Flexibility Is Important For Your Trusts Too

By: Randall A. Denha, J.D., LL.M.

With the election of a new President, the constant back and forth between Democrats and Republicans, stock market turbulence and tax impermanence, it’s safe to say that there is considerable angst and uncertainty among us.  How can one be expected to implement trust structures utilizing all of the bells and whistles of planning with such confusion?

Fortunately, for many of us, our families and our beneficiaries, we have more clarity. As such, we can structure trusts that benefit these classes of people, but how can we do this with the possibility of changes in the future to the family or the law?

Dynasty Trusts, or trusts that continue for the benefit of a surviving spouse’s lifetime and then for the benefit of several generations have become the norm. Drafting trust agreements that will cover the administration, investment, and distribution of trust property over the span of multiple decades is difficult. In fact, trust agreements can be made flexible to address changes in the lives of beneficiaries and the governing laws by: 1) Carefully selecting trustees; 2) Defining trust beneficiaries; 3) Including powers of appointment; 4) Allowing for trust decanting; and 5) Providing for the appointment of a trust protector.

The Wrong Trustee Can Undermine Your Client’s Wishes

Choosing the right succession of trustees for an irrevocable trust that is intended to continue for years into the future is critical to the trust’s success and longevity. Typically, your initial thought is to name one or more family members as Trustee(s) who can then appoint additional family members because they will better understand the varying needs of the beneficiaries and will keep the costs of administering the trust down. But in reality, family members will not be able to fulfill all of their fiduciary obligations without hiring legal, investment, and tax advisors. These expenses will add up and can ultimately cost more than a corporate trustee, such as an independent trust company, which will be able to meet all fiduciary obligations under one roof for one fee.

On the other hand, forcing trust beneficiaries to be stuck with the wrong trustee without a reasonable means for removing and replacing the trustees will land the beneficiaries and trustee in court. It is crucial to build provisions into the trust agreement which allow beneficiaries or a trust protector (more on that below) to remove and replace trustees without court intervention.

Planning Tip: Selecting a trustee is one of the most important decisions that you will make when creating a long-term trust, either with inheritance protection trusts or dynasty trust provisions. Serious consideration should be given to naming a corporate fiduciary, either alone or as a co-trustee with a family member or trusted advisor. A corporate trustee will act as a neutral party to oversee discretionary distributions and investment strategies that benefit both current and remainder beneficiaries. To create flexibility, specific beneficiaries (such as current income beneficiaries) or a trust protector should be given the right to remove the corporate trustee and replace it with another corporate trustee.

Trust Beneficiaries Need to Be Clearly Defined

Consideration needs to be given to who you want to include as trust beneficiaries today, tomorrow and years from now into the future. Should adopted children be included (both minor and adult adoptees)? How about children born using “assisted reproductive technology”? In the past the definition of a “descendant” was straightforward, but today it can encompass much more than blood heirs.

Planning Tip: While you cannot predict or foresee everything that will happen in the future, you should still take the time to consider who you want to benefit after you are gone. Clearly defining the class of beneficiaries who will benefit from the trust will allow for a smooth transition between generations and potentially head off litigation.

Powers of Appointment Can Add or Eliminate Beneficiaries
If you are concerned about how children, grandchildren, or great grandchildren will eventually grow up, you can build flexibility into any trust by giving a surviving spouse or other beneficiary the ability to include or exclude heirs through a power of appointment. A power of appointment (or disappointment based on the way it’s used) is also important when a trust is designed as a generation-skipping trust but one or more beneficiaries do not have children. Another use of a power of appointment is to allow for the inclusion or exclusion of charitable beneficiaries. Trust structuring should incorporate planning for flexible provisions to react to future conditions. Powers of appointment are becoming increasingly popular for various reasons in facilitating future flexibility.

Planning Tip: Powers of appointment at each generation should be considered when designing a trust that is intended to last for decades into the future. The powers can be as limited or as broad as you wish, without creating any gift tax or estate tax problems.

Trust Decanting Takes Something Old and Makes it New
Trust decanting involves taking the funds from an existing trust and distributing them to a new trust that has different and more favorable terms. Decanting may be authorized under state law and should be included as an option in every trust agreement.

