Unique and Creative Uses of Modern Trusts Involving Investments and Insurance

Transcription

1 400 Unique and Creative Uses of Modern Trusts Involving Investments and Insurance Al W. King III, JD, LL.M. I d like to start by saying that we are purely an administrative trust company and do not provide investment or insurance services, but we work with professional advisors, CPAs, lawyers, and wealthy individuals from across the country. In doing so, we cannot help but learn and see what s going on in the industry with unique trust strategies and structures and how the wealthy and their advisors are utilizing these structures. What I am going to do is go through some of these unique and creative modern trust structures; however, before I get into the specifics, I d first like to touch on the current wealth environment around the country and the world. In 2013, nearly 2 million people around the world became millionaires. That s a 15 percent increase from 2012, and the total number of millionaires increased to a record 13.7 million. The world s wealthiest 1 percent have $110 trillion in assets, 65 times the wealth of the poorest 50 percent. Moreover, the richest 85 people in the world have as much wealth as the bottom 50 percent, or 3 billion people. The United States is still the wealthiest country in the world by far. There are more than 7 million millionaires in the United States, followed by China with 2.37 million and Japan with 1.24 million. In addition, the proportion of millionaire households in the United States is still relatively high at 6 percent, which is the sixth highest in the world. In addition, according to the 2014 Forbes list, the number of high-net-worth individuals continues to grow since 268 billionaires were added in These billionaires have an overall net worth of $6.4 trillion, and the United States again leads with more than 490 billionaires. The asset composition of these high-net-worth individuals is also very interesting to an investment or insurance professional. According to a Credit Suisse Wealth Databook study, the United States has roughly 65 percent in financial investments while only about 45 percent of the wealthy s assets are nonfinancial. In addition, if we look to where in the country these highnet-worth individuals are living, we see that most, by a long shot, call New York home, followed by Los Angeles, Chicago, Washington, DC, San Francisco, Boston, and so on. People often wonder exactly how much income and/or wealth someone needs to have to be included in the top 1 percent or the top 20 percent; this table lists some absolute dollar amounts associated with various income and wealth classes. [visual] As you can see, mean household income for the top 1 percent is about $1.3 million while their mean household net worth is roughly $16.43 million. Now, if we do not include their homes in the equation, we see that the top 1 percent s household mean wealth is about $15.1 million. In addition, for the top 20 percent in the United States, the median household income is at $226,000 and the mean household net worth is around $2 million or about $1.7 million, not including their homes. In terms of types of financial wealth, the top 1 percent of households have 35 percent of all privately held stock, 64.4 percent of financial securities, 38 percent of trusts, and 61.4 percent of business equity. The top 10 percent have 81 to 94 percent of stocks, bonds, trust funds, and business equity and almost 80 percent of non-home real estate. Since financial wealth is what counts as far as the control of Al W. King III, JD, LL.M. King is the co-founder, co-chairman, and co-chief executive officer of South Dakota Trust Company LLC (SDTC). SDTC is a national trust boutique serving wealthy families all over the world with more than USD 28 billion in assets currently under administration. Previously, King was managing director and national director of estate planning for Citigroup and the co-founder and vice chairman of Citicorp Trust South Dakota. King is the co-vice chairman of the editorial board for Trusts & Estates magazine and has been inducted into NAEPC s Estate Planning Hall of Fame. South Dakota Trust Company LLC 10 East 40th Street, Suite 1900, New York, New York, USA Alking@sdtrustco.com phone: website: sdtrustco.com View this presentation in the Resource Zone at mdrt.org or purchase from mdrtstore.org.

