also modernize these trusts to maximize flexibility and control to protect against future uncertainty. This can be accomplished if the client’s resident state has flexible non-judicial or judicial reformation/modification statutes as well as decanting statutes.39 Generally, if the client’s state doesn’t provide such statutes, then the family can look to change the situs of a trust to a modern trust jurisdiction with these statutes and then modernize the trust so that the trust can provide flexibility and control to deal with any future uncertainty as previously discussed.
Unprecedented Planning
Unprecedented times and an uncertain future call for unprecedented planning. Modern directed trusts are one of the best vehicles to provide wealth preservation along with flexibility intergenerationally. Whether the federal estate, gift and GST tax exemptions are high, low or repealed altogether, trusts still make sense for a multitude of non-tax reasons. Consequently, the modern directed trust continues to increase in popularity. This has resulted in a desire for long term and unlimited duration trusts. It’s important for advisors to continue to make clients aware of the flexibility provided by these modern trusts combined with their ability to protect against current and future uncertainties intergenerationally.
Endnotes
1. Generally, modern trusts are those drafted to provide maximum flexibility with the use of directed trust, privacy, asset protection and other contemporary trust laws and concepts. See Al W. King III, “Drafting Modern Trusts,” Trusts & Estates (December 2015).
2. The federal estate, gift, and generation-skipping transfer (GST) tax exemption is $12.06 million (for married couples a combined $24.12 million) (2022). This exemption is set to expire in 2026 and sunset back to $5 million. Note, proposals by the Democratic-led Congress and President have suggested a return to the exemption amount of $5 million as soon as 2022. Some proposals have also mentioned a return to $3.5 million estate and GST tax exemptions and a $1 million gift tax exemption.
3. See supra note 1.
4. For example, Alaska: unlimited 1,000 year limit with limited power of appointment; Delaware: unlimited (except real estate, 110 years); Nevada: 365; New Hampshire: unlimited; South Dakota: unlimited; Tennessee: 360 years; Wyoming: 1000 years. See Al W. King III, “Interesting Trends With Modern Trusts: Income vs. Estate Taxes,” Trusts & Estates (December 2018).
5. Traditionally, the directed modern trust law boutique states have been Alaska, Delaware, Nevada, New Hampshire, South Dakota, Tennessee and Wyoming.
6. Harvard and Yale endowment asset classes 2021: public equity, private equity, hedge funds, real estate, natural resources, bonds/Treasury-inflation protected securities, other real assets (for example, commodities and natural resources/metals), cash, leverage buyouts, venture capital, absolute return, foreign equity, domestic equity and fixed income. Seehttp://www.harvardmagazine.com/2021/10/harvard-endowment-surges-11-3-billion-university-surplus and https://investments.yale.edu/.
7. Al W. King III, “Interesting Trends With Millennials and Trusts,” Trusts & Estates (February 2021).
8. For example, the investment committee of a directed trust can direct the administrative trustee to hold an investment limited liability company (LLC), which in turn may invest in desired impact and social investments for the trust or other desired value directed investments. Generally, the trust is the 100% owner member of the investment LLC and a family member(s), that is, a family member with specific environmental, social or governance concerns, can be the manager of the investment LLC and deploy capital to fit their goals. See King, ibid.
9. The Uniform Prudent Investor Act (UPIA), passed in 1994 and adopted by most jurisdictions, requires trustees to pursue an overall investment strategy considering various factors when formulating an investment program. The delegated trust structure typically involves a family trustee and requires that any trustee delegating their responsibilities must conduct due diligence on whom they’re delegating to and why they believe that the delegation is prudent. For delegated trusts, the delegating trustee is generally responsible for ongoing monitoring of the co-trustees and/or fiduciaries to whom they’ve delegated. Delegating is typically done with investment management, particularly if the delegating trustee is a family member who doesn’t have the capability to do the investment management themselves or provide investment advisory services for the trust; see also Charles D. Fox IV and Thomas W. Abendroth, “Trustee Liability for Investments: A Review of the Current State of the Prudent Investor Rule; Delegation; and Direction,” American Bankers Association (April 6, 2017).
10. See Al W. King III and Pierce H. McDowell III, “Selecting Modern Trust Structures Based on a Family’s Assets,” Trusts & Estates (August 2017).