Reasons for decanting a trust may include any of the following:

• Amending the trustee succession provisions.
• Converting a trust that terminates when a beneficiary reaches a certain age into a dynasty trust.
• Changing a support trust into a full discretionary trust so that a beneficiary’s creditors cannot seize assets from the trust.
• Clarifying ambiguities or drafting errors in the existing trust.
• Changing the governing law or trust situs to a state with lower taxes.
• Modifying powers of appointment.
• Merging similar trusts into a single trust or creating separate trusts from a single trust.
• Adjusting the trust terms to provide for a special needs beneficiary.

Planning Tip: You may be concerned that including decanting provisions into a dynasty trust will defeat your long-term goals and intent. However, including the authority to decant a trust inserts flexibility into the trust agreement from the beginning, reducing the risk that any beneficiary will end up in court to fix a trust that no longer makes practical or economic sense.

Trust Protectors Can Fix Just About Any Problem
A Trust Protector is an individual or entity that is empowered to make trust changes so that your wishes can be ultimately fulfilled. The Trust Protector can be specifically named in the trust agreement, or the trust can provide for the appointment of a Trust Protector when and as needed.

A Trust Protector’s duties can be as limited or all-encompassing as you choose. In essence, a Trust Protector can be given the power to modify the terms of a trust without necessarily having to decant it and to address unforeseeable events such as changes in tax laws or family dynamics. A Trust Protector is appointed, literally, to protect the integrity of the trust agreement, so that it performs as originally intended, even in the face of changed personal, family, financial or legal circumstances.

Planning Tip: Of all of the options that you can include in your trust agreement to insure flexibility, trust protector provisions are the most flexible. This is because a Trust Protector can be given very broad (or narrow) powers, including the right to appoint, remove and replace trustees; include or exclude beneficiaries; adjust powers of appointment; and decant the trust into a new one. Therefore, trust protector provisions should be included in all trust agreements.

QTIP’ing a Marital Trust

Trying to predict how much a person will have at his or her death and how much will be subject to federal estate taxes is very difficult. Added to the mix is the uncertainty of life itself— which spouse will outlive the other, will he or she remarry, and other major life issues. For these reasons, it’s important to establish an estate plan that not only promotes flexibility in the allocation of your estate property, but also retains tax advantages. One of the more attractive options that many married couples incorporate into their estate plans is the use of a QTIP trust. The Qualified Terminable Interest Property trust, or QTIP trust, serves like a “crystal ball” for the uncertainty of the future in marital trust planning. Not only does it provide for your surviving spouse and other loved ones after your death, but it also offers flexibility to your Trustee in maximizing your federal estate tax savings. Here are a few ways a QTIP trust provides flexibility:

• The executor has up to 15 months to decide whether to make the QTIP election and over what portion of the trust.
• The QTIP election could be made by a formula, thus providing a “savings clause” to assure that no estate tax would be paid at the first spouse’s death (if his or her assets are over the new $10 million basic exclusion amount – or $5 million exclusion amount after the increased exclusion amount has sunset).
• Any non-QTIP trust portion could pass to a standard bypass trust under a “Clayton” provision. The idea behind the Clayton provision is to still require a Marital Trust and Family Trust upon the death of a spouse, however, the surviving spouse is given the option to choose the tax treatment of the Family trust: either keep it as a traditional Family trust which provides estate tax protection but often results in higher capital gains tax, or treat it as a “QTIP Marital Trust” which does not provide estate tax protection but is more favorable with respect to the capital gains tax. Some planners believe that the surviving spouse should not be the executor making the QTIP election if there is a Clayton provision. The IRS might argue that if the spouse makes the election, the spouse makes a gift of some or all of the assets that would have been in the QTIP trust.

Is Your Trust Agreement Flexible?

Unfortunately, if your Living Trust agreement is more than a few years old, it will most likely lack provisions for allowing the trust terms to be adjusted as the needs of the beneficiaries and governing laws change. The good news is that modern trust law contemplates these changes and can often be invoked to fix an old trust that has gone sideways.