The cloud of uncertainty hanging over the state of our current and future health, politics, economy and tax legislature makes flexible trust planning more important now than ever. Modern trusts can be drafted, and existing trusts can be 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 exemptions to fund a flexible modern trust for important nontax reasons. These nontax reasons allow a family to deal with future uncertainties. A few of the important nontax reasons are discussed below.
Promotion of Family Values and Social Responsibility
The ability to pass on family values intergenerationally is very important to many families. 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 directed trust’s 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 sensitive 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, comprising family and family advisors, can flexibly deal with unanticipated family needs. The grantor and the beneficiaries can add or remove DC members.
In addition, these noncharitable modern directed trusts may be drafted to allow for distributions not only to family beneficiaries but also to charitable beneficiaries. Distributions to charity from a noncharitable modern directed trust allow for the promotion of family social responsibility and result in an unlimited income tax deduction to the trust. The charitable deduction to the trust, however, is usually secondary to most families.
Beneficiary Quiet
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. 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.
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%. This has increased since COVID-19. Modern directed trusts provide great intergenerational divorce protection. Most trusts traditionally rely on the spendthrift clause to protect family trust assets from divorce. 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, 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. 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. This discretionary interest protection also includes HEMS distribution powers. It’s therefore difficult to garnish discretionary trust property in these states directly or as a spendthrift clause exception creditor.
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. 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. 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.
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. 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 gravesites, 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. The hope is that they can be brought back to life at some point in the future.
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 nontax 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.
*The full-length version of this article, “Flexible Trusts to Deal With Future Uncertainties,” appears in the January 2022 issue of Trusts & Estates.