Advisors often include irrevocable trusts as part of a comprehensive estate plan to achieve both tax and non-tax goals. The use of irrevocable trusts can cause apprehension because of the perception that irrevocable trusts are inflexible in changing circumstances. This article explores how the use of a trust protector may provide flexibility in an irrevocable trust to address these concerns.
This third and final part of a three-part series discusses changes to an irrevocable trust using a trust protector. The first part explored Changing “Irrevocable” Trusts Through Judicial and Nonjudicial Modification, and the second part reviewed Changing “Irrevocable” Trusts Through Decanting.
While judicial and nonjudicial modification and decanting derive from state law, trust protector provisions originate from the trust instrument itself and by extension, from the grantor. The grantor decides which powers to give a trust protector. For example, the trust protector may possess the power to remove and replace a trustee or appoint additional trustees; to direct, consent, or veto investment decisions; to modify the trust in response to changes in tax or state law; to change governing law or situs; to appoint assets to a class of people or charity in a non-fiduciary capacity; to alter beneficial interests in the trust; to modify the trust in response to changes in trust assets; or to turn off grantor trust status. Think about the trust protector as someone who fixes a specific issue only and has no input regarding daily trust administration.
You may be wondering how a trust protector differs from a trust advisor, distribution advisor, or special trustee. The powers given, rather than the name used, determine whether the party is a trust protector. Trust protectors have a limited but vital role and maintain the power to adjust the trust in the future, long after the creation of the trust and perhaps, after many generations when the trust needs a quick fix. Any time you change an irrevocable trust, ensure that there are no unintended tax consequences, either to a beneficiary, or the grantor.
While it is tempting to think of a trust protector as a trustee, remember that the trust protector may not have the same fiduciary duties as the trustee. State law determines whether trust protectors have fiduciary duties. Some states, like Missouri, have statutes that presume that the trust protector is a fiduciary but allow the grantor to override that presumption in the trust instrument itself. Other states, like Alaska, impose the reverse presumption that a trust protector is not a fiduciary and require that the trust protector be made a fiduciary in the trust itself, if desired. Remember to consider the interplay between the trustee and the trust protector, especially if you intend for the trustee to take direction from the trust protector.
Let’s go back to our example from Part II. Donald established a trust for the benefit of his nephews, Huey and Dewey, naming his nephew, Louie, as trustee and Webby Vanderquack as trust protector. Louie makes distributions to Huey and Dewey in his sole discretion, for the lifetime of each of Huey and Dewey. Huey, Dewey, and Louie recently had a falling out over rights to their latest movie. Louie threatens to withhold distributions to Huey and Dewey. Webby, as the trust protector, can remove Louie and replace Louie with Donald’s friend, Mickey. In this situation, the trust protector exercises her power to name a new trustee who will resume distributions to the beneficiaries without the current trustee’s cooperation and without court intervention thereby solving the issue. This is but one example of the many ways that a trust protector can exercise her listed powers and fix the trust to better address beneficiary needs.
If you have concerns about how an irrevocable trust can adapt to changing needs over time, consider naming a trust protector who can adjust the trust to account for changes in beneficiaries’ needs or changes in the laws. Trust protectors avoid court, do not require the cooperation of the trustee or beneficiaries, and can solve a problem quickly. The use of a trust protector adds flexibility to a trust, especially when limitations or obstacles prevent judicial and nonjudicial modification or decanting. Remember that the trust protector has the powers listed in the trust. With some careful consideration of the trust protector’s powers, it’s easy to create an irrevocable trust that will evolve with changing needs.
Tereina Stidd, J.D., LL.M. (Tax)
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128