2 Unique and Creative Uses of Modern Trusts Involving Investments and Insurance 401 income-producing assets, we can say that just 10 percent of the people own the United States of America. Within the United States, 66.3 percent of the population is below age 50. There are an estimated 77 million baby boomers who are or will be retiring at a rate of an estimated 10,000 per day. That s almost 4 million per year, so as you can see, the glass is half full for the estate planning industry. However, many of these families are worried that the beneficiaries of their trusts are going to lie on the beach and play golf all day with their money. This is now a major concern for many families. As Warren Buffet said, I want to give my kids just enough so that they would feel that they could do anything, but not so much that they would feel like doing nothing. The main point to remember is that due to modern trust structures available today, trusts are no longer vehicles that lawyers and banks create to keep what is rightfully the beneficiaries. The bad taste in a client s mouth based upon his or her experience with an older trust in an antiquated trust jurisdiction is now gone. What most clients lawyers do not know is if they are doing a trust in a jurisdiction where these modern trust, tax, and asset protection laws are available, i.e., South Dakota, Alaska, or Delaware, they do not have to technically be practicing there. They can draft the trust, integrate the South Dakota, Alaska, or Delaware law, and then get local lawyers in these jurisdictions to opine on the document at nominal fees. The last thing you want to do as an advisor is to make the lawyers think they are going to be removed from the equation, because they are a key part of the team. If you can sell them on these concepts and show them that you are a quarterback of these concepts and know whom to bring to the table to assist the lawyers, the lawyers might have other clients to work with you in the future. We have seen that happen a lot in the insurance and investment community. It is important to note that six popular desires are very important to clients doing trust planning. As you could guess, family governance/involvement, education, and succession is one of the top desires we see. In addition, these families want to retain some level of control and flexibility of their trust structures while also retaining control in their investment planning as well. They also desire to have their trusts promote social and fiscal responsibility, which can be accomplished through perpetual trusts with incentive provisions. Asset protection/wealth preservation is also a very popular desire we are seeing today. Finally, saving on estate taxes, generation-skipping transfer taxes, state income taxes, and premium taxes is a very popular goal and desire for families. Whom these families choose to serve as trustee is very interesting. A Family Office Exchange (FOX) study recently reported that 70 percent of wealthy families do not use corporate trustees, opting to use family members, business colleagues, or friends. The FOX study also noted that the biggest family trustee concerns are concentration of assets, business interests, and personal liability issues for the individual family trustee. Personal liability for family members serving individually as a trustee can result from improper asset allocation, lack of diversification, unacceptable due diligence and monitoring, environmental issues with real estate, and other distribution and/or investment issues. The directed trust, trust protector company/special purpose entity, and private family trust company (PFTC) are three of the modern trust structures which can combat these potential liability issues without inhibiting a family s flexibility and control. Directed Trust Families are becoming more sophisticated about wealth management, incorporating modern trust documents into their estate-planning goals and looking for ways to maximize the flexibility of their trust investments. Typically, a trustee s duties and flexibility regarding investment responsibilities vary depending upon whether a state has adopted the Prudent Investor Act (PIA), whether a trust is directed or delegated, the individual state statutes, the trust instrument itself, and whether the trustee is a nationally chartered bank or trust company subject to Office of the Comptroller of the Currency (OCC) regulations. Adopted in 1994, the PIA itself reflects a modern portfolio theory and total return approach to the exercise of fiduciary investment and discretion. Most states have embraced some form of the PIA that allows the trustee to acquire most types of investments. The PIA also measures investment performance based upon an assessment of the entire portfolio versus the asset-by-asset analysis required by its predecessor, Prudent Man Rule. Because the PIA mandates that a fiduciary exercise the care, skill, and caution to make and implement investment and management decisions as a prudent investor would, a trustee may even be required to delegate investment authority if the trustee is not sufficiently expert to perform that function for a particular trust. Even a fiduciary with investment skill may delegate certain investment functions. For example, a corporate