11. See Al W. King III, “The Private Family Trust Company and Powerful Alternatives,” Trusts & Estates (February 2016).
12. See supra notes 1 and 9; See Al W. King III, “So You Want to Be a Trustee?” Hofstra University—Private Wealth & Taxation Institute (May 2017).
13. Ibid.; see supra notes 1 and 10.
14. Typically, a distribution standard that isn’t limited to an ascertainable standard (for example, health, education, maintenance and support) is deemed tax sensitive. For tax-sensitive distributions, the fiduciary needs to be an individual who isn’t related or subordinate to the grantor or “adverse” as defined in Internal Revenue Section 672(c). An individual is related to the settlor within the meaning of IRC Section 672(c) if the individual is a brother, sister, spouse, parent, child, grandchild, great grandchild or any individual to whom the settlor sends a W-2.
15. Al W. King III, “Are Incentive Trusts Gaining Popularity?” Trusts & Estates (October 2017).
16. Al W. King III, “Charitable Giving With Non-Charitable Trusts,” Trusts & Estates (June 2015).
17. IRC Section 642(c) allows for an unlimited charitable income tax deduction to a non-charitable trust for distributions made from non-charitable trusts to charity. It also shifts the 3.8% net investment income tax to charity. To obtain the Section 642(c) deduction, it’s important that the trust have a mandatory direction or a discretionary power to pay funds to charity. Existing trusts can’t be reformed/modified to add this power to receive the income tax deduction; see supra notes 7 and 15.
18. Al W. King III, “Unique Trends and Approaches to Charitable Giving,” Trusts & Estates (November 2021). See Bank of America, “The 2018 U.S. Trust Study of High Net-Worth Philanthropy,” Bank of America (2018), www.privatebank.bankofamerica.com/articles/2018-us-trust-study-of-high-net-worth-philanthropy/ (90% of the wealthy donate to charity and only 17% do so for tax purposes).
19. Al W. King III, “Should You Keep a Trust Quiet (Silent) From Beneficiaries?” Trusts & Estates (March 2015).
20. See supra note 1.
21. For more information on trust protectors, see Alexander A. Bove, Jr., “Trust Protectors: A Practice Manual with Forms” (August 2014).
22. Ibid.; for example, Delaware and South Dakota.
23. See supra note 11.
24. Al W. King III, “How Long-Term Trusts Can Assist With Uncertainties Like COVID-19,” Trusts & Estates (August 2020).
25. Ibid.
26. Al W. King III, “The Trust Spendthrift Provision-Does it Really Protect?” Trusts & Estates (December 2016).
27. Al W. King III, “An Update on Third-Party Discretionary Trusts With Spendthrift Provisions” Trusts & Estates (October 2019).
28. Ibid.
29. For example, Alaska, Delaware, Nevada, South Dakota, Tennessee and Wyoming.
30. See supra note 26.
31. See supra note 24.
32. Al W. King III, “Defend Against Attacks on DAPTs,” Trusts & Estates (October 2014).
33. Ibid.
34. Al W. King III, “Privacy, not Secrecy, Is Still Important to Families,” Trusts & Estates (August 2019).
35. Al W. King III, “Trusts Without Beneficiaries-What’s the Purpose?” Trusts & Estates (February 2015); Alexander A. Bove, Jr., “Rise of the Purpose Trust,” Trusts & Estates (August 2005), Alexander A. Bove, Jr., “The Purpose of Purpose Trusts,” Asset Protection Strategies Volume II: Planning with Domestic and Offshore Entities, Chapter 9 (2005); Alexander A. Bove, Jr., “The Purpose of Purpose Trusts,” Probate & Property (May/June 2004); Alexander A. Bove, Jr., “Trusts Without Beneficiaries: Planning With Purpose Trusts,” Boston Bar Association (Oct. 21, 2014); Alexander A. Bove, Jr. and Ruth Mattison, “The Purpose Trust Becomes a Work of Art,” Estate Planning (October 2016).
36. Al W. King III, “Anticipating the Unanticipated With Trust Planning,” Trusts & Estates (September 2018).
37. See supra note 24.
38. Ibid.
39. Al W. King III, “Decanting is a Popular Strategy, But Don’t Ignore Several Key Considerations,” Trusts & Estates (August 2018). See also Al W. King III, “Are Irrevocable Trusts Really Irrevocable?” Berks County Estate Planning Council (March 2016).