Designing The Trust To Maximize Results

Once it has been decided that a Beneficiary Controlled Trust should be used, the design of the trust to achieve and maximize the desired results becomes important.

In its simplest structure, the trust could be designed whereby the beneficiary would be the sole trustee and have the right to any or all of the income, plus access to principal limited to health, education, support and maintenance, plus a broad special power of appointment during life and/or at death to anyone other than the beneficiary, his creditors, his estate or the creditors of his estate.

However, in most instances this trust variation is not recommended because greater flexibility, tax benefits and creditor protection can be obtained using a discretionary Beneficiary Controlled Trust with multiple trustees.

By using friendly, independent trustees (or special trustees who could act under appropriate circumstances), certain powers can be woven into the trust agreement that could not exist if there were no independent trustees. This is so because powers that are rather innocuous in the hands of an independent trustee would cause tax and creditor problems if lodged in the hands of a beneficiary/trustee.

Use of an independent co-trustee generally is acceptable when one realizes that the grantor may have broad removal and replacement powers as long as the replacement trustee is not a “related or subordinate party” as defined in IRC 672(c). Alternatively, such power may be lodged in the hands of the beneficiary.

The basic philosophy of this article is that a transfer of property in trust improves the value of the property to the trust beneficiaries. The corollary of that thesis is that distributions from the trust, in the absence of a compelling reason to make distributions, such as onerous income tax consequences, should be avoided. The consequence of making distributions would be to move wealth from a tax and creditor protected environment into one that is exposed.

Because of the dynastic nature of the trust, the adverse effect of such leakage would be magnified greatly. It is anticipated that the investment pattern would be designed to enable the trust to realize and optimize the grantors goal to avoid transfer taxes and provide creditor exposure for multiple generations.

A broad special power of appointment is often given to the primary beneficiary of a trust, particularly if it is a Beneficiary Controlled Trust. A power of appointment is a desirable ingredient in most trusts because it adds flexibility and permits the trust to be modified in order to deal with changes in the law or family circumstances. Its importance increases when the trust is dynastic because there is a greater possibility of change in family circumstances or tax laws. For many clients, the power of appointment is, and should be, an essential ingredient of the plan. They may not be inclined to proceed with their planning in its absence because of a concern of interference by a complaining beneficiary.

The use of a special power of appointment enhances the objective of using a Beneficiary Controlled Trust in that it provides added control in the hands of the primary beneficiary. For example, by giving the trustee broad latitude in investing, including high risk/reward opportunities, it can be anticipated that some transactions will fail. If there were no trust, there would be no accountability to more remote descendants. By coupling the power of appointment with broad discretionary powers in the hands of the trustee/beneficiary, the result would be that the trustee/beneficiary would have the functional equivalent of no accountability with respect to the trust.

If the creator of the trust desires to provide the beneficiary with rights that are as close to outright ownership as possible, the power holder can be given the power to appoint the property in favor of anyone, in trust or outright, other than himself, his estate, his creditors or the creditors of his estate without causing estate inclusion.

A concern often voiced by dynasty trust candidates and some of their advisors is that they dont want to be irrevocably locked into a trust arrangement forever. A power of appointment that can be exercised by making outright distributions, thus terminating the trust, easily can finesse that perceived problem.

–Dan Munroe and Steve Oshins


Reproduced from National Underwriter Life & Health/Financial Services Edition, November 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.