While most potential clients understand the purpose of wills, even sophisticated clients have difficulty understanding the manner in which trusts work and the benefits they can provide. Trusts are a fundamental estate planning tool. While they can be used in a straightforward manner, they also offer the flexibility to provide solutions for unique and sometimes difficult situations.

In simple terms, a trust is an arrangement in which a grantor transfers property to a trust and the trustee holds and administers that property for the benefit of the beneficiaries of the trust.  The trustee acts as a fiduciary to those beneficiaries, owing them duties and responsibilities imposed by law and the governing trust document.

Multiple Uses of Trusts

Many clients think of trusts primarily as a tax savings vehicle. Over the past decades, trusts were widely used as an arrangement to minimize the federal estate tax. Two factors have reduced the need for these types of trusts. First, spouses now possess the ability to share their credit against the estate tax (portability of the credit), with the surviving spouse using any of the first-to-die spouse's unused exclusion against the estate tax. Second, the amount of a person's estate excluded from federal estate tax has jumped from $650,000 to $11,400 over the last 20 years. These two factors now allow a married couple to protect up to $22.8 million from the estate tax without requiring the use of a trust. While there are many reasons that such a trust would still be appropriate, including future changes to the law and exclusion amount, the generation skipping tax, and for assets with the potential for a high rate of appreciation, the federal estate tax is not currently a primary concern for most individuals.

Another use of trusts is to remove assets from an individual's estate during their lifetime. By gifting assets to a properly structured trust for the benefit of one's children, for example, the grantor avoids federal estate tax and state inheritance taxes on the gifted assets. These trusts still play an important role in estate planning. Further, since the current estate tax exclusion is equivalent to and unified with the gift tax exclusion, these trusts also allow high net worth individuals to lock in the current high exclusion amount by removing assets from their estate today.

Trusts also can be used to for asset protection purposes, charitable purposes, to allow qualification for government benefits (special needs trusts) and to hold assets for the benefit of multiple beneficiaries or multiple generations. The remainder of this article, however, focuses on the way in which trusts allow clients to exercise control of their assets even after they are given away. These strategies can be beneficial to clients regardless of their financial and tax situation, by setting up rules restricting a beneficiary's access to the trust's assets.

Protection for the Next Generation

There are almost endless options regarding the level of control that clients can choose to exercise over gifts made to their family members. While a beneficiary might view restrictions in a trust as an unwelcome attempt to control them, a parent will view the same restriction as protecting beneficiaries from themselves.

A descendants' trust included in a will, referred to as a testamentary trust, is a common way that parents seek to balance support of their children with continued exercise of control over the inherited assets. Life insurance and other assets can be directed into the trust at the parents' death. Faced with the contingency that they might not be around to raise their children, most parents prefer to limit their children's access to trust assets and choose a trusted family member, adviser or institution to manage the trust as trustee. These trusts generally either mandate or provide discretion for a trustee to make distributions to help educate and support the child into at least early adulthood, assuming there are sufficient assets to do so.  The trusts often allow children full access to the funds when they are at an age the parents predict they will be sufficiently mature to handle the assets, but some families prefer that assets be subject to the trust for a child's lifetime. These trusts may allow the child to act as a trustee or co-trustee at some point, to provide experience with managing the trust assets while still remaining subject to limitations on how they can be used.

Such descendants' trusts are not limited to minor children and are not limited to gifts at the time of death. Individuals set up trusts for their children and grandchildren for various reasons: to guard against a potential bad choice of spouse; to address creditor issues; and to prevent mismanagement of finances. Of late, a particular concern is the best way to handle gifts to those family members who are dependent on or abusing drugs or alcohol.

One cannot avoid the news that the Philadelphia area and much of the country are confronting widespread abuse of opioids. Putting aside the political, law enforcement and health care response and strategies to deal with this crisis, it also presents a difficult dilemma for parents and grandparents who have a loved one who is suffering from opioid addiction or some other type of addiction that reduces their likelihood of acting responsibly. There is a definitive uptick in conversations about this issue, usually with parents and grandparents, who are struggling with how to provide for loved ones with substance abuse issues. While some individuals are reticent to discuss the issue with their attorney, it appears that the widespread news about the epidemic is driving more clients to actively address the issue in their estate plans rather than hoping for the best.

Individuals often feel trapped in this situation. They want to provide support for the family member, but are concerned that a gift of money will either be wasted or used in a way that contributes to the addictive behavior. Some may decide to disinherit the child, leaving money to their other children and hoping that the other children will work something out to help their sibling. This obviously places those other children in a tough position.

A trust can help address this dilemma. This type of special-purpose trust, however, must be carefully designed to achieve its purpose. In some ways, it is similar to any trust established for a child. In almost every trust established for a descendant, the grantor wants to protect the child from his or her own mistakes and from others taking advantage of the child. The difference with a trust for the benefit of a known substance abuser is that the trustee of this special-purpose trust must be given a mixture of discretion and direction. The choice of trustee, while always important, is critical for these trusts.

One feature of these trusts is to authorize the trustee to receive medical information regarding the beneficiary who is abusing or dependent upon drugs or alcohol. Since the beneficiary will be required to provide authorization for the trustee to receive such information, the ability to receive distributions is sharply limited if such authorization is not provided. These trusts usually include a distribution plan applicable while the beneficiary is using or abusing substances and a more liberal distribution plan after the beneficiary is in recovery. Prior to entering a recovery program and in the initial stages of a recovery program, perhaps as long as two years, distributions on behalf of such a beneficiary may be limited to those that support recovery. The term “recovery” needs to be well-defined in the trust, providing for testing to monitor compliance and at least a certain time period of substance free living. During this period, the trustee might be directed to apply funds on behalf of the beneficiary rather than distributing assets directly to the beneficiary.

Another useful feature of such a trust may be to allow for distributions to the beneficiary's spouse or children if the trustee determines that distributions should not be made directly to the beneficiary. Clearly, this power needs to be weighed against the beneficiary's choice or potential choice of spouse.

The trustee also may be provided with the power to hire professionals to evaluate the beneficiary, even after he or she has not used or abused substances for years. This allows the trustee to continue to monitor the beneficiary and, if appropriate, alter the manner in which distributions are made.

Summary

When establishing a trust, there is always a tension between providing enough funds to help support the beneficiary and encouraging the beneficiary to establish their own path. With a beneficiary who is dependent on or addicted to drugs and alcohol, these issues become even more difficult. A properly drafted trust can provide a degree of comfort that assets will be used to help such beneficiaries as they struggle with these health issues.

Joseph N. Frabizzio is of counsel at Robson & Robson. He holds an LL.M. in taxation and helps clients minimize their federal and state tax obligations associated with business transactions. He also assists clients with complex trusts and estates issues and business and succession planning. Frabizzio can be reached at 610-825-3009 or [email protected].