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

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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

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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

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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

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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

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Furcating Trustee Authority

• Administrative Trustee• “General” Trustee• Distribution Trustee / Adviser• Investment Trustee / Adviser

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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

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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

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Furcating Trustee Authority

• Investment Trustee / Adviser– Oversees or directs trust investments

• A “Trustee” or an “Adviser”– Title holder, or power holder only?

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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

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Implementation andDecision Making

When does each optionmake the most sense?

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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

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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

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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?

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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

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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!)

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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

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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”

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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

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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

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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

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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!

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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

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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)

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Power to remove and replace retained by the grantor?

Yes

No

Is person being removed acting in a fiduciary capacity?

No

Yes

No 2036(a)(2) or 2038(a)(1) concern.

Must replacement be not related or subordinate to grantor with IRC 672?

2036(a)(2)/2038(a)(1) concern. Beyond Wall logic.

No2036(a)(2)/2038(a)(1) concern. Beyond Rev.

Rul. 95-58.

Yes

Within Rev. Rul. 95-58

Trust Protectors

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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

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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

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Designing In Flexibility Using a Trust Protector

A Carefully drafted Trust Protector Provision may:

Allow the Protector to add skip beneficiaries laterGranting the non-skip beneficiaries GPOAs over any portion of

the trust that ultimately creates a taxable generation-skipping transfer

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Questions?

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