3 402 trustee lacking expertise in a specific investment area such as foreign securities or venture capital may properly delegate that particular responsibility. Unsurprisingly then, the adoption of PIA has meant that both directed and delegated trusts two very different concepts have gained in popularity. Pursuant to Section 185 of the Restatement (Second) of Trusts, a trustee is generally not liable for following the instructions of a person empowered by the trust instrument. Nonetheless, a trustee must ensure that following such instructions doesn t violate the trust agreement or a fiduciary duty owed to the beneficiaries of the trust. Section 185 provides only a superficial definition of directed and delegated trusts. A few states go further by having statutes that relieve trustees of liability vis-à-vis directed and delegated trusts. Generally, a delegated trust is one in which the trustee has contracted with a third party to perform some or all of the trustee s discretionary investment management functions with respect to the trust. The trustee of a delegated trust may have some duties regarding selection of the investment manager as well as some ongoing monitoring functions. In a directed trust, the trustee generally has no discretionary investment duties. A directed trustee generally has no other duty than to follow directions of the empowered person. The power to direct is initiated by and within the control of a third party as expressed in the trust instrument. Unlike the delegated trustee, the directed trustee typically does not have any selection or monitoring functions, except to ensure that the grantor s intent as expressed in the trust document is being followed. A directed trust is generally drafted so that a trustee s duties and discretion as to distributions and/or investments are removed by a provision in the trust agreement, and/or by state statute, and given to an investment committee/ trustee ( investment committee ) and distribution committee/trustee ( distribution committee ) as well as a trust advisor and/or trust protector. Each of these individuals or entities plays an important role in the functioning and administration of the modern trust in accordance with the trust instrument. The modern directed trust generally provides for an administrative trustee who acts in a directed capacity, that is to say, one who is not responsible for the trust s investment management but rather takes direction from an investment committee. The administrative trustee s duties may include taking title and ownership of the trust assets, establishing and maintaining a trust bank account, preparing or signing the trust tax returns, preparing and sending trust statements, and making distributions and receiving contributions. The administrative trustee also ensures that the trust document is followed. (For example, if the investment managers are investing in hedge funds and the trust document specifically prohibits that type of investing, the administrative trustee must report this failure, and if nothing is done to correct it, the administrative trustee may have no other choice but to resign.) Generally, investment provisions in the trust are fairly broad. Those individuals who make investment decisions for the trust comprise the investment committee, which typically is drawn from the grantor s family members, investment advisors, and consultants and/or managers. The investment committee directs the administrative trustee regarding investment management of the trust. Generally, after a grantor designates a family member or members to be on the investment committee, they in turn hire the appropriate investment professionals. Alternatively, a grantor may appoint in the trust instrument an investment professional to directly serve on the investment committee, but flexibility is generally lost in doing so. The investment committee also may direct and manage insurance, closely held stock, partnerships, limited liability corporations (LLCs), real estate, art, and other illiquid assets held by the trust. A grantor may select committee members based on their experience and expertise with a particular asset class. Because trustees also make distributions, a grantor may establish a distribution committee to determine when such discretionary distributions should be made. This committee can be composed of both family and independent members. It s important, though, to be cognizant of the need for filling the committee with independents for tax-sensitive distributions. The administrative trustee can fill this independent role and therefore is often appointed to this committee. Tax-sensitive distributions are typically discretionary distributions requiring a non-subservient person (that is to say, no family employees or family members and so on) to make the independent decision to make a distribution from the trust so that the trust remains out of the grantor s estate. The trust protector also is being used more and more with domestic trusts to supplement many directed trusts investment and distribution committees. Several states now have trust protector statutes, and advisors are drafting the trust protector function into trust documents even in states without specific statutes, which may be risky.

