Is there anywhere we don’t see acronyms? Certainly in the legal profession we have our share, particularly when estate planning trusts are involved. We have GRATs, CRUTs, SLATs, QPERTs, DAPTs, and a host of others. I call these (and all those trusts whose identity is known to us by letters or acronyms) the “alphabet trusts.” For estate planning practitioners, the abbreviated tag we assign to the trust says it all. That is, when we refer to a trust as a GRAT or an ILIT, for example, we know from that reference pretty much what the trust is, what it says, and what it is intended to do. Of course there are numerous other details, but if we mistake a GRAT for an ILIT, we’ve got a real problem.
The ever-expanding group of alphabet trusts is based on a combination of tax regulations, revenue rulings, and cases, refined by private letter rulings, IRS pronouncements, and professional commentary that in turn have generated the unique provisions that must be included in each of the trusts. Failure to include one or more of the essential provisions or the inclusion of certain extra provisions can easily cause the trust to lose the tax benefits for which it was established. Depending on the circumstances, the loss can be irretrievable, such as when the remainder of a deceased grantor’s charitable remainder trust did not pass to a qualified charity because of a drafting oversight in the dispositive provision.
But some such oversights can be corrected, such as the case in which a GRAT inadvertently provided for the remainder to pass to grandchildren of the grantor at the end of the GRAT term. Because the GRAT was irrevocable, the trust faced a huge generation-skipping tax on the grantor’s death. But in this case the grantor was still alive, so a court reformation of the trust could be accomplished (at the expense of the drafting attorney). Then there is the case in which unforeseen circumstances in the family picture warrant a major change to the irrevocable trust, but the trust is not one that lends itself to reformation and simply cannot be accomplished. For instance, the client established an ILIT for her three children, funded with a large, paid-up life insurance policy on her life, distributable outright and equally to the children or their survivors on her death. One of the children murdered a sibling but was acquitted on a technicality, so he now will share half the insurance proceeds. The mother is helpless to omit the acquitted son from her trust.
Of course, there could be numerous additional examples, but the message is that all of these alphabet trusts are typically irrevocable, and correction of an oversight or error, or making a desired adjustment because of changed circumstances, if not prohibited, is almost never an easy matter, even if it is not too late. For this reason, the more flexibility we can build into such trusts, the greater the probability the trust can correct an oversight or adjust to a sudden change and stem or avoid the exposure to loss. Fortunately, as many of us have come (or are coming) to acknowledge, the use of a trust protector can provide a new and powerful key to the flexibility we seek.
A protector can be defined as a party who has power over the trust but who is not a trustee. Although this definition would appear to include anyone who has a power of appointment over a trust, that is not at all the same as a protector. When a settlor appoints or provides for the appointment of a protector in her trust, it is reasonable to assume she wants someone who will act in the best interests of the beneficiaries and consistent with the intended purposes of the trust. It is hasty and somewhat irresponsible to conclude that that would be the settlor’s intended role of a holder of a power of appointment. That is, the holder of a power of appointment is under no duty to act and under no duty to consider the interests of the beneficiaries or the purpose of the trust. Her only duty is not to commit a fraud on the power (for example, breach the terms of the power or benefit from its exercise). The use and purpose of a protector is to help ensure the smooth administration of the trust and to actively consider the best interests of the beneficiaries and the purposes of the trust. It is in this role that the protector, rather than the simple power holder, can address problems and cause the trust to adjust to unforeseen situations without the need for court action.
With this in mind, following are some observations on how a protector could be used in alphabet trusts. Note that space prohibits a discussion of every alphabet trust and every concern. Hopefully, practitioners can apply their own expertise and imagination on how their particular trusts can benefit from the added flexibility.
Some of the trusts we have in mind provide for fixed remainder beneficiaries, such as the GRAT or QPRT, which typically name the grantor’s children as remaindermen. They seldom contemplate major changes in the children’s circumstances when the trust term expires, such as divorce, disability, lawsuits, and so on. A protector of such a trust could, for example, be given the power to amend the dispositive provisions for the children to provide a holdback, a transfer to a trust for the beneficiary, or even the deletion of a beneficiary, without the need for court action and without the loss of the trust’s tax benefits.
The same concerns could apply to almost any irrevocable trust, but careful attention must be given to the extent of the powers granted to a protector. They must be carefully tailored to the type of trust involved and the objectives of that trust. If the protector’s powers are too broad, the very existence of a power could disqualify the trust and defeat its purpose. For example, an MQT (Medicaid qualifying trust) that grants a protector a broad power to amend will cause the trust assets to be fully countable for Medicaid eligibility purposes, because this is a means for the settlor to receive principal. Similar disqualifying results might apply to charitable remainder or charitable lead trusts.
In drafting the protector’s powers, in addition to avoiding the inclusion of a power that might jeopardize the qualification of the trust for its intended purpose, consideration should be given to the inclusion of a form of “savings” clause, such as, “Notwithstanding the foregoing, no power shall be exercisable by the protector which would [cause the remainder to be included in the grantor’s estate], [affect the grantor’s eligibility for Medicaid benefits], [violate the provisions of the IRC § 664 and the regulations thereunder], etc.” Certainly, we would not want the protector to be able to add or delete the income beneficiaries of a GRAT or a QPRT, nor of a SLAT or a CLT, but we may want that power in a DAPT or an ILIT. Similarly, the power to terminate the trust would be a problem during the term period of a GRAT or QPRT, but thereafter it could be considered.
For new trusts, therefore, the inclusion of a protector should be considered, but the powers granted must be even more carefully considered. There is also the option of providing for a springing protector, in which the trust allows a protector to be appointed when needed and only for the period needed. When the trust is already in place and there is no apparent mechanism for the appointment of a protector, consider decanting the trust into a new trust with identical provisions except for the addition of a protector with the desirable limited powers. Either way, the flexibility of the trust will be greatly enhanced, and the resolution of otherwise complicated problems can be rendered as simple as ABC.