Estate Planning With The Flexible Irrevocable Trust

Estate Planning is getting more difficult for many of us. An estate plan these days needs flexibility. The estate tax law might change, the value of property in the estate fluctuates, and personal circumstances can change.

Flexibility is fairly easy to put into a will with the “but it” clause I’ve discussed in past visits. The will sets the disposition of the estate, and the “but it” clause says that the disposition will be different if the tax law changes.

The will, however, often is only part of the estate plan. Irrevocable Trusts are important elements of many estates and are among the most useful estate planning tools. An irrevocable trust can reduce estate and income taxes, avoid probate, and add creditor protection. The trusts also provide many more options than simply leaving property outright to beneficiaries. The trusts can have limits, controls, timetables, and other features.

The solution for adding flexibility to irrevocable trusts can be a feature borrowed from offshore or foreign trusts.

Offshore trusts always needed extra flexibility. The grantors creating the trusts often were worried that the overseas trust companies would turn out to be crooked or that there would be political or legal changes in the country in which the trust was located.

To combat such problems, offshore trusts long have had trust protectors. These are individuals empowered to take certain actions when in the judgment of the protectors they seemed in the best interests of the trusts. The standard clause allowed the protector to either change the trustee or move the trust to another country. The protector is someone independent of the trustee.

The protector is needed because the grantor of the trust cannot retain such powers. If the grantor could take these actions, the grantor would be considered owner of the trust. All income would be taxed to the grantor, and the property would be included in the grantor’s estate.

Estate planning professionals are starting to include protectors in irrevocable trusts based on the U.S. Other names used for the position are special trustees or trust advisors.

A protector can have either broad or limited powers, and the actions the protector can take are limited largely by the grantor’s imagination and desire.

A protector might be empowered to add or delete beneficiaries. This can be helpful if additional births in the family are likely. The protector might be allowed to change the age at which distributions will be made, the amounts of the distributions, or other terms of trust distributions. This can be helpful when a beneficiary develops a problem such as debt, substance abuse, or gambling. There also might be a need to accelerate distributions for a medical emergency or disability. Of course, the protector can be empowered to change the trustee or location of the trust.

When a dynasty trust to last for several generations is contemplated, a protector might be a good idea to adapt to new circumstances. This could become more important since a number of states are dropping the old rule against perpetuities that limited the life of a trust.

There are two ideal circumstances to consider using a trust protector.

One circumstance is when a trust is created during your lifetime. The trust has to be irrevocable to get estate tax benefits. Yet, there could be new family members, existing members might pass away, or relationships could change. The grantor is powerless to alter the trust, but a protector can add or delete beneficiaries and make other changes.

The other circumstance is when the trust won’t be funded until the grantor’s death. At that time, of course, the grantor won’t be able to change the trust for new circumstances.

The prospect of changing tax laws is another good reason to consider a protector. A protector also can be a good idea when the trust holds shares of a family business or significant real estate. Family members usually don’t want a professional trustee voting business shares or deciding how the property is to be managed or developed.

A trustee, of course, could be empowered to make these changes, though the trustee is not likely to decide to change trustees. In addition, many professional trust companies refuse to accept such powers. They don’t want to be choosing between beneficiaries or making other decisions. They want to invest the trust, prepare tax returns, and make distributions according to instructions.

The decisions a protector makes depend on knowledge of the family and its circumstances. So, you should prefer a family member, friend, or professional advisor rather than a professional trustee to be the protector.

The choice is a tough one. The protector must be someone you trust for honesty, judgment, and knowledge of the family and your wishes. You also need to decide if there should be a process for selecting a successor protector after the first one is not capable of continuing. You could have either the protector name the successor or set up a committee to name the protector. Some lawyers say there should not be a successor protector, because the initial protector was selected for unique qualities.

Some estate planning lawyers won’t use protectors on U.S.-based trusts because there isn’t a lot of law to give them guidance. Only three states have statutes officially recognizing protectors (Delaware, Idaho, and South Dakota).

A potential protector should know that there could be legal liability attached to the position. Many estate planning specialists   who normally agree to serve as trustees or estate administrators will not serve as protectors. They believe any changes they make would be legally challenged and result in time-consuming and expensive court action. That possibility should be considered when deciding which powers to give a protector.

The potential for changing circumstances leads estate planning advisors to seek new tools to gain estate planning flexibility, and the trust protector is a tool to consider.