4 Unique and Creative Uses of Modern Trusts Involving Investments and Insurance 403 Trust protectors typically have the duty to: Modify or amend the trust instrument to achieve favorable tax status or respond to changes in the Internal Revenue Code, state law, or the rulings and regulations thereunder Increase or decrease the interests of any beneficiaries to the trust Modify the terms of any power of appointment granted by the trust (although a modification or amendment may not grant a beneficial interest to any individual or class of individuals not specifically provided for under the trust instrument) Remove and appoint a trustee, trust advisor, investment committee member, or distribution committee member Terminate the trust Veto or direct trust distributions Change situs or governing law of the trust or both Appoint a successor trust protector Interpret terms of the trust instrument at the request of the trustee Advise the trustee on matters concerning a beneficiary Amend or modify the trust instrument to take advantage of laws governing restraints on alienation, distribution of trust property, or the administration of the trust Special Purpose Entities/Trust Protector Companies Special purpose entities are also gaining in popularity; however, only a few states currently allow these types of entities. The trust protector company or the unregulated special purpose entity alternative is generally used in combination with the directed trust structure. A recent trend is to establish unregulated entities, such as a limited liability company, to place a liability umbrella over the heads of the individuals filling the roles of trust protector, investment committee, and/or distribution committee. It is very difficult, if not impossible, to acquire individual liability insurance coverage to serve as committee members and/or trust protector. However, some insurance companies will provide coverage to an entity established specifically for these purposes, thus protecting the trust protector and committee members. Such an entity would also provide legal continuity of its corporate existence by continuing without regard to any single individual s death, disability, or resignation. The entity typically has bylaws that allow members to be added or removed so that the entity can continue along with the trust. These entities have to be properly structured to avoid estate tax inclusion issues. Delaware, Nevada, and Wyoming also allow them on a case-by-case basis. These entities are generally exempt from regulated private trust company status and are typically special-purpose-type entities with limited defined duties. Reformation/Modification and Decanting Existing Trusts The ability to modify/reform the trust can generally be inserted into a trust document at its creation. Reformations/ modifications may also take place without language in the trust document if state law permits and there is a petition to court by trustee or majority of beneficiaries. Reformations and modifications are generally easiest when both the grantor and the beneficiaries are alive and all agree with the reformation/modification. Unborn beneficiaries can be represented pursuant to virtual representation statutes in some states. Some state statutes also permit a trustee or beneficiary to petition the court to modify or reform the administrative or dispositive terms of the trust. This can be done if circumstances that were not anticipated by the trustor have arisen and if the modification of the trust would substantially further the trust or the purpose for creating the trust. Additionally, the reformation can generally be accomplished in order to conform the terms due to a mistake of fact or law when the trustor s intent can be established. In order to achieve the trustor s tax objectives, the terms of a trust instrument may be construed or modified in a manner that will not violate the trustor s probable intention. Investment Flexibility Many states, such as New York, California, Massachusetts, Connecticut, New Jersey, Illinois, Washington, and Minnesota, are not directed trust states as Alaska, Delaware, Nevada, and South Dakota are, but are delegated trust states. Consequently, whether a family or an institutional trustee is involved, due diligence and ongoing monitoring of the trust assets are required in these delegated trust states. Many family member trustees are not in compliance and risk individual liability in the event of a future lawsuit by a beneficiary as a result of improper diversification, asset allocation, a bad investment, or a bad performance. Consequently, many people like to reform/modify or decant an existing delegated trust to a directed trust so that these issues do not exist. Additionally, a heavy concentration

5 404 in one asset or asset class is not generally an issue with a directed trust but can pose major issues for a delegated trust. Old Distribution Standards (i.e., 33 Percent Age 25, 33 Percent Age 30, and 33 Percent Age 35) Older trust distribution standards requiring principal distributions at various ages may no longer be desired. These old standards can be modified to a purely discretionary standard. The modern directed trusts have family members controlling most of the distributions from the trust for health, education, maintenance, and support. Consequently, amending the trust to a purely discretionary standard versus required principal distributions at various ages may be desirable. For instance, with the older distribution standards, once distributed, the principal is no longer asset protected and is subject to estate, GST, and