Editor’s note: This is part six of an ongoing series about using trusts and LLCs in estate planning, asset protection and tax planning. The effectiveness of these powerful tools — especially for asset protection and tax planning — depends very much on how they are configured to work together and whether certain types of control over assets and property are surrendered by the property owner. See below for links to the other articles in the series.
Control and protection are always the key tradeoffs in irrevocable trusts. Despite what a company marketing a “special” trust may say, the more control that a trust maker keeps over an irrevocable trust to direct the trust, manage trust assets and distribute from the trust, the less asset protection the trust will provide to the trust maker and related beneficiaries.
But most trust makers are reluctant to relinquish all control over a trust — the trust maker may wish to continue operating, trading or managing the investment of the trust assets. On top of this, the trust maker might not know the trustee well enough to trust them. So, what can a trust maker do to be confident that their assets are secure, properly managed and distributed to the beneficiaries in the manner that the trust protector wishes?
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Fortunately, there are several tools in modern trust design that can provide a trust protector with checks and balances over the trust, but still reduce the trust maker’s direct dominion, power and control over the trust for purposes of achieving stronger asset protection, without subjecting the trust property to unchecked control by the management trustee or distribution trustee.
Consider a 'trust protector'
One of the indirect powers that the trust maker of an irrevocable trust might utilize to ensure that the trustees act in the best interests of the trust maker or the trust maker’s beneficiaries is the power of a “trust protector.” Trust protector powers over an irrevocable trust can vary from trust to trust, depending on the terms of the trust agreement creating the trust, though the trust protector powers can even include powers to amend the trust and appoint different beneficiaries. Sometimes the trust protector is even permitted to appoint the trust maker as a temporary beneficiary of an irrevocable trust in which the trust maker was not named as a beneficiary. In other situations, the trust protector can ask the distribution trustee to reimburse the trust maker for expenses or taxes that the trust maker pays for the trust when the trust earns money.
Additionally, the trust protector office can hold a “fiduciary” power, under which the trust protector must act in the best interests of the beneficiaries, or the trust protector can be a non-fiduciary power to avoid the trust protector having duties to the beneficiaries. While “best interests” sounds great, it can be a problem when a trust protector needs to take actions that are contrary to the interests of the current beneficiaries as shown in the following example:
Example. A trust maker with no present beneficiary rights needs a distribution from the irrevocable trust that the trust maker earlier formed, to cover a major expense of the trust maker. The trust protector orders the distribution trustee to name the trust maker as a temporary beneficiary and make a distribution to the trust maker. The existing beneficiaries of the irrevocable trust, like all beneficiaries of trusts, do not like seeing money that could have been distributed to them, or stayed in the trust for their benefit, go to someone else. However, under the terms of the trust formation agreement, the trust protector has the authority to order the distribution trustee to make a distribution to the trust maker and determines that the trust maker should get the distribution. The irrevocable trust beneficiaries could cry “foul play” against the trust maker. However, under the trust agreement, the trust maker is not a fiduciary who must act in the best interests of the beneficiaries of the irrevocable trust, and the trust protector can use the trust protector powers in a way that is contrary to the beneficiaries without facing liability under fiduciary standards.
Ultimately, the distinction in whether the trust protector is bound by a fiduciary duty to act in the best interests of the beneficiaries can be critical in reducing the trust protector’s liability and preventing many beneficiary disputes over distributions. To avoid the trust protector powers from undermining the asset protection of a trust, it may be advisable to require that the replacement of the trust protector be by a court with jurisdiction over the trust.
Consider appointing advisory committees
In addition to providing provisions to appoint a trust protector, an irrevocable trust could also contain provisions for direction by advisory investment committees and advisory distribution committees. The fiduciary liability of the trust advisory committees can be limited if the irrevocable trust agreement provides that the investment and distribution committees provide only advisory, non-mandatory instructions to an independent management trustee.
Again, if the trust maker retains “control” over an irrevocable trust by putting themself in charge of management or distributions, the control lessens the asset protection achieved by the trust. However, a trust maker surrendering control over the trust to independent distribution trustees and management trustees can consider appointing a trust protector and advisory committees as a check and balance.
