Given my experience with my mom, it is not surprising that the first topic I want to cover is who should be named trustee. The truth is that there is no single answer to that question, because trusts (which are simply vehicles where beneficiary ownership is separated from legal ownership) are created for many different reasons. The trustee, who holds legal title and owes the beneficiary a fiduciary duty to manage the assets held in the trust for the beneficiary’s benefit, can be an individual, an institution or even the beneficiary, depending on the purpose of the trust.
Many trusts are created to take advantage of spendthrift protection. In Texas, like most states, a trust created for a beneficiary other than the grantor (the person establishing the trust) provides some level of protection from the creditors (called spendthirft protection) of that beneficiary if someone other than the beneficiary is trustee or, if the beneficiary is trustee, the trustee is limited in making distributions to an “ascertainable standard.” The typical ascertainable standard is the “health, education, maintenance and support” of the beneficiary. Words matter here, and Texas is very strict. In Lehman v. United States, 448 F. 2d 1318(5th Cir. 1971) the court held that use of the word “comfort” along with support and maintenance was enough to negate an ascertainable standard.
Estate and Gift Taxes
Ascertainable standard is very important for estate and gift taxes as well. The IRS looks to state law to determine if an ascertainable standard exits, and, if it does, then it is possible for trust property to pass from one beneficiary to another without estate or gift tax consequences. So, for example, if dad creates a trust for his son for the son’s life and then to the son’s descendants , the trust property will escape estate taxes at the son’s death. Of course, the initial funding of the trust by dad is a gift, but that is a topic for another day.
Often trusts are created for estate tax savings where spendthrift protection is a secondary consideration.
May or Shall
As I said words matter here, and the use of the words “may” or “shall” before the distribution standard impacts the creditor protection significantly. Use of the word “may” means the distribution is discretionary. Use of the word “shall” means the distribution is mandatory. Of course, if the distribution is mandatory, it provides less creditor protection than if the distribution is discretionary.
Who is the Trustee
Finally, who the grantor names as trustee impacts the level of creditor protection. A trust naming the beneficiary as trustee with an ascertainable distribution standard will provide a modicum of creditor protection. A trust naming an independent person as trustee with a wholly discretionary distribution standard provides the highest level of creditor protection. Care should also be taken in selection of successor trustees or successor trustee selection methods.
Trusts are not one size fits all. You essentially start with a clean canvas. It is up to the attorney to carefully discuss with the client all options and objectives and inform the client about the benefits and risks of each option along the decision tree.