income taxes. However, Alaska, Delaware, Nevada, and South Dakota have unique statutes that state that a discretionary interest in a trust is not a property right, thus providing the ultimate asset protection. Thus, reforming/modifying a trust to a purely discretionary standard could provide powerful asset protection and estate planning. Decanting Decanting is the process of appointing trust property in favor of another trust. Some trusts provide the trustees the power to decant in a trust document. A few states have also enacted extremely favorable decanting statutes. A trust generally permits trustees to pay trust principal over to one or more beneficiaries, which is called the power to invade the trust. If the trustee has any discretion over income or principal, some decanting statutes permit a trustee to pay property to another trust for a beneficiary or beneficiaries. One alternative to decanting is to reform and modify the trust in court, as previously discussed, and at the same time restate the trust utilizing the new state s law. The resulting restated trust would utilize South Dakota law for interpretation, construction, validity, and administration. This can be done on a case-by-case basis. Consequently, decanting does not require court involvement, whereas reformation/modification and restatement generally does. Sometimes court involvement is desired. Reformation and modification both result in keeping the original trust, whereas decanting results in the transfer of assets from an existing trust to a newly created trust. The process involves the appointment of a new trustee to an existing trust, and then the new trustee would decant (i.e., distribute trust assets) to the newly drafted trust. Private Family Trust Company Some families with a net worth of $200 million or more may consider establishing their own private family trust company (PFTC). As with the directed trust structure, the PFTC is a great way for family members to dramatically reduce their personal liability versus serving as trustees in an individual capacity. A PFTC is generally an LLC that qualifies under state law to be a trust company. It is owned and operated by the family and provides fiduciary and wealth management services to that family. Traditionally, families have chosen as their trustees family members, advisors, and/or corporate trustees. PFTCs allow families to involve their members, advisors, and institutions in similar trust functions/roles while serving the PFTC. A PFTC may be an interesting way for families to reduce their liability. In a PFTC, the family acts as trustee with an LLC/PFTC entity owned by the family with directors and officers insurance protection. Typically, a family member may not be able to obtain this type of insurance protection while serving individually. The typical modern private family trust company structure and procedure to establish will be discussed. Others Reasons to Establish a PFTC PFTCs, if properly regulated, are SEC exempt and provide many other advantages, some of which are listed below: Planning opportunities for deducting investment fees (in light of the Knight case, a decision by the US Supreme Court) The PFTC has generally provided for maximum deductibility of trust administration fees and expenses. Investment management fees that are integral to the trust have generally been deductible by charging an overall trustee fee that includes the investment management fee. The Knight Supreme Court case now requires that investment fees be separated out from the overall trustee fee and subject to the 2 percent adjusted gross income limitation. This requirement has been delayed by the IRS, and final clarification is expected on this matter. Many advisors claim that PFTCs will still provide ways to fully deduct the investment fees from the trust. Provide a resolution of successor trustee issues Provide convenience and accessibility

6 Unique and Creative Uses of Modern Trusts Involving Investments and Insurance 405 Efficient they control overhead and provide economies of scale Improved family governance with LLC/PFTC structure Enhanced ability to properly administer and operate illiquid family assets in trust (i.e., LLCs, FLPs, real estate, oil and gas, and so on) Allow for holding large concentrations of stock on any asset class and provide extensive flexibility with asset allocations Ability to establish SEC exempt business trusts and common trust funds as an alternative to collective investment vehicles/partnerships, which are generally required to register with the SEC and limited to 99 investors Privacy As ruled by IRS, if properly established, PFTCs not subject to estate tax inclusion (IRS Notice ) Allow for better informed trust distribution and investment decisions Enable families to efficiently work with their own family office and all outside product advisors (i.e., investment, insurance, and so on) Broad powers a PFTC is the only form a family office can take to provide fiduciary services directly to family members rather than just supporting the family s individual trustees or unaffiliated corporate fiduciaries. A South Dakota PFTC has all the powers of a South Dakota Money Lending Company and consequently all of South Dakota s great lending statutes. Dynasty Trust Since the turn of the twentieth century, many wealthy families have successfully left a legacy of wealth for future generations that, in several cases, continues today. Through the use of family trusts, now called dynasty trusts, these individuals are able to arrange their affairs so that their assets will not be ravaged by estate