The best estate-planning tool you've never heard of

March 5, 2001

The "trust protector," a relatively new concept, may be the key to helping your heirs avoid losses, fights, and other misery.

The "trust protector," a relatively new concept, may be the key to helping your heirs avoid losses, fights, and other misery.

You don't want to experience what these doctors went through:

  • "When I was 10," recalls a Midwestern surgeon, "my father died suddenly, and my uncle became the trustee of his estate. He managed the investments badly, and their value dropped about 30 percent." "My brother Paul and I were co-trustees for my irresponsible brother Bob," says a Nebraska FP. "Soon Paul began promising Bob we'd hand out more money from the trust if Bob would invest in Paul's real estate partnerships. It took a terrible family fight before Paul finally let my sister take over for him."

  • "A trust officer admitted that his bank was so worried about losing principal in trust accounts that they kept most of the money in their own CDs," remembers a Missouri ophthalmologist. "They were happy if the trusts grew 2 to 4 percent a year. And most families never complained."

  • "I've seen a doctor's family greatly hurt by a badly mismanaged trust," says Gideon Rothschild, an estate planning attorney in New York City. The trust was established by the doctor's grandmother at a bank's overly conservative trust department. The bank was a lousy investor, and the money saw no growth for years—a great misfortune but alas, no crime. "The beneficiaries had no way to discharge the trustee, since the bank wasn't mishandling the trust," says Rothschild. "Short of legal wrongdoing, it can be very difficult to remove a trustee, and it often requires a long court procedure."

In all of these situations, a trust protector could have helped. That's a specially appointed individual who can watch over a trust and, if necessary, replace a trustee or make other changes. The concept has long been needed, say many experts, but it's so new that little law exists on it. Moreover, the term "protector" can mean different things to different people. In fact, many estate-planning attorneys aren't even familiar with the idea. So you may need to check out the details yourself, before deciding whether to call an attorney about adding a protector to your plans.

A trust protector who can come in as a white knight, or at least a mediator, may offer a valuable fail-safe mechanism. "You'd have someone in place who could resolve disputes readily, without the pain of long fights—or the agony of legal fees," says attorney Stephan R. Leimberg of Bryn Mawr, PA. "Some families may have a natural diplomat who's the obvious choice; in other cases, you might prefer someone who's not even related to you. Every situation is different, but filling that position can provide some real breathing space."

Simply considering the idea of a trust protector may stimulate some worthwhile thinking about who your trustees should be, how their power should be defined and limited, and other aspects of your estate plan. Let's take a closer look.

Where did the protector idea come from—and why is it catching on now?

In a way, it came from beyond the sea: People who transfer assets to overseas trusts for protection must give up control to an overseas trustee—and they're often concerned that they may later want to have those assets moved elsewhere. "In that setting, it's common to provide for a protector, a third party who can have certain kinds of authority over a trustee," says Rothschild. But why has this idea come ashore now?

First, because of changes in domestic law. "Formerly, trusts couldn't legally last much longer than a generation," notes attorney Mark B. Edwards of Mooresville, NC. "So you'd typically set one up for children who'd receive all the principal by age 35 or so. That's not such a long time frame to plan for." But now some state laws are changing, allowing trusts to be perpetual.

At the same time, bank trust departments—which once did seem perpetual—now appear much less so. "Your friendly neighborhood bank may be bought by an international conglomerate, and its management and policies could be overhauled with no warning," says Norristown, PA, attorney David J. Schiller.

Another reason for the increasing popularity of trust protectors: "People sue more today," notes Schiller. "The person you want as trustee may be leery of the fiduciary responsibility—which can be substantial—and you might be reluctant to ask that individual to accept it. But if you provide for the role of protector, you can have someone overseeing a trust whose liability is either limited or nonexistent. The best way, then, to involve the friend, relative, or adviser whom you really want might be to appoint that person as the trust protector."

What kind of role does a protector really play?

The protector's primary purpose is to exercise limited authority over a trustee, only when required. For example, sometimes a trustee should be replaced—maybe a trust department becomes hard to deal with, or a personal conflict arises with an individual trustee. In such cases, it may be legally difficult or at least awkward for heirs to call for a replacement trustee, so having a third party with that power could be very helpful.

Also, new family situations or changing laws might make it appropriate to change a trust's location, perhaps to assure that it will be governed by a different state law, notes attorney Martin M. Shenkman of Teaneck, NJ.

Moreover, decisions about trusts may involve both business and personal matters, and having a protector may make it easier to ensure that these decisions are made by the most appropriate people. Consider problems that might arise from the crystal-ball-type planning built into many trusts. Will your toddlers be able to manage half of their inheritances at age 30? Or will they need only one-third at age 35?

People write numbers like those into trusts, notes Edwards, and then simply cross their fingers. "It might be reasonable to allow some leeway about such matters, as heirs get older—yet you might feel hesitant to let some future trust officer assess your adult children's maturity," he says. "With trusts for the benefit of children, then, you might have your spouse as a protector, with specific powers to modify that part of the trust. Who'd be better at doing so? You could still have a corporate trustee to make the investment decisions."

Then wouldn't you almost always want a family member as protector?

As with choosing trustees, the answer for a given trust depends on several crucial factors: For example, will your choice create a tax problem?

It might, because a trust is often created to hold assets so that they won't land in your taxable estate or the taxable estate of another family member. But you can't have it both ways: If someone has a lot of control over a trust, its assets may become taxable in that person's estate, and the estate plan could fail. That can cost your family a fortune, because estate-tax rates quickly reach 55 percent.

