Estate planning today often encompasses a series of goals, ranging from tax planning to asset management and asset control strategies. Many ultra-high-net-worth families seek asset or divorce protection planning, multigenerational planning, privacy, asset control and flexibility, and income and estate tax savings. Flexibility and control are more and more the centerpiece of estate planning objectives. Fortunately, many states have changed their laws to adapt to today’s changing estate planning landscape. The use of directed trusts within certain state jurisdictions is fast becoming a planning solution that gives ultra-high-net-worth families the control and flexibility they seek.
What Is a Directed Trust?
To understand a directed trust, it is helpful to know how it differs from other trusts. With most trusts, the trustee controls all aspects of the trust, including the investment management of trust assets and distribution decision-making to the trust’s beneficiaries.
A directed trust can be structured differently. It allows you to remove one or more powers from the trustee’s control—such as investment authority and/or distribution authority—and give such authority to a designated individual instead, sometimes called a “trust advisor” or “trust director.”
Who Is Involved?
In a directed trust agreement, an investment direction advisor is usually named to control the investment management of trust assets. The investment direction advisor could be the grantor—the creator of the trust—or someone else known to the grantor. A directed trust can also name a distribution direction advisor who makes distribution decisions, following the language in the trust agreement. The distribution direction advisor cannot be the grantor or anyone who will benefit from the trust but could be someone in whom the grantor has confidence. This separation of trustee duties can make directed trusts so appealing.
A Look at Favorable Jurisdictions
While increasingly popular, directed trusts are not new. Delaware adopted the practice of using directed trusts in the early 1900s and modified their usage in the mid-1980s. Directed trust law was designed to accommodate the wealthiest families, and, over the past 40 years, more states have changed their laws to attract more trust business. Currently, 17 states have adopted the Uniform Directed Trust Act, and a few states, including Delaware, South Dakota, Nevada, Alaska and New Hampshire, have the most flexible and favorable trust laws for ultra-high-net-worth families. But if your client is interested in leveraging a directed trust and lives outside one of these states, there is no need for them to pack their bags. Neither you, your client, nor their assets have to be based in a certain state to take advantage of its estate planning benefits. Only the trustee has to be located in the state to take advantage of its trust laws.
These favorable state jurisdictions can offer other planning benefits:
- Significant benefits for dynasty planning and asset protection planning;
- Enhanced privacy;
- Capabilities to modify existing trusts; and
- Absence of state tax on trust income and capital gains.
The Power of the Protector
For another layer of control, flexibility, and security, you can use a trust protector—a designated individual who can help ensure the grantor’s intentions are carried out. The grantor chooses the individual for the role and spells out their powers in the trust agreement.
A trust protector can potentially:
- Remove and appoint the trustee or successor trustee;
- Change the legal situs and governing law of the trust, which may be useful if the legal situs and governing law in a different state is advantageous to the trust beneficiaries (e.g., a change of situs to a state with no trust income taxes);
- Terminate the trust (i.e., if the trust is small and not economical to continue);
- Amend and modify the trust agreement;
- Determine distributions from the trust; or
- Name a successor trust protector or co-trust protector.
Remember that a trust protector is not a trustee but a powerholder named in the trust agreement. A trust protector can be a family member who is not a trust beneficiary.
Establishing a Directed Trust
Establishing a trust is rarely a one-size-fits-all process. By dividing up responsibilities, creating flexibility, and using a favorable jurisdiction, a directed trust can be a valuable tool for you and your family when crafting an estate plan. Consider consulting with an estate planning attorney to learn how directed trusts and estate planning strategies can protect your wealth for future generations.
Chris Smith is Head of Trust Services at Morgan Stanley Wealth Management.