taxes as each generation passes away. Generally, the dynasty trust either distributes the income of the trust to the grantor s children during their lifetime or adds the income to the trust principal. The trust also generally provides discretion to distribute the trust principal for the health, education, maintenance, and support of the children. Upon the death of the children, any remaining principal of the trust becomes available for the grandchildren and other family descendants during their lifetimes. Consequently, the dynasty trust continues until all funds are distributed, there are no living descendants of the trust grantor, or the trust terminates by operation of state law. Most states and offshore trust venues limit the duration of a trust (typically, 80 to 110 years); however, many states are dynasty trust states with unlimited or long-term durations. These dynasty trusts are one of the most powerful estate planning tools available under current law and offer much more than family trusts used by estate planners in both the traditional and insurance trust contexts. This type of trust offers significant long-term flexibility and advantages to individuals throughout the United States who want to establish a truly perpetual, tax-favored source of income and capital for future generations of family members. These advantages are unique under the laws of certain states and are available to residents and nonresidents alike. A dynasty trust can be designed to be a third-party or a self-settled trust. A third-party trust is a trust created by a grantor for the benefit of others. (The grantor is not a beneficiary of the trust.) In a self-settled trust, the grantor can be a permissible discretionary beneficiary, which is only allowed in some states, such as South Dakota. As a result of the potential estate and GST tax issues associated with a self-settled dynasty trust, many advisors structure the dynasty trust as a third-party trust. However, depending upon the clients, they may need access to the trust in the event of an unforeseen hardship or may need to live off of the trust in the future; consequently, many advisors take a very conservative strategy in order to plan around this issue. Basically, this strategy involves utilizing an independent trust protector with the discretionary authority to add the grantor as a beneficiary. A trust protector is being utilized more and more with domestic trusts to supplement the investment and distribution committees of many directed trusts. For this strategy, the trust is generally established similarly to the self-settled trust; however, the grantor will not be a stated permissible beneficiary. Instead, the governing instrument will give the trust protector the discretionary authority to add beneficiaries from a class of individuals that would include the grantor. This class may be defined as something like X s [grantor s grandparent s] descendants. Many advisors suggest that this strategy may possibly accomplish a couple of things. First, the trust is designed/ structured as a third-party discretionary trust. By not having the grantor as a stated permissible beneficiary, some of the possible estate and GST tax issues with self-settled trusts may be alleviated. Second, with the trust protector having the discretionary authority to add a beneficiary from a class of individuals that includes the grantor, the grantor may be added as a beneficiary if the need should arise.

7 406 As previously mentioned, the dynasty trust is designed to permit the passage of significant wealth through multiple generations without the imposition of transfer taxes, even though the beneficiaries have the enjoyment of the property similar to that of outright ownership. For this reason, the trustee should be encouraged to acquire assets for the use of the beneficiaries rather than make distributions to them. Therefore, as previously discussed, the trust should allow the trustee to permit investing in not only financial assets and life insurance but also such assets as closely held stock, family limited partnership interests, artwork, real estate, jewelry, and other family heirlooms, such as vintage automobiles, as well as grantor-retained annuity trusts (GRAT) and charitable lead annuity trusts (CLAT) remainder interests. The level of growth and risk depends upon how the trust fits into the family s financial future. A properly structured, funded, and invested dynasty trust can be a powerful tool in achieving significant transfer tax savings across multiple generations. Insurance Planning The promissory note sale to a defective dynasty trust technique can be used both for life insurance and for other investments. Its use as a life insurance vehicle is invaluable to the life insurance agent who is often limited by the amount of life insurance that can be purchased gift and GST tax-free using a Crummey trust. The sale of discounted assets to a defective trust is an income-tax-free method of leveraging the gift and GST tax exemptions to move significant wealth down multiple generations. The trust should be drafted to last in perpetuity so that the beneficiaries save estate taxes and the assets are protected from the beneficiaries personal creditors, including spouses. Another popular funding option for the dynasty trust is private placement life insurance (PPLI). PPLI is a variable universal life insurance policy that provides cash value appreciation based on a segregated investment account and a life insurance benefit. It is designed to maximize savings and minimize the death benefit. Usually the investment account