The law currently places a limit of $675,000 on what you can leave to relatives other than a spouse, free of estate tax. As a result, planners often recommend to doctors' families that each parent leave that maximum to the children. But if the surviving spouse needs the money first, it's typically left in trust for the benefit of that spouse for life, with the balance going to the kids (tax-free) only after the widow's death.

Clearly, you might want your spouse to be a trustee of that trust, but to avoid the too-much-control trap, you'd have to severely limit his or her powers. So you might make your spouse co-trustee instead of sole trustee. And the spouse in such a situation shouldn't have too much authority to change other trustees, anyway—especially individual ones, who might not be as independent as the corporate kind.

The same sorts of issues apply when heirs serve as protectors. That's why experts, who best know how to draw such delicate lines, should decide how much authority your heirs can have.

To avoid trouble, you need to look at the whole picture, cautions David Bray, a vice president with Firstar Bank Private Client Group in St. Louis. That means, for instance, that besides the protector's control over the trustee, you also must consider how much leeway that trustee has. "There could also be estate-tax liability, say, if you're a beneficiary of the trust and the trustee can make certain discretionary distributions to you," Bray adds.

Then is the opposite true—I should never select a beneficiary as a protector?

It's not necessarily that dangerous. Still, this is one of the trickiest areas, because the answer depends on the circumstances of a particular trust, and how the protector's role is defined. When designing a trust in which the protector's function is very limited—say, to replacing a corporate trustee when necessary—an attorney may see no problem having a beneficiary as protector. "After all, beneficiaries often have the legal right to replace trustees, and providing that power in the capacity of 'protector' essentially just makes the task easier for them," says Rothschild.

He's careful to add a caveat: "If a trust gives a beneficiary who's a protector much greater powers, the trust assets may be considered in his taxable estate, or the trust may even become void." Some trusts give protectors authority to exercise discretion over distributions, notes Mark Edwards, who agrees that there could be tax trouble when a protector with such authority is also an heir.

Another crucial factor: When you increase the protector's power, you're also likely to expose that protector to greater fiduciary liability. "Of course, you can minimize that liability with careful drafting," says Edwards. "Still, this is another tradeoff you have to keep in mind, because insulating the protector from liability is typically of great concern, too."

Can't you simply appoint a relative co-trustee?

Often, that approach works. "I may give a corporate trustee the power to modify the trust, as necessary—for example, when new tax laws require it—and give an individual trustee the right to replace the corporate trustee, provided the replacement is truly independent," says Pittsburgh estate-planning attorney, Robert B. Wolf.

But as in more intimate relationships, not every marriage of family and corporate trustees runs smooth. "In one case, a bank where I was working simply had to resign as co-trustee," notes David Bray. "A widow was co-trustee with the bank, but she was terrified of making any decisions without consulting her daughter, who was a capable, but very busy, investment banker in New York. Yet the widow wasn't willing to have the daughter appointed in her place. Ultimately, the bank had to bow out. I only hope the widow resolved things later."

A protector would have prevented trouble here, Bray says. "While it's unusual for a co-trustee situation to become such a drawn-out tug of war, if there had been a protector to persuade her to step aside in favor of her daughter, this long and awkward conflict might have been avoided."

Another alternative is the committee approach, which Wolf has seen used in large families. "You might have several independent parties—they generally should not be beneficiaries—who, as a group, might have the right to hire and fire trustees, or to supervise distribution decisions."

Despite the legal problems in some cases, isn't it pretty easy to have a trustee replaced?

Sometimes. But trust documents often don't provide clear procedures for changing trustees.

Even when they do, problems can occur. For example, a beneficiary who has the right to change advisers may make things worse, without the advantage of good advice on that decision. And who's to give it? "One longtime client of ours was convinced by her broker to switch her trust account to his brokerage firm," says Bray. "The firm managed things badly, especially after she died. Professional trust companies are set up to take care of things quickly after a death, but the brokerage completely neglected matters. Not only did bills pile up, but they let her apartment lease continue for seven months."

When the poorly performing trustee is a relative, an ouster can lead to a fight that tears the family apart. Rather than risk that possibility, some heirs may choose to just put up with the existing trustee, unhappily.

Can I be sure my state law allows for a protector?

It probably doesn't; few states have written the concept into law. But that needn't hold up your planning. "Even though most states don't explicitly provide for protectors," says Stephan Leimberg, "it should be possible to have the role filled anywhere."

Of course, it will take careful drafting, notes Mary L. Hickok, a trust attorney at Wilmington Trust in Wilmington, DE. "In Delaware, we've had this concept for a long time, but we use the term 'trust adviser.' Some institutions, though, may not favor giving authority to an outsider who can replace them easily, so you need to consider that point, too."

You also must protect the protector. "If you want to insulate that person from liability, you'll have to be very particular in drafting the document to clarify the protector's responsibilities," says attorney Martin Shenkman. "Since this concept is relatively new, you're wise to seek out an attorney who's familiar with what has been developing in this area."

Will a trust protector add to the cost of trust administration?

Again, this is new territory. Some advisers say you needn't pay the protector a fee; others disagree: "You shouldn't ask someone to take on such a job without some sort of fee," says Shenkman. "There's responsibility, and because of the quasi-fiduciary role, there may be liability, too." As for what's reasonable, at this point no one can truly say. So the best course is to discuss the fee issue and the scope of the position with your attorney, your heirs, and—don't forget this one!—the person you'd like for the job.

Whether or not you use a trust protector, thinking about one is valuable. Yes, it may add another level of complexity to your estate plan, but good planning doesn't mean you won't face hassles; it just means the headaches you go through now may spare your family bigger headaches—or real unhappiness.