In light of Bruce Willis's highlight of dementia, it makes sense for wealthy families to understand how to use directed trusts in a simple way under the South Dakota trust law to plan for current or future incapacitation planning. This blog will answer the questions of why, when with situational examples, and how with case studies.
What is a directed trust?
A directed trust is a type of trust that gives a grantor greater control over the management of trust assets. In a directed trust, the grantor first appoints an independent trust company. Then, within the same trust document, they appoint an investment trustee (i.e., the family's financial advisor/wealth advisor/financial planner) responsible for managing the trust assets per the grantor's instructions. However, the grantor can also appoint a "trust protector" who has the authority to remove and appoint new investment trustees and the corporate trustee. This can provide the grantor with greater flexibility and customization in managing the trust, while still ensuring that the trustee acts in the best interests of the trust beneficiaries.
What makes South Dakota trust law so good for directed trusts?
South Dakota trust law is considered to be one of the most favorable in the United States for directed trusts. This is due to several factors, including strong privacy protections, favorable tax laws, and a progressive approach to trust administration. South Dakota allows for greater flexibility in the creation and administration of trusts, including directed trusts, which can offer grantors greater control and customization over their trust assets. Additionally, South Dakota has a robust trust industry with experienced and knowledgeable trust professionals, which can provide added assurance and peace of mind to grantors (e.g., like us).
Why is it important for wealthy families to plan for current or future incapacitation?
Planning for incapacitation is critical for wealthy families as it ensures that their assets and well-being are protected in the event of diminished faculties. Here are a few reasons why:
- Wealthy families often have complex assets and investments, which can be difficult to manage without proper planning and support.
- Without a plan in place, family members may face challenges and disputes over the management of assets, which can lead to costly legal battles.
- Planning for incapacitation can ensure that family members are cared for and provided for if the grantor can no longer make decisions for themselves.
- Directed trusts can offer greater flexibility and customization in managing trust assets, which can be especially important for families with unique or complex needs.
- Working with experienced and knowledgeable trust professionals, such as those in South Dakota, can provide added assurance and peace of mind to grantors and their families.
What are the benefits and drawbacks of directed trusts for incapacity planning?
Advantages of directed trusts:
Directed trusts offer several advantages for grantors who want greater control over their trust assets, particularly in the context of incapacitation planning. Here are a few examples:
- Flexibility: Directed trusts can be especially useful in incapacitation planning as they offer greater flexibility and customization in managing trust assets. By appointing an investment trustee, the grantor can ensure that their trust assets are managed in accordance with their wishes even if they become incapacitated.
- Privacy: Directed trusts can offer greater privacy protections for grantors and beneficiaries in the event of incapacitation. By appointing a trust company in South Dakota (i.e., like us), the grantor can keep their personal information and investment decisions confidential, which can be particularly important in cases where the grantor's incapacitation may be related to sensitive medical conditions.
- Asset protection: Directed trusts can offer greater asset protection for grantors and beneficiaries in the event of incapacitation. By appointing and working collaboratively between the trust company in South Dakota and the investment trustee (e.g., financial advisor / wealth advisor / financial planner) with the authority to manage trust assets, the grantor can protect their assets from potential creditors or legal challenges, which can be especially important if they become incapacitated.
Potential drawbacks of directed trusts:
While directed trusts offer many benefits, there are also potential drawbacks that grantors should be aware of when incorporating directed trusts into their incapacitation planning. Here are a few examples:
- Complexity: Directed trusts can be more complex to create and administer than traditional trusts, which can add additional layers of complexity to incapacitation planning. It is important to have an experienced and knowledgeable professional to assist with creating and administrating the directed trust. A financial advisor working collaboratively with an advisor-focused trust company solves this problem.
- Administrative costs: Directed trusts can be more expensive to create and administer than traditional trusts, which may increase the costs associated with incapacitation planning. Most states do not offer robust directed trust statutes and 30-40% of family trustees charge a fee anyway.
- Risk of disputes: Directed trusts can lead to disputes between the grantor, trust protector, and trustee if there are conflicting opinions on how to manage the trust assets. It's important to have clear guidelines and instructions in place to avoid misunderstandings or disputes, especially in the event of incapacitation.