uses tax-inefficient hedge fund strategies. PPLI cash values may be directed by a client s chosen investment advisor, and the investment advisor may be substituted for another advisor in the future. Cash values accumulate income and capital gain tax-free and are also available tax-free using withdrawals of cost basis (total premiums paid) and very low cost loans. At the insured s death, the death benefit is payable tax-free; therefore, all investment gains, dividends, and interest are compounded without income tax. Assuming any reasonable lifetime investment return, the costs of the PPLI will be much less than the taxes that otherwise would have been paid. The PPLI cash values are as liquid as the underlying investments and allow in-kind distributions as well. The cash values are in a separate account and are not subject to the general creditors of the life insurance company. Competitive state premium taxes and modern domestic trust laws, as well as improved domestic regulatory costs and state consumer laws for insurance policies, have resulted in much larger life insurance contracts being issued onshore in South Dakota or Alaska versus the traditional route of offshore. Generally, state premium taxes are imposed on premiums paid for the life insurance by the state in which the applicant for the insurance policy is resident, domiciled, or sitused. The insured s resident state generally does not levy a premium tax on the premium paid for the life insurance policy purchased by a trust (either revocable or irrevocable) or an LLC in South Dakota or Alaska. South Dakota has the lowest state premium tax (i.e., 8/100ths of 1 percent, or 8 basis points) in the United States for premium payments in excess of $100,000. Alaska has the second lowest at 10 bpts. The majority of the other states average between 1.75 to 2.5 percent. Additionally, South Dakota has very favorable trust and insurance statutes. An important issue to consider regarding the state premium tax is the retaliatory tax. A retaliatory tax generally allows the state to whom the premium tax is paid to impose the premium tax of the state in which the insurance company is located if that rate is higher. South Dakota by statute does not allow for the opportunity to charge a retaliatory tax for a large case. It is also very important to verify that the domestic insurance companies recognize the low state premium taxes in South Dakota. Asset Protection Trusts generally provide excellent asset protection. As previously discussed, a self-settled trust is one of the more frequently used types of domestic asset protection trusts (DAPTs). It is generally a discretionary irrevocable trust where the grantor or settlor is a permissible beneficiary. If properly structured, creditors cannot reach the assets in a self-settled trust to satisfy certain creditor claims against the settlor. A self-settled trust can be drafted to either keep trust assets within the settlor s estate or remove them, which allows a wealthy individual to establish a self-settled trust even though that individual s gift tax exemption has been fully utilized.

8 Unique and Creative Uses of Modern Trusts Involving Investments and Insurance 407 Generally, the settlor would place 10 to 40 percent of financial assets into a DAPT to protect those assets from possible future creditors. The settlor is a permissible discretionary beneficiary of the DAPT but does not generally use the trust for everyday living expenses since doing so could weaken the asset protection. South Dakota was the first state in the United States with a discretionary support statute. According to many advisors, the Restatement (Third) of Trusts might have blurred the line, allowing for a fully discretionary trust to possibly be attached by a beneficiary s creditors as a property interest. South Dakota was the first state to codify the common law and Restatement (Second), which defines the types of interests a beneficiary has in a trust and therefore the rights of a beneficiary s creditors. Consequently, a discretionary interest in a trust is not a property interest in South Dakota. Additionally, limited powers of appointment and remainder interests are also not property interests. This can be advantageous from an asset protection standpoint. Alaska recently adopted a statute similar to South Dakota s, and Delaware, Nevada, and Wyoming have much more limited versions of this statute. This statute is very useful relative to asset protection planning of the trust beneficiaries. The location of trust property is an important consideration from an asset protection standpoint. Consequently, many individuals title assets located in other states to an LLC or LP in the DAPT state, which in turn is titled to the DAPT. Using the DAPT s state LLC/LP laws further ties the trust property to the jurisdiction of the self-settled trust, allowing for increased asset protection. The asset protection afforded by LLC and LP statutes varies by state. Some states, such as Alaska, Delaware, Nevada, and South Dakota, have sole remedy charging order as the exclusive remedy protection, which is generally considered the most desirable. A charging order only gives a creditor the rights of a partnership or LLC interest, and it does not give a creditor any voting rights. A charging order is simply a right to a distribution, if and when one is ever made, and it leaves a creditor without any means to force a distribution. This results in a waiting game between the client and the creditor, which usually forces the creditor to settle for significantly less than the original judgment