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Does your trust need protection?

A trust protector may be the answer

Designing an estate plan can be a delicate balancing act. On the one hand, you want to preserve as much wealth as possible for your family by protecting it from estate taxes and creditors' claims. On the other hand, you want to have some control over your assets during your life.

Unfortunately, these two goals often conflict with each other. Generally, the most effective way to remove wealth from your taxable estate and shield it from creditors is to place it in one or more irrevocable trusts. But, as the name suggests, an irrevocable trust requires you to relinquish control over the trust assets. One potential solution to this problem is to appoint a trust protector.

What is a trust protector?

A trust protector is often compared to a member of a corporation's board of directors. A trustee manages the trust's day-to-day affairs while the trust protector serves in an oversight capacity to prevent trustee mismanagement and to participate in certain major decisions.

A trust protector's specific powers are set forth in the trust document. They may include the power to:

• Add, remove or replace a trustee,
• Appoint a successor trustee or successor trust protector,
• Add, change or eliminate beneficiaries' interests,
• Amend the trust or redirect distributions to comply with new laws or reflect
  beneficiari-changing circumstances,
• Change the trust's governing law or jurisdiction
• Consent to the exercise of a power of appointment,
• Direct, consent to or veto investment decisions
• Interpret ambiguous terms in the trust agreement,
• Resolve deadlocks between co-trustees, and
• Terminate the trust.

One advantage of using a trust protector is that you can confer powers on the protector that you wouldn't be able to hold yourself without exposing your assets to creditors or triggering gift or estate taxes.

Bear in mind that a trust protector should be distinguished from a trust advisor, who is available to advise the trustee but has no power to make binding decisions on trust matters.

What are the benefits?

Trust protectors offer two primary benefits:

1. They provide a check against mismanagement, fraud or abuse by the trustee. A trust protector might have the power to remove or replace the trustee, or veto certain decisions, if the trustee isn't acting in the beneficiaries' best interests.

2. They allow you to build some flexibility into an otherwise rigid estate planning tool. Many people are reluctant to transfer assets to an irrevocable trust for fear that changing tax laws or changing circumstances years or even decades later may affect the trust's ability to achieve their original goals. At the same time, they may be hesitant to provide the trustee with too much discretionary authority over the trust. A trust protector can step in when circumstances change and modify the trust or take other actions to ensure that the trust continues to accomplish your estate planning objectives.

For example, suppose you establish a trust for the benefit of your 5-year-old daughter. The trust agreement provides for the assets to be distributed when she turns 25. At 19, however, she demonstrates maturity and financial discipline beyond her years and could really use the money to help pay her college expenses. A trust protector could modify the trust to allow earlier distributions. On the other hand, if your daughter turns out to be a spendthrift, the trust protector could modify the trust to delay her receipt of the funds.

Or, what if your main purpose in establishing a trust is to reduce or eliminate estate taxes and, ten years from now, Congress permanently repeals the estate tax or doubles the exemption so that your estate is no longer exposed to the tax? You could give your trust protector the power to terminate the trust under those circumstances and return the funds to you.

Which powers should your trust protector have?

There's no one right answer to this question. It depends on the nature of your estate plan, your family's situation, the capabilities of the trustee and your specific estate planning objectives. But in most cases, it's advisable to limit the trust protector's authority to relatively narrow circumstances.

For one thing, if the trust protector's power over day-to-day management of the trust is too broad, he or she will effectively serve as a co-trustee. Then the question becomes "Who will protect your trust from the protector?"

Is a trust protector a fiduciary? Another issue is whether the trust protector is considered a fiduciary. Fiduciaries are held to a higher standard of care than nonfiduciaries and, therefore, may be exposed to liability if a court determines that they failed to act in the best interests of the trust and its beneficiaries.

There's some uncertainty about whether a trust protector is a fiduciary. In some states, for example, a trust protector is presumed to be a fiduciary unless the trust agreement specifies otherwise. But many states' laws are silent on the issue. Arguably, the broader a trust protector's powers, the more difficult it will be to argue that he or she is not a fiduciary.

Trust protectors may be more valuable if they're not considered fiduciaries. There are two reasons for this: First, without fear of liability, a nonfiduciary is free to make major decisions without the added expense and delay of seeking court approval. Second, it's easier to attract qualified trust protectors if liability isn't a big concern.

However, keep in mind that, unless your state's law specifically addresses the role of trust protector, there may be some uncertainty over a trust protector's legal obligations. Some commentators argue that a trust protector should be considered a fiduciary regardless of the language of the trust agreement or the extent of his or her authority. A fiduciary can be defined as someone in whom another has placed the utmost trust and confidence to manage and protect property or money. A trust protector seems to fit that description.

Handle with care

Appointing a trust protector can be a powerful tool for building flexibility into an irrevocable trust and adding an extra layer of protection for your hard-earned wealth. If you decide to use this strategy, be sure to discuss it thoroughly with your tax and legal advisors: Trust protector provisions must be drafted with care to ensure that they comply with applicable state law and are consistent with your estate planning objectives.
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