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Proactive Trust Planning to Protect Your Clients
Planning for trusts has evolved substantially over the years. “Modern” trusts are more comprehensive, flexible and protective than those that were more typically completed only a few short years ago. Understanding the characteristics of modern trust drafting is critical to achieving better protection for clients. But this planning can extend well beyond just planning new trusts. Even existing irrevocable trusts that might have been created in a less optimal manner may be improved. And it may be feasible to bring back into a protective trust structure gifts and bequests that were made out of trust. The IRS and the Obama administration have taken a less-than-favorable view of some of the planning techniques. Practitioners need to be aware of these risks so that they can encourage clients to act quickly when advisable.
Are Trust Assets Reachable?
Whether a trust is reachable in a divorce proceeding will depend on a number of trust characteristics. If a trust is deemed a “support” trust, which directs the trustee to make distributions to support the beneficiary, it may be reachable. A common support standard is Health Education Maintenance and Support, referred to by the acronym “HEMS.” Support trusts may have to rely on a spendthrift provision for any protection from claimants. In contrast, a “discretionary” trust gives the trustee the power to determine if, when, and how much to distribute from the trust. A pure support trust might be easier to reach in a matrimonial action. A pure discretionary trust may be more difficult to reach, because the trustee does not have to exercise the discretion given. While these generalities provide useful constructs, reality is much more complex because many trusts are actually a blend of the two principals, and all of this is compounded by the differences in state law.
In 2011, a New Jersey case held that the trust could not be counted for purposes of determining alimony. It was not appropriate to impute income to a party based on her beneficial interest in a discretionary support trust. Tannen v. Tannen, 416 N.J. Super. 248 (App. Div. 2010), aff'd, — N.J. —, — A.3d —-, 2011 WL 6090130 (2011). See Shenkman, Martin M. et al., Recent NJ Case Upholds Protection of Trust, The Matrimonial Strategist, Feb. 2012, available at http://bit.ly/1u1xhvp. In a recent Florida case, the court permitted the former spouse of a beneficiary to access distributions as they were made from a discretionary trust. Berlinger v. Casselberry, Case No. 2D12-6470 (Fla. 2d DCA Nov. 27, 2013).
Although the trust in the Tannen case was not pierced, the costs incurred were likely substantial, and it is not fully clear that the conclusion was correct. The trust in Berlinger was pierced. Why accept this level of risk? With modern trust drafting and planning options, the risks to which the beneficiaries in Tannen , Berlinger and scores of other cases were subjected may be avoided.
Modern Trust Provisions
When planning a trust, or correcting a problematic existing trust (see below), consider counseling clients to incorporate each of the following provisions or mechanisms to provide a greater level of protection from a future matrimonial action.
Independent Trustee
It has become more common to name institutional trustees for a host of reasons. Having an institutional trustee imbues a trust with independence, which can be helpful. Also, institutional trustees have processes and procedures that greatly enhance the likelihood that trust formalities will be followed. This can be vital to the trust's being respected in a challenge. This is something few individual trustees tend to do. When an institutional trustee is vested with distribution decisions, the distribution will likely be the result of a documented formal process of consideration by a distribution committee.
Discretionary Distribution Standard
Whenever possible, and even in light of the Berlinger case above, discretionary distribution standards should always be favored. Permitting an independent trustee, ideally an institutional trustee, to make distributions “at such times and in such amounts as the trustee determines” allows the trustee to make distributions with consideration of the current relevant circumstances. This can provide greater protection under most states. It is not clear that the Berlinger court would have necessarily pushed so far if the husband had not taken some of the steps he had.
Trust-'Friendly' Jurisdictions
Include a provision in the trust agreement allowing the trustee or trust protector to change jurisdictions. This will facilitate changing jurisdictions well in advance of any problems arising. The better approach, however, is to have the situs of the trust in a trust-”friendly” jurisdiction from inception. The most common are Alaska, Delaware, Nevada and South Dakota. Specifically for matrimonial protection, Nevada appears to have the best statutory provisions with no exception creditors whatsoever, even for alimony and child support. See http://bit.ly/1maVITL.
Perpetual Term
Modern trust drafting favors very long term or even perpetual trusts. Too often, older trusts, and even newer trusts prepared by many practitioners, have mandatory payouts when a beneficiary attains a certain age. That can emasculate any protection the trust might afford.
Division of Trust
Trusts should include broad and liberal powers to divide the trust into separate entities. While these powers have traditionally been included when generation-skipping transfer tax planning was undertaken, they can have important uses in maximizing divorce protection for a trust. For example, a trust may not name the client as a beneficiary, but rather give a trust protector or a person acting in a non-fiduciary capacity the right to name or add the client as a beneficiary. If the trust is divided and the power to add the client as a beneficiary is only made over a small portion of the trust, the larger portion of the trust may remain safer from a future attack.
Trust Protector Flexibility
The trust should include the designation of a trust protector who is a fiduciary granted the power to change trustees, governing law, situs and other important factors affecting the trust. This can provide an incredible level of flexibility to respond to a future matrimonial challenge.
