Written by David I. Faust, Partner at Gallet Dreyer & Berkey, LLP.

Complex estates—whether they’re complicated because of assets or family situation—take special handling, and the estate holder may want to control who gets what and how—even after they're gone. Two types of trusts can help achieve this goal, but which should they choose, and why? Trusts & estates and tax law attorney David I. Faust, partner at Gallet Dreyer & Berkey, explains.

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One cannot handle the disposition of one’s estate from the grave, but one can determine who will handle that disposition. The two basic ways to do so are by wills or trusts.

The larger and more complex the estate, and the person’s family and interactions, the more critical is the decision as to who will make investment and distribution decisions post-mortem. For example, a client with young children, where interests, needs and abilities are yet to be evident, may need drastically different things from an advisor than a client whose children are more mature and show distinctly different needs and potentials.

Putting aside bequests to a surviving spouse, other family members, friends and charities, as well as tax considerations if the estate is substantial enough for such concerns, the simple course is to bequeath one’s estate to all children or issue equally. That’s the easy answer but not necessarily a satisfactory one, especially if the estate is large and there is a concern about differences in merit or need among the beneficiaries, or the continuation of an operating business to consider. A solution can be a trust, providing some flexibility regarding asset management, investments and distributions, but which kind of trust…testamentary or inter vivos?

Testamentary vs. Inter Vivos:

A testamentary trust is one created by a will. It is amendable and revocable so long as the testator (the person whose will it is) is alive and competent. An inter vivos trust is created while the person is alive; it can be either revocable or irrevocable, as the grantor (the person who creates it) wishes.

In either case, the trustee(s) can be given guidance as to how assets should be managed and how discretion should be exercised, by precatory language in the will or trust, coupled, in the case of a trust, with a Letter of Wishes. One can have multiple trustees, either with common rights and obligations or distinct ones. For example, one to make investment decisions, another to make distributions decisions. In either case, abuses of distribution can be brought to the Surrogate’s Court. Absent a “protector” (explained below), there is no check on the trustee other than litigation, with all of the costs in both time and money. There are at least two significant differences between testamentary and inter vivos trusts.

A testamentary trust is governed by the laws of the jurisdiction where the will under which it was created was admitted for probate, typically the domicile of the testator. An inter vivos trust can be created virtually anywhere in the world with a trust law. Citizenship, domicile or residence are not generally required for an inter vivos trust.

Trusts are created for various reasons, including providing flexibility in the distribution of benefits, preserving assets such as a family business, protecting assets from creditors, providing for a disabled beneficiary, avoiding the rules against perpetuities or avoiding restrictions on dispositions. Tax considerations often play a part in determining the nature and structure of a trust.

Various common law jurisdictions have established a thriving financial services industry, an important component of which was trust laws which purported to provide more secure asset protection, avoid forced heirship and provide protection for the grantor’s wishes, which often were inconsistent with the laws of the grantor’s citizenship, residence or domicile.

In recent decades, various states have enacted trust laws providing many, if not all, of the purported benefits of such offshore trust laws. New York is not (yet) among those states, but choosing an inter vivos trust still gives a New York grantor a wide choice of jurisdiction and trust laws.

Protectors:

Another key difference is the availability of a protector. An inter vivos trust can have one or more “protectors” who can, among other things, monitor and even control the trustee and ultimately remove and replace a trustee. Using a protector is common in offshore trusts and is gradually becoming accepted in New York and other US jurisdictions in inter vivos trusts, but not with testamentary trusts. This can be particularly useful if the trustee is a trust company or other institutional trustee. Such a trustee may be the right choice to invest and manage a significant estate, but may not know the grantor’s family, wishes or intentions beyond what may be in a Letter of Wishes.

A protector, typically a close friend or advisor, can not only be given the power to remove and replace the trustee, but also to control both investments and distributions with a more intimate knowledge of the grantor’s intent beyond that which can be reflected in a Wish Letter.

Protectors, in some states called “investment advisors” or “distribution advisors,” can have affirmative powers, negative powers or both. Affirmative powers are the ability to direct the trustee to do something: make a specific investment, divest an investment, make a distribution or take some other action. Negative powers require specified decisions of the trustee to be approved by the Protector.

A trust can have an investment protector, whose powers are limited to investment matters, a distribution protector, whose powers are limited to ordering or approving distributions, or the same person with both powers.

Protector’s powers are not specified in a statute, rule or regulation; they are provided for in the trust agreement. They can be as broad or specific as the grantor wishes; for example, limited to decisions over a specified dollar amount or limited to “major decisions,” defined as they would be in a partnership or loan agreement. The use of a protector can be a very flexible but effective tool to insure that the fiduciary powers of trustees are exercised as the grantor would wish.

In common law jurisdictions, where protectors are widely used, challenges to a protector’s decisions are often couched as allegations of “fraud on a power.” Causes dealing with such a challenge depend on whether the protector is a fiduciary. One can specify in the trust agreement whether the protector is, or is not, a fiduciary based on such things as the relationship of the protector to the trustee, the grantor and the beneficiaries and the language of the trust which describes the protector’s powers.

This is a matter which, like many in this area, requires a balancing of interests. Making the protector a fiduciary may be a control on the protector’s powers, but also limit the willingness of someone to accept that responsibility. Expressly disclaiming fiduciary status may give the protector immunity from responsibility for decisions which violate fiduciary standards such as, but not limited to, “prudent person” standards or even self-dealing. The definition of the status and risk of a protector must be approved by the trustee, which may object to what could be perceived as arduous and unacceptable restrictions on the trustee’s discretion and, at the least, may require full indemnity from following a protector’s directions.

The very word “trust” implies that the grantor is transferring assets to a trustee who will deal with those assets not for his/her or its own benefit but for the benefit of others—the beneficiaries. Protectors can provide a measure of assurance that the trustee will not abuse that power. How to protect against the abuse of power is a matter for another day.

Conclusion:

The alternatives available to a grantor of a trust create a corresponding obligation on the part of the grantor’s advisor to explain and consider a wide range of choices such as a form of trust, jurisdiction, powers and guidance to trustees, whether to use a protector(s), if available, and the powers to be given to a protector(s) before drafting the terms of a trust, whether testamentary or inter vivos.

While beneficiaries are generally not parties to any trust agreement, whether testamentary or inter vivos, an advisor must consider the interests of the beneficiaries as well as those of the grantor, the trustee and the protector(s), if any. Without such considerations, the likelihood of an agreement which will satisfy the wishes of the client in both theory and in practice is remote.

David I. Faust is a partner at Gallet Dreyer & Berkey. His practice focuses on trusts & estates, asset protection and tax law.