What are the types of directed trusts used for incapacity planning?
Revocable trusts using directed trusts
A revocable trust can be an effective tool for incapacity planning when the directed trustee is named as the successor trustee. In a revocable trust, the grantor retains control over the trust assets during their lifetime and can make changes or revoke the trust at any time. However, in the event of incapacitation, the directed trustee roles (aka splits into two) can step in and manage/distribute the trust assets according to the grantor's wishes. The corporate trustee makes the distribution decisions tied to the grantors overall comprehensive financial plan and the investment trustee has the broad authority to manage the trust assets, including making investment decisions. Additionally, each trustee (corporate and investment) are held responsible and liable for their specific roles while serving in the best interests of the trust beneficiaries. This can provide added assurance to grantors who want to ensure that their assets are managed properly in the event of incapacity. It's important to work with an experienced and knowledgeable trust professional when setting up a revocable trust with a directed trustee, to ensure that the trust is structured properly and all legal requirements are met.
Case Study: How a Revocable Trust with Directed Trust Features Solves Incapacity Planning
The challenge: A financial planner’s client, a UHNW successful entrepreneur in their late 50s, had built a successful business and amassed significant wealth. However, they were increasingly concerned about their health and the possibility of losing their faculties. They wanted to ensure that their assets would be properly managed and that their family would be provided for in the event of incapacity. The financial advisor approached us to help create a concept plan that would be drafted by the client’s estate planning attorney that would provide them with peace of mind.
The solution: After conducting a thorough analysis of the client's financial situation and their concerns, working in collaboration with the financial advisor and estate attorney, the creation of a revocable trust with directed trust features was created. We worked closely with the client and their advisor team to create a tailored plan that included detailed instructions for the management of their assets in the event of incapacity. The trust documents named the financial advisor as the investment trustee, who had the sole fiduciary authority to manage the assets according to the client's wishes.
The outcome: The client was extremely pleased with the final plan, which gave them peace of mind that their assets would be properly managed in the event of incapacity. The team approach between the corporate trustee and the investment trustee (i.e., the financial advisor) was able to step in and manage the assets according to the client's wishes, providing added assurance to the client and their family. The trust also included privacy protections and asset protection features, ensuring that the client's personal information and assets would be kept confidential and protected from potential legal challenges or creditors.
Wrapping up, the use of a revocable trust with directed trust features can be a powerful tool for incapacity planning, providing clients with greater control over their assets and added assurance that their wishes will be carried out in the event of incapacity.
Irrevocable trusts for directed trusts
An irrevocable trust can also be an effective tool for incapacity planning when the directed trustee is appointed to manage the trust assets immediately. In an irrevocable trust, the grantor transfers ownership of their assets to the trust and gives up control over them. Once the trust is created, the grantor cannot revoke or make changes to the trust, except in limited circumstances. By appointing a directed trustee, the grantor can ensure that the trust assets are managed according to their wishes, even if they become incapacitated. The directed trustee can be given broad authority to manage the trust assets, including making investment decisions and distributing assets to the trust beneficiaries. Additionally, the directed trustee has a fiduciary duty to act in the best interests of the trust beneficiaries and can be held accountable for their actions. It's important to work with an experienced and knowledgeable trust professional when setting up an irrevocable trust with a directed trustee, to ensure that the trust is structured properly and all legal requirements are met.
Case Study: How an Irrevocable Trust with Directed Trust Features Solves Incapacity Planning
The challenge: An advisor's client, multi-generational, thinking about legacy issues in their late 60s, had accumulated significant wealth through their career and investments. However, they were concerned about the possibility of incapacitation and wanted to ensure that their assets would be appropriately managed and distributed to their beneficiaries in the event of incapacity. The advisor approached us to work together to create a plan that would provide their client with peace of mind.
The solution: After a thorough analysis of the client's financial situation and their concerns, we collectively recommended the creation of an irrevocable trust with directed trust features. The advisor lead the charge working closely with our onboarding team and the estate planning attorney and the client to create a customized plan that included detailed instructions for the management and distribution of their assets in the event of incapacity. We were named as the corporate trustee and the financial advisor was named as the investment trustee under a directed trust, who had the authority to manage the trust assets and we would make distributions to the client's beneficiaries according to the client's wishes.