amount. Many states have judicial foreclosure sale statutes, which allow a creditor to obtain a charging order but no voting rights. A creditor will then typically complain to the court that no distributions have been made from the partnership or LLC. As an additional remedy, the court may then order a judicial foreclosure sale of the limited partnership interest or LLC, which may or may not completely pay off the judgment debt. These statutes generally do not provide great asset protection. A DAPT in a state without a sole remedy charging order statute as the exclusive remedy drastically weakens the asset protection planning. Privacy is a high priority for clients and an important consideration for asset protection planning. Most states keep trust matters public with few exceptions. South Dakota has a comprehensive privacy statute for trust matters, i.e., total seal forever. Delaware will seal trust information for three years in select cases and then open it to the public. Some state statutes will award attorneys fees in a trust contest. The trust statutes of South Dakota and Delaware provide that a court may award attorneys fees and costs to any prevailing party. Consequently, the trustee can be reimbursed for attorneys fees if the plaintiff loses in South Dakota. Nevada is slightly different in that only if the petitioner wins may the court award attorneys fees. The Nevada statute appears to permit a court to award attorneys fees and costs only to a prevailing petitioner; thus, if the trust were sued by a beneficiary or a creditor and the trust prevailed, permissible attorneys fees under this section may not apply. In Alaska, if a trust is voided or set aside, the court may award attorneys fees (with reference to civil code award of attorneys fees). Thus, as is somewhat similar to Nevada, an Alaska court may award attorneys fees only if the petitioner wins and the trust is voided or set aside. This would presumably apply to a creditor. Please note that these apply to the trust statutes and not the states civil procedure. Purpose Trust Generally, a purpose trust is a trust that is created for a purpose rather than for a specific beneficiary. Traditionally, trusts need to have specific beneficiaries for whom the trust is established, for instance, for individual family members or a charity. In a purpose trust, the trust is established for something (purpose) rather than for someone (beneficiary). Purpose trusts may not be established in every state. Some states, such as Nevada and Alaska, only allow for pet trusts (trusts with the purpose to care for a pet) or honorary trusts (trusts with the purpose to care of a gravesite). South Dakota is one of a couple of states that allows purpose trusts to be established for any lawful purpose, not just for pets or honoraries. In determining where to establish a purpose trust, an important consideration is the trust duration allowed (i.e.,

9 408 how long the purpose trust may lawfully exist). Some states limit the duration of a trust, for instance, to a term of years or to the end of the life of the pet. Delaware and South Dakota are unique in that they allow for a perpetual purpose trust (i.e., the purpose trust has no restriction as to length of time it can be in existence). Thus, a Delaware and South Dakota purpose trust can last in perpetuity if desired. This means that grantors intent to provide trust funds for the specific purpose can be carried out for as a long as they desire. This can be an important consideration in establishing a purpose trust. International Families There is also a huge market in the United States international families. There can be a foreign trust in Alaska, Delaware, Nevada, or South Dakota with foreign clients holding offshore assets with no US tax consequence if properly structured. Many foreign families want to come to the United States because many of the offshore jurisdictions are blacklisted by their home countries, such as in the Bahamas and Bermuda. The offshore assets are never brought into the United States; they are simply titled into the onshore trust. The other side of the market is if you have individuals who came to the United States and are now green card holders and they have foreign parents or grandparents without a green card and no ties to the United States. The latter can gift as much as they want into a US trust without any limits or US gift, estate, or generation-skipping taxes that a US citizen would have. That creates a big insurance opportunity because insurance could be purchased by the trust on the US children/grandchildren, which allows for federal and state tax free withdrawals to the children and grandchildren who are here as well as leveraging trust assets via the death benefit. Conclusion If there is anything I hope you come away with, it is that the glass is really half full for families who want to take advantage of all that trusts have to offer but who are not looking to relinquish flexibility and control when it comes to their trust investments/insurance. Whether it be through directed trusts, special purpose entities/trust protector companies, private family trust companies, and/or all of the above, these modern and unique trust structures allow families to remain in the driver s seat if desired. Additionally, we ve seen today that existing, out-of-date trusts can be modernized by reformation/modification or decanting. We have seen how grantors are using purpose trusts to care for something versus someone in perpetuity and how modern trust law has international families now looking to the United States for trust situs.