Power to Add or Change Beneficiaries
The trust could give an independent party, such as the beneficiary's close friend, the power to add and remove beneficiaries, including the ability to remove that beneficiary and add that beneficiary's spouse. As illustrated above, the client could be added or removed as a beneficiary. If the client remarries, adding the new spouse as a beneficiary might facilitate a means of providing indirect economic benefit to the client without naming the client as a beneficiary. This strategy should provide a greater safeguard against a challenge by a former spouse. The person holding this power might expressly be designated to act in a non-fiduciary capacity so that no court could impute a responsibility to add the client as a beneficiary or to act with regard to a fiduciary obligation to the client.
Planning for trusts has evolved substantially over the years. “Modern” trusts are more comprehensive, flexible and protective than those that were more typically completed only a few short years ago. Understanding the characteristics of modern trust drafting is critical to achieving better protection for clients. But this planning can extend well beyond just planning new trusts. Even existing irrevocable trusts that might have been created in a less optimal manner may be improved. And it may be feasible to bring back into a protective trust structure gifts and bequests that were made out of trust. The IRS and the Obama administration have taken a less-than-favorable view of some of the planning techniques. Practitioners need to be aware of these risks so that they can encourage clients to act quickly when advisable.
Are Trust Assets Reachable?
Whether a trust is reachable in a divorce proceeding will depend on a number of trust characteristics. If a trust is deemed a “support” trust, which directs the trustee to make distributions to support the beneficiary, it may be reachable. A common support standard is Health Education Maintenance and Support, referred to by the acronym “HEMS.” Support trusts may have to rely on a spendthrift provision for any protection from claimants. In contrast, a “discretionary” trust gives the trustee the power to determine if, when, and how much to distribute from the trust. A pure support trust might be easier to reach in a matrimonial action. A pure discretionary trust may be more difficult to reach, because the trustee does not have to exercise the discretion given. While these generalities provide useful constructs, reality is much more complex because many trusts are actually a blend of the two principals, and all of this is compounded by the differences in state law.
In 2011, a New Jersey case held that the trust could not be counted for purposes of determining alimony. It was not appropriate to impute income to a party based on her beneficial interest in a discretionary support trust.
Although the trust in the Tannen case was not pierced, the costs incurred were likely substantial, and it is not fully clear that the conclusion was correct. The trust in Berlinger was pierced. Why accept this level of risk? With modern trust drafting and planning options, the risks to which the beneficiaries in Tannen , Berlinger and scores of other cases were subjected may be avoided.
Modern Trust Provisions
When planning a trust, or correcting a problematic existing trust (see below), consider counseling clients to incorporate each of the following provisions or mechanisms to provide a greater level of protection from a future matrimonial action.
Independent Trustee
It has become more common to name institutional trustees for a host of reasons. Having an institutional trustee imbues a trust with independence, which can be helpful. Also, institutional trustees have processes and procedures that greatly enhance the likelihood that trust formalities will be followed. This can be vital to the trust's being respected in a challenge. This is something few individual trustees tend to do. When an institutional trustee is vested with distribution decisions, the distribution will likely be the result of a documented formal process of consideration by a distribution committee.
Discretionary Distribution Standard
Whenever possible, and even in light of the Berlinger case above, discretionary distribution standards should always be favored. Permitting an independent trustee, ideally an institutional trustee, to make distributions “at such times and in such amounts as the trustee determines” allows the trustee to make distributions with consideration of the current relevant circumstances. This can provide greater protection under most states. It is not clear that the Berlinger court would have necessarily pushed so far if the husband had not taken some of the steps he had.
Trust-'Friendly' Jurisdictions
Include a provision in the trust agreement allowing the trustee or trust protector to change jurisdictions. This will facilitate changing jurisdictions well in advance of any problems arising. The better approach, however, is to have the situs of the trust in a trust-”friendly” jurisdiction from inception. The most common are Alaska, Delaware, Nevada and South Dakota. Specifically for matrimonial protection, Nevada appears to have the best statutory provisions with no exception creditors whatsoever, even for alimony and child support. See http://bit.ly/1maVITL.
Perpetual Term
Modern trust drafting favors very long term or even perpetual trusts. Too often, older trusts, and even newer trusts prepared by many practitioners, have mandatory payouts when a beneficiary attains a certain age. That can emasculate any protection the trust might afford.
Division of Trust
Trusts should include broad and liberal powers to divide the trust into separate entities. While these powers have traditionally been included when generation-skipping transfer tax planning was undertaken, they can have important uses in maximizing divorce protection for a trust. For example, a trust may not name the client as a beneficiary, but rather give a trust protector or a person acting in a non-fiduciary capacity the right to name or add the client as a beneficiary. If the trust is divided and the power to add the client as a beneficiary is only made over a small portion of the trust, the larger portion of the trust may remain safer from a future attack.
Trust Protector Flexibility
The trust should include the designation of a trust protector who is a fiduciary granted the power to change trustees, governing law, situs and other important factors affecting the trust. This can provide an incredible level of flexibility to respond to a future matrimonial challenge.
Power to Add or Change Beneficiaries
The trust could give an independent party, such as the beneficiary's close friend, the power to add and remove beneficiaries, including the ability to remove that beneficiary and add that beneficiary's spouse. As illustrated above, the client could be added or removed as a beneficiary. If the client remarries, adding the new spouse as a beneficiary might facilitate a means of providing indirect economic benefit to the client without naming the client as a beneficiary. This strategy should provide a greater safeguard against a challenge by a former spouse. The person holding this power might expressly be designated to act in a non-fiduciary capacity so that no court could impute a responsibility to add the client as a beneficiary or to act with regard to a fiduciary obligation to the client.
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