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A Second Look: Estate Planning Using Trust Protectors as a Team March 21, 2011 Carl R. Waldman, Esq.
Trust Protectors • Common in offshore jurisdictions • Little guidance in American law • Role is different from trustee • Perspective of trusted family friend or advisor • Counter-balance to impersonal institutional trustee • Enhanced flexibility without adverse tax consequences
What is a Trust Protector? • Trust Protector is an old role • Often used in offshore trust planning • Typically intended to watch over the Trustee • Fulfill Trust Settlor’s intent • Generally limited in scope
What is a Trust Protector? • Use of Trust Protectors in Domestic Planning • Scope has expanded substantially compared with traditional role • Some jurisdictions have enacted statutes addressing Trust Protector status • Delaware • Idaho • New Hampshire
Allocating or Furcating Trustee Authority “Furcation”: • Latin origin: “furca” – “to branch or fork” Estate Planning Context: • Branching or forking discrete trustee authority to other power holders
Furcating Trustee Authority • Origins in Asset Protection Context: • Separating general trustee duties from distribution authority “Distribution Trustee” • Broader Asset Protection Model: • Carving trustee role among multiple power holders
Furcating Trustee Authority • Administrative Trustee • “General” Trustee • Distribution Trustee / Adviser • Investment Trustee / Adviser
Furcating Trustee Authority • Administrative Trustee • Diversifying responsibilities to establish / preserve legal nexus in desired jurisdiction • Maintains trust records, accounts, tax returns • “General” Trustee • Manages regular trust operations
Furcating Trustee Authority • Distribution Trustee / Adviser • Make / withhold distributions from the trust • Intended to be objective third party • Insulates trustee from pressure & liability associated with power to distribute
Furcating Trustee Authority • Investment Trustee / Adviser • Oversees or directs trust investments • A “Trustee” or an “Adviser” • Title holder, or power holder only?
Furcating Trustee Authority • Investment Trustee / Adviser • May be granted specific powers to: • Hold, maintain, or cancel life insurance • Direct sale or exchange of property • Open, manage, and close accounts
Implementation andDecision Making When does each optionmake the most sense?
Use of Trust Protectors in Domestic Trusts • Typical statutory provisions are intended to divide or allocate fiduciary roles • “Furcated” Trusteeship options • Administrative Trustee to preserve desired situs • Distribution “Adviser” to direct distributions • Distribution “Trustee” to actually make distributions, if preferred • Investment “Adviser” to direct investments • Directed Trust Statutes serve to protect Administrative Trustees
Use of Trust Protectors in Domestic Trusts • For the most part, Trust Protector role is defined by the Trust Agreement • Treated as a contractual provision • Trust Protector can have range of authority extending from extremely limited to extremely broad • Typical Trust Protector role is to provide supervision of Trustee
Positive or Negative Role? • Traditional Trust Protector role is more defensive • Assure that Trustee carries out Settlor’s intent • Protect beneficiaries from overreaching Trustee • There is no specific statutory limitation on scope or nature of Trust Protector • When does a Trust Protector start to act like a Trustee? • What limitations are placed on the Trust Protector?
Limited Trust Protector Authority • Remove and replace Trustee • Authority can be extensive (without cause) or more restricted (removal only due to Trustee bad behavior) • Range of potential replacements typically defined in the Trust Agreement • Possible for an independent Trust Protector to have the authority to select a related or subordinate party as successor Trustee
Extending the Authority of the Trust Protector • Trust Protector may have a substantial role in modifying the estate plan • Change governing law or situs of Trust • Selecting a jurisdiction with more favorable asset protection rules (i.e., Delaware, Alaska, Nevada, South Dakota, Wyoming) • Removal to jurisdiction with better income tax rules (i.e., any place other than California or New York!)
Extending the Authority of the Trust Protector • Resolving disputes between Co-Trustees • Resolving controversies between Trustee and beneficiary • Control spending by Trustee • Limit Trustee’s compensation • Construe/interpret the provisions of the Trust Agreement
The Trust Protector as Investment Advisor • Trust Protector may serve to direct investments • Trust Protector may be given ability only to veto certain investment decisions made by Investment Advisor or Investment Trustee • Limited statutory authority except Delaware directed trust provisions pertaining to “Trust Adviser”
Giving the Trust Protector Maximum Authority • Sue or defend litigation involving Trust assets • Ability to amend or revoke Trust Agreement • Add or delete specific beneficiaries or classes of beneficiaries • Change terms of distributions to beneficiaries • Decanting to another Trust Agreement for same beneficiaries
Trust Protectors • Fiduciary or nonfiduciary status? • Who should serve and who should have the power to designate successors? • Gift and Estate Tax Concerns • Income Tax Concerns
Fiduciary Status • Statutes generally don’t define the standards for Trust Protectors • Trustees are always held to a fiduciary standard • Trust agreement may specify whether a Trust Protector will be treated as a fiduciary • McLean case (Missouri 2009 decision) held trust protector was a fiduciary because of trust agreement provisions
Fiduciary Status • Concerns regarding public policy if drafting lawyer or other close advisor can avoid fiduciary status • Will you serve if you are held to a fiduciary duty? • Would you want someone who is not held to a fiduciary standard to serve as your Trust Protector? • Expect to see many more decisions on this issue in the future!
Who Should Serve as Trust Protector? • Not the Settlor (see asset protection cases such as Affordable Media (Anderson) where Settlor’s service as Trust Protector defeated the plan) • Not a family member due to possible tax complications • Should be someone who is not a related or subordinate party
Who Should Hold the Power to Remove or Replace Trust Protector? • Probably not the Settlor unless explicitly limited to those who are not related or subordinate • Beneficiaries? • Third party? • Court of competent jurisdiction (most conservative option but may be impractical)
Trust Protectors No 2036(a)(2) or 2038(a)(1) concern. Power to remove and replace retained by the grantor? No Yes 2036(a)(2)/2038(a)(1) concern. Beyond Wall logic. Is person being removed acting in a fiduciary capacity? No Yes 2036(a)(2)/2038(a)(1) concern. Beyond Rev. Rul. 95-58. Must replacement be not related or subordinate to grantor with IRC 672? No Yes Within Rev. Rul. 95-58
Trust Protectors • Removal and Replacement • “Decision Tree” (supra) doesn’t consider asset protection issues • Offshore cases often attack grantor’s power to remove/replace protector • Forces grantor to appoint protector who will disgorge assets to creditors • Otherwise, the “impossibility” defense is likely to fail
Specific Examples of Trust Protector • PLR 200537044 • Trust Protector designated as having authority to convert standalone IRA Trust from accumulation trust to conduit trust • Result – Trust agreement satisfied IRA designated beneficiary rules
Designing In Flexibility Using a Trust Protector A Carefully drafted Trust Protector Provision may: Allow the Protector to add skip beneficiaries later Granting the non-skip beneficiaries GPOAs over any portion of the trust that ultimately creates a taxable generation-skipping transfer