What is a Trust Protector?
Earlier this month, we posted a blog about trust decanting and how it is a way to update an irrevocable trust if the original trust’s terms become outdated.
That being said, trust decanting isn’t the only way to update a trust or put safeguards in place to ensure you can.
Two other methods to explore are trust protectors and asset substitution powers.
What Is a Trust Protector?
A trust protector is an independent third party who is given specific powers to modify a trust after it’s been established.
Unlike trustees who manage the day-to-day admin of trust assets, trust protectors only step in if strategic decisions need to be made to keep the trust aligned with your family’s needs.
The role was made to get around the inflexible nature of irrevocable trusts. So, trust protectors allow for adjustments as long as they don’t compromise the trust’s fundamental tax and asset protection benefits.
Trust protectors can usually:
Remove or replace trustees
Modify distribution standards
Add or remove beneficiaries
Change trust situs (the state where the trust is governed)
Terminate the trust (under certain circumstances)
Substitute trust assets with assets of equivalent value
Who Needs a Trust Protector?
Anyone can name a trust protector, but they’re especially worth considering if you belong to a high net worth or complex family, are a business owner, or in a family with multi-generational planning goals.
High-Net-Worth Families
If your trust holds millions of dollars and will benefit multiple generations, the ability to adapt it is important. You might not expect circumstances to change, but tax laws are updated constantly, family dynamics can shift, beneficiary needs will probably change, and new investment opportunities can emerge. Having a trust protector helps ensure your trust can evolve too, oftentimes without needing a court proceeding.
Business Owners
If your trust holds business interests or real estate, a trust protector can help navigate changing business conditions, succession planning needs, or opportunities to optimize the trust’s holdings through asset substitution.
International Families
Just as U.S. tax law is ever changing, other countries also regularly update theirs. So, if your family has assets or beneficiaries in multiple countries, having a trust protector makes sure you can adapt your trust structures to stay tax-efficient.
Long-Term Trusts
Circumstances might not change much in the short term, but for families with dynasty trusts or generation-skipping trusts meant to last generations, having the ability to update yours is even more important.
Who Can Be a Trust Protector?
Technically speaking, anyone can be a trust protector. The right one for your family will depend on a few things, like their expertise and alignment with your family’s values.
Professional Trust Protectors
Many families choose professional trust companies, attorneys, or trust protector firms thanks to their expertise in trust law and tax planning. They are objective and less likely to be influenced by family dynamics or personal relationships.
Family Members
Some families make a family member their trust protector, especially if they have financial or legal expertise. However, this can be risky since you can’t be certain that no conflicts of interest will arise, or that they will be able to handle the emotional burden of making difficult decisions affecting family members.
Committee Structure
For complex situations, appointing a committee of trust protectors can help guarantee balanced decision-making. Your committee could be made up of a professional advisor, a family member, and an independent third party, with decisions requiring unanimous consent.
Most trusts include provisions for successor trust protectors. This ensures continuity if the original protector becomes unable or unwilling to serve.
No matter who you choose, your ideal trust protector should be competent, objective, and have no conflicts of interest.
How else Can I Modify a Trust?
Trust protectors are one option to make sure your family can update its irrevocable trust as time goes on. Swap powers are another way through which you can modify a trust.
However, rather than updating the trust’s terms or structures, swap powers allow certain parties to substitute trust assets with other assets of equivalent value.
This seems simple but provides flexibility and opens the door to a number of strategies for tax planning and investment management.
How do Swap Powers Work?
Swap powers let you exchange assets held in your trust with other assets of equivalent fair market value.
The grantor (the person who established the trust) or another designated party can be the one with swap powers.
Why would this be useful? Let’s say your trust holds $1M in low-basis stock. You could substitute $1M in cash, effectively moving the low-basis stock back to your personal ownership.
How do Swap Powers benefit my Tax Planning?
By substituting high-income-producing assets for low-income assets, you can shift income between the trust and your personal holdings.
You can also substitute appreciating assets for non-appreciating assets, controlling which will grow in the trust versus in your personal estate.
How do Swap Powers benefit my Investment Management?
Swap powers can allow for portfolio optimization without tax consequences. If market conditions change or new investment opportunities arise, assets can be efficiently moved in and out of the trust.
If you want to grant someone swap powers, your trust must specifically outline them with clear rules and limitations.
While swap powers generally don’t trigger income tax consequences, they can have estate and gift tax implications.
As is the case with trust decanting, both trust protectors and swap powers require careful planning and implementation to make sure you’re achieving your desired results and avoiding tax or legal consequences.
As tax laws, family circumstances, and planning opportunities continue to change, these mechanisms can give you peace of mind that your trust can adapt and continue to serve your family’s needs.
For families with sophisticated planning needs, the question isn’t whether you need flexibility in your trust structures, but rather how to build flexibility proactively.
As always, we recommend working with a tax professional who understands both tax strategies and wealth management.
Author: Rob Cucchiaro, CFP, CRPC, AAMS
Questions answered in this blog:
Is trust decanting the only way to modify an irrevocable trust?
What are other ways I can edit an irrevocable trust?
What are trust protectors?
What are common powers of a trust protector?
Who needs a trust protector?
Who should my trust protector be?
What happens if my trust protector dies?
What happens if my trust protector no longer wants to be the trust protector?
What are swap powers?
How do swap powers work?
What is the purpose of swap powers?
How do swap powers benefit my tax planning?
How do swap powers benefit my investment management?
This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.