The Modern Trust

A phrase commonly thrown around in estate planning literature is the use of a modern trust. Some states tout that they have modern trust statutes in order to attract trust business. What is meant by a modern trust is that it is a trust that is highly flexible to respond to future changes.

There is plenty of discussion these days with the need to build more flexibility into a trust, in order to respond to future changes and address uncertainty triggered by economic, political changes, or even the change in the health of beneficiaries. The perceived need for more flexibility in dealing with trusts is prompted by the increased use of dynasty type trusts that are intended to avoid federal estate and generation skipping transfer taxes for multiple generations while sheltering assets from creditor claims.

While responding to changes in tax laws is often offered as the need to build flexibility into a trust, there are plenty of other reasons why a trust may need to be adapted in future years to address: (i) asset protection; (ii) a beneficiary’s divorce; (iii) unexpected beneficiary litigation; (iv) a beneficiary’s change in health prompts the need to become eligible to access governmental benefits; (v) business succession changes; (vi) the preservation of legacy assets like collectibles or heirlooms; and (vii) to promote family values and governance responsibilities.

There are a variety of ways in which a modern trust can intentionally be made more flexible and modified to adapt to perceived changes either in the law or the trust beneficiaries’ needs. Some of those provisions, or options, that should be considered in intentionally making a trust more flexible are the following.