The outcome: The client was extremely satisfied with the final plan, which provided them with peace of mind that their assets would be properly managed and distributed in the event of incapacity. The directed trustee situation under their irrevocable trust was able to step in and manage the trust assets immediately upon the client's incapacity, providing added assurance to the client and their family. The trust also included asset protection features, ensuring that the client's assets were protected from potential creditors or legal challenges.
Bottom line, the use of an irrevocable trust with directed trust features can be a powerful tool for incapacity planning, providing clients with greater control over their assets and added assurance that their wishes will be carried out in the event of incapacity.
What are some situational examples of how to use directed trusts for incapacity planning?
- The case of a business owner who created a revocable trust with directed trust features to ensure that their business would be properly managed and their family would be provided for in the event of incapacity. The grantor separated the investment trustee between the business assets and financial assets so that, when the time occurred, each trustee was able to step in and manage the trust assets according to the client's wishes, providing added assurance to the client and their family.
- The case of a philanthropist who created an irrevocable trust with directed trust features to ensure that their charitable contributions would be properly managed and distributed in the event of incapacity. The investment trustee managed the trust assets and the advisor friendly trust company made distributions to the client's preferred charities according to their wishes.
- The case of a real estate investor who created a revocable trust with directed trust features to ensure that their real estate holdings would be properly managed and distributed in the event of incapacity. The trust assets had the real estate held in manager managed LLCs with the investment trustee as the LLC manager and trust protector with the independent trust company making distributions to the client's beneficiaries according to their wishes.
- The case of a wealthy family who created an irrevocable trust with directed trust features to ensure that their assets would be properly managed and distributed to their children and grandchildren in the event of incapacity. The families long-standing financial advisor managed the investments and collaboratively worked with the trust company to make distributions to the family members according to the client's wishes.
- The case of an individual with a disabled child who created a revocable trust with directed trust features to ensure that their child's needs would be properly met in the event of incapacity.
- The case of an art collector who created an irrevocable trust with directed trust features to ensure that their art collection would be properly managed and distributed in the event of incapacity. The art was held in manager managed LLCs with the investment trustee acting as the LLC manager and trust protector. Should the art be sold, the trust company would be there to follow the distributions to the client's beneficiaries according to their wishes.
- The case of a wealthy individual who created a revocable trust with directed trust features to ensure that their assets would be properly managed in the event of incapacity.
- The case of a retired executive who created an irrevocable trust with directed trust features to ensure that their assets would be properly managed and distributed in the event of incapacity.
Are there additional reading sources for using directed trusts for incapacity planning?
"Planning for Diminished Capacity: Directed Trusts and Powers of Attorney" by Richard C. Ausness - This article discusses how directed trusts and powers of attorney can be used to plan for a grantor's potential future incapacity. It explores the benefits and drawbacks of each option and provides guidance for estate planners.
"Directed Trusts and Fiduciary Liability: New Law, Old Lessons" by Thomas W. Abendroth and Kyle D. Noller - This article analyzes the legal and practical considerations surrounding directed trusts, including the potential risks and benefits for fiduciaries. It also discusses recent changes in the law and provides guidance for trustees.
"Directed Trusts: The New Kid on the Block" by Brett W. Johnson - This article provides an overview of directed trusts, including their history, advantages, and potential drawbacks. It explores how directed trusts can be used in estate planning and provides guidance for trustees and estate planners.
"Directed Trusts: Practical Considerations for the Estate Planner" by Kevin Matz - This article discusses the practical considerations involved in creating and administering directed trusts. It explores the benefits and drawbacks of using directed trusts in estate planning and provides guidance for estate planners.
"Directed Trusts - When and Why to Use Them" by Robert W. Goldman and Mindy Herzfeld - This article explores the circumstances in which directed trusts may be useful in estate planning, including situations where the grantor has concerns about future incapacity. It provides guidance for estate planners on how to incorporate directed trusts into their clients' estate plans.