Example. The trust maker wants to form a self-settled irrevocable trust for asset protection, naming themself as beneficiary. The trust maker wants to achieve maximum protection with the trust, so they inquire about appointing trustees to make decisions on trust distributions and a trustee to make decisions on trust management. The trust maker does not want to retain the power to distribute the trust assets or to manage the trust assets. Additionally, the trust maker wants to provide for a trust investment committee to advise the management trustee on how the trust assets should be managed, and the trust maker also wants to provide for a trust distribution committee that can advise the distribution trustee on how to distribute trust assets. The trust maker also wants to appoint a trust protector who does not have a fiduciary duty to the trust maker to ensure that the trust protector is not “subordinate” because the trust protector has no duty to the trust maker. In advance of signing the trust, the trust maker hires one professional trust company to fill the role of the management trustee, the trust maker hires a CPA to fill the role of distribution trustee, the trust maker hires a lawyer to serve as the trust protector, and the trust maker asks three friends and three siblings who are not trust beneficiaries to serve on the respective trust investment committee and the trust distribution committee to advise the trustees on management/investment as well as distribution of trust assets. The trust maker pays each of these professionals, friends and family members for the work they will perform for the trust.
Several trustees and committees could get pricey
Appointing several trustees, trust advisory committee members and trust protectors to fully protect a trust may be overwhelming and expensive for an irrevocable trust maker. The trust maker might not know enough people willing to serve on the committees and might not want to incur all the costs for appointing professionals to serve these roles. Rather than sticking their head in the sand, feeling helpless and doing nothing to protect their assets, the trust maker is better off by designing the irrevocable trust so that these different trustees, trust protectors and trust advisers can gradually be appointed, perhaps upon the occurrence of a triggering event such as an increase in net worth.
Asset protection with irrevocable trusts is not black-and-white — asset protection is better thought of as falling on a spectrum from good to better and best. Balancing the costs and benefits of the protection is key. Doing nothing at all provides no asset protection, so by setting up the irrevocable trust and reducing the trust maker’s control over the trust, at least the trust maker is on the path toward best practices in asset protection over time.
My next article will be about trust income tax planning with grantor trust provisions.
Other Articles in This Series
- Part one: To Avoid Probate, Use Trusts for Estate Planning
- Part two: How Quitclaim Deeds Can Cause Estate Planning Catastrophes
- Part three: Revocable Trusts: The Most Common Trusts in Estate Planning
- Part four: With Irrevocable Trusts, It’s All About Who Has Control
- Part five: Ins and Outs of Domestic Asset Protection Trusts (DAPTs)
Related Content
-
Seven Local Social Security Offices Are Suspending In-Person ServicesA departure from closing locations, seven local Social Security offices will temporarily stop all in-person service and will only be available by telephone.
-
The Explosion of New AI ToolsThe Kiplinger Letter Workers and consumers soon won’t be able to escape generative AI. Does that mean societal disruption and productivity gains are right around the corner?
-
This Underused IRA Option Offers Tax Benefits and Income SecurityLooking to avoid running out of money in retirement? Consider longevity protection provided by a QLAC as a component of your retirement income plan.
-
These Four Books Explore How to Leverage Our Outrage PositivelyThe authors offer some powerful tools to help us find solutions to discord rather than remaining silent or blowing up in anger.
-
Financial Pitfalls to Avoid in Your 30s, 40s and 50sAs you pass through each decade of working life and build wealth for retirement, watch out for the financial traps that can hinder your progress.
-
Five Key Retirement Challenges (and How to Face Them Head On)Life will inevitably throw challenges at you as you get older. But making a flexible retirement plan — and monitoring it regularly — can help you overcome them.
-
Four Action Items for Federal Employees With $2M+ SavedIf you can't stand the chaos, maybe you can walk off into the sunset of retirement. Here are some thoughts on how to figure out if that would work for you.
-
How to Help Accelerate Support for Women's EqualityInternational Women's Day was earlier this month, and the theme this year is Accelerate Action. Here's how we can all pitch in to help drive gender parity.
-
How Tariffs Could Impact Affluent RetireesThe wealthier you are, the less price increases on groceries and cars will hurt you, but if markets dive or we enter a recession, that's a different story.
-
How to Help Shield Your Retirement From InflationPicking the right investments at the right time can help ensure inflation won't flatten your retirement savings. Here are some tips.
