A Matter of Trust - and Trustee
Your Trustee's Identity and Location May Make a Big Difference
By Jonathan Bell
There are many good reasons - tax and non-tax - why you might create one or more trusts as part of your estate plan. The foremost reason may be estate tax savings, but you may have non-tax reasons such as ensuring that assets pass to certain children, or to protect family members incapable of managing their financial affairs.
It follows that once you have decided that your estate plan should include a trust, it will be necessary to identify a trustee. You may have seen newspaper articles regarding the possible benefits of using a trustee in a particular jurisdiction, rather than simply appointing a bank, trust company or individual in your home state. This column is intended to help cut through some of the confusion surrounding this question and get down to what really will matter to your particular situation.
First, reaffirm precisely why you are setting up the trust in the first place. Tax savings for example, In estates of significant size (a couple owning, say, more than $2 million in total assets, including residential real estate), the estate plan is highly likely to include a "bypass" trust - allowing assets to be available to a surviving spouse but not considered part of his or her taxable estate on his or her death. The idea: to bypass the surviving spouse and avoid wasting the estate tax exemption of the first of the couple to die, through "over-qualification" of assets for the marital deduction and unnecessarily increasing the size of the survivor's estate.
Among non-tax reasons, trusts are also often part of estate plans in second marriages where couples want to be sure that, after the surviving spouse's death, the assets of the first spouse to die will pass to his or her own children - not to the children of the survivor. And for centuries trusts have been used to protect family members, either because the intended beneficiary is unable to manage his or her own affairs due to age or disability, or because (though fully competent in other respects) he or she simply cannot handle money - needing, in other words, a "spendthrift trust."
The Trustee's Role
So, unless your trust is drafted with highly inflexible provisions regarding investments and the use of the trust assets (both of which I would strongly advise against), who your trustee is may matter a great deal. The trustee will probably determine what assets to buy and sell and how much will be distributed to beneficiaries over a long period, and she or he will be important to the eventual success of your trust plan. Of course, you can never be certain of success, but creating even more uncertainty by reaching out beyond people and institutions you know well doesn't sound like a particularly good bet to me.
Still, some people will argue - and with some merit -that there can be benefits in looking beyond your local bank, your lawyer or a nearby family member to find your trustee. The income tax treatment of your trust, how long it can last and how vulnerable it may be to creditors' claims may all be affected by where the trustee is located.
The most significant benefit of using a trustee outside your own state can be obtaining more favorable income tax treatment of the income and capital gains that are retained in the trust and not distributed to beneficiaries. If income and gains are going to be accumulated in the
trust for some time (perhaps for a young child until he or she goes to college or marries, or in another situation where the beneficiary just doesn't need the trust assets at all for a while, if ever) the benefits may be substantial if the trust can be created in or moved to a state with no state income taxation on the undistributed income and gains, such as Alaska, Florida or South Dakota.
The Benefits Next Door
It may surprise you, however, to know that many other states, including some considered "high-tax" states for residents such as New York and Massachusetts, will also forego charging income taxes on accumulations in trusts created in those states by non-residents. So it makes good sense to talk to your estate planning attorney about the state income taxation of your trust, based on the identity and location of the trustee. It may be possible to obtain the same results in a nearby state.
There are supposedly other benefits available to trusts created in certain jurisdictions. Some states have been extending the period that a trust can remain in existence without the assets again having to become the property of one or more individuals. This has been done by dramatically extending or even eliminating the so-called "rule against perpetuities" so that "dynasty trusts" can be created to last virtually forever. Call me a contrarian, but I think it is far too soon to tell whether this trend is a particularly beneficial one for most people planning their estates.
So-called "asset protection" trusts are another visible development differentiating one state from another. A growing number of jurisdictions are trying to attract trust accounts to local banks and trust companies by passing legislation intended to deny creditors access to funds held for the benefit of the creators of those very same trust accounts for their own benefit.
Protective Device?
Offshore trusts created for similar purposes on certain Caribbean and Pacific islands have been used for some time by very wealthy Americans who were worried about creditors' claims. How successful these offshore vehicles have been is difficult to determine, and the benefits of choosing a particular U.S. state on the basis of its asset- protection laws are completely untested, because the statutes are so new.
But in the final analysis, asset protection trusts are really only an extended form of spendthrift trusts, which are time-tested and work very well virtually everywhere when it comes to protecting beneficiaries other than the trust grantors themselves. As a result, unless you are creating the trust to benefit yourself during your lifetime, rather than your family members after you are gone, asset protection is not a particularly relevant issue in your estate planning.
Bottom line: In choosing a trustee, look primarily at what the trustee is going to be doing for you and your family, next at possible income tax savings from going out of state, and only incidentally at any other benefits you might be offered.
Jonathan R. Bell is a partner at Duane Morris LLP. He is a Fellow of the American College of Trust and Estate Counsel.
A graduate of Yale College and Harvard Law School, Bell has been practicing as an estate planner for more than 30 years. You may reach him at
jrbell@duanemorris.com
.
As printed in Longevity Alliance's Newsletter: Momentum, August 2006