1. Directed Trusts: It is possible for a trust to use a trust director (formerly called a trust protector) to direct the trustee about duties otherwise held by the trustee under the law. For example, a favorite investment advisor could be named as a trust director to direct the trustee to make specific investments held in the trust. A person or committee could be named as a trust director with respect to making distributions from the trust, thus directing the trustee when and to whom to make discretionary distributions. A trust director could also be given a power to veto any proposed distribution to a trust beneficiary by the trustee. Any number of duties or powers can be given to a trust director under the trust instrument, which then leaves the named trustee with only administrative responsibilities, e.g., filing tax returns, while taking directions from the trust director(s).
2. Authorize Unique Investments: A trustee’s investment responsibility is normally limited by the Uniform Prudent Investor act (UPIA) which carries the general duty to diversify trust assets unless the trust’s purpose is better served without such diversification. However, there could be occasions when diversification in trust investments might not be the best course for a trust, e.g., low-cost basis assets are held in the trust and their sale would trigger a large capital gain, or a closely-held family business is held in trust. The trust instrument could relieve the trustee from having to follow the UPIA when it makes investments, authorizing the investment in alternative or private equity (illiquid) investments. Or the trust instrument could authorize a trust director to direct the trustee to invest in a manner that is not consistent with the UPIA.
3. Power to Convert: Some trust instruments direct the trustee to make distributions of trust income to the current trust beneficiary. Capital gains usually are not classified as trust income under fiduciary accounting principles. There are periods though when interest rates are low so that a little distributable income is generated by the trust’s assets. Accordingly, the mandatory distribution of trust income to the current trust beneficiary may not be sufficient to fulfill the trust creator’s purpose for the trust. The trustee could be given the power to convert the trust from a “pay all income” to a “pay a percentage of trust assets” type of trust. This percentage distribution directive is called a unitrust. Accordingly, instead of paying all trust income the trustee pays to the trust beneficiary 4% or 5% of the trust’s assets for the year, usually this amount is determined on the last day of the prior calendar year. It is much easier to identify the amount that the current beneficiary will receive from the trust (which will include all the trust’s income and some of the trust’s principal) during the year. A unitrust makes budgeting by the beneficiary much easier, while it minimizes the trustee’s decision on how trust assets should be invested.
4. Change in Situs and Law: The trustee (or a trust director) can be given the power to change the situs and the law of trust to further its flexibility. A state other than the trust creator’s residence might have more favorable laws, such as promoting dynasty-type trusts that can last for centuries all the while avoiding federal estate and generation skipping transfer taxes, and preserving wealth, or privacy, for the trust beneficiaries. For example, Michigan does not permit (yet, anyway) silent or quiet trust where a young adult trust beneficiary is not informed by the trustee of the trust’s existence, its assets, or that person’s beneficial interest until they reach a more mature age when they have more financial maturity, or they can better appreciate family values. Delaware permits a trustee to avoid having to provide a copy of the trust, or an accounting of the trust’s assets, to a trust beneficiary for a defined period. Accordingly, a trustee might want to change the situs of a Michigan trust to Delaware in order to take advantage of Delaware’s quiet trust laws.
5. Trust Modifications: Several provisions under Michigan’s Trust Code authorize a probate court to modify the terms of a trust at the request of a trustee or a trust beneficiary, so long as the material purposes of the trust are not impaired. However, that judicial modification entails a trip to the probate court, the use of attorneys, and the probability that some trust provisions will be disclosed in a public court hearing. A modern trust might contain a nonjudicial settlement provision by which the trustee and the trust beneficiaries can agree to modify either the trust’s administrative provisions (currently permitted under Michigan’s laws) or the trust’s dispositive provisions (not permitted under existing Michigan law) without the need to obtain judicial approval of the change to the trust. Other states permit seemingly unlimited modifications to a trust without a court becoming involved. A non-judicial settlement trust provision could save time, expense, and publicity by avoiding any probate court proceeding.
6. Trust Decanting Powers: If the trustee possesses discretion to make distributions from the trust to its beneficiaries, the trustee could distribute trust assets to a new trust, created by the trustee, to effectively modify the terms of the old trust. This ability to transfer assets from an existing trust to a new trust created by the trustee is called the exercise of a decanting power. While Michigan has two separate decanting statutes that permit the trust assets to be decanted to a new trust either to change a trust’s administrative provisions, or in more limited situations to change the beneficial interests in the new trust, there are statutory procedures that must be followed. It is possible for a trust instrument to confer on the trustee (or a trust director) the power to decant trust assets, or to change the interests of a beneficiary, or to add trust beneficiaries, using the instrument’s own, unique, decanting power, even without notice to the existing trust beneficiaries. For example, if a beneficiary who suffers from a drug addiction is scheduled under the trust instrument to possess the right to withdraw 50% of his or her share of the trust assets upon attaining the age 40, the trustee might decant the trust assets to a new trust where the trust beneficiary does not possess any withdrawal right.
7. Pets and Purpose Trusts: A pet is tangible personal property. Consequently, a trust that is established to maintain a pet after its owner’s death is classified as a purpose trust. In Michigan a pet trust can last for roughly 21 years. In addition, the probate court can reduce the amount that the trust instrument directs to be set-aside to preserve the pet. Other states use far more favorable purpose trust statutes, where there is no living person as a beneficiary, but the trust’s purpose can continue indefinitely to hold and protect assets. An example would be a purpose trust that is created to hold and preserve collectibles, artwork, vacation homes, or other family heirlooms. No living person is named as the designated beneficiary of the purpose trust. A trust director, like a family member, could be named to guide the trustee in how these trust assets are preserved, or made available for use by family members (who technically are not trust beneficiaries.)
8. Defining the Family: There is now considerable uncertainty as to who constitutes a family member, when terms like children, grandchildren, issue or descendants are used in a trust instrument. Historic definitions of these terms have not moved beyond family births and adoptions to surrogacy, in vitro fertilization, artificial insemination, or other evolving legal relationships, e.g., equitable adoption. Rather than rely on ‘old time’ concepts of family, heir, or descendant, a modern trust can specifically describe who the trust creator wants to be treated as part of the extended family, and thus a potential beneficiary of his or her trust.
9. Asset Protection Trusts: At common law, an individual could not create a trust with themselves named as a trust beneficiary and then use the trust’s ownership of assets as a shield from the individual’s creditors. About 19 states now, including Michigan, have changed that common law rule. Now, an individual can create an irrevocable trust, transfer assets to that trust, and be a discretionary beneficiary of the same trust. If done without any intent to defraud or hinder the collection efforts of a future creditor, the transferred assets to the trust are protected from future judgement creditors. Thus, those individuals who are in high risk professions, or who are concerned about becoming a target in our highly litigious society, can comfortably transfer assets to a domestic asset protection trust, enjoy the benefits of those transferred assets, while protecting those assets from future creditor claims, including claims in a future divorce.

These are just a few of the examples of how a trust instrument can be adapted to add considerable flexibility to address unforeseen future changes in the law and in the needs of trust beneficiaries. A modern trust, especially one that features the use of trust directors, is particularly useful to respond to changing circumstances, personalize the trust’s administration using individuals as trust directors who may be more familiar with trust beneficiaries and their unique needs, while also enhancing the wealth preservation features of a trust all the while providing greater flexibility to meet constantly changing circumstances. While Michigan does not hold itself out to the nation as a modern trust jurisdiction, it does use many of these features that trust creators may wish to consider when they adopt a trust.