Probably the most common reason Americans create trusts is probate avoidance. Certain states have very expensive or tedious probate processes (i.e., judicial proceedings to administer the assets of a decedent) so it is common in those states for people to use revocable trusts as their primary estate planning document. The revocable trust is most useful in those states if it is fully funded; that is, if the client transfers all of his or her assets to the trust during life, so there are no assets left in his or her own name that would require probate for proper disposition. But even if the client does not actually re-title all assets into the name of the trust, in certain jurisdictions (notably, California), it may be possible to avoid probate merely by listing assets among the assets of the revocable trust on a schedule to the trust instrument, as those assets can be re-titled into the name of the trust after the client’s death without the requirement of going through probate.
Revocable trusts have traditionally not been as popular in New York as they have been in certain other jurisdictions such as California and Florida. One explanation for the revocable trust’s comparative lack of popularity in New York is, no doubt, reluctance on the part of the New York T & E bar to adapt to new concepts. But in fairness to T & E attorneys in New York, because the probate system here is not unduly expensive or tedious, there has not been as much of a need for revocable trusts: probate avoidance is, after all, a lower priority where probate is less onerous. In addition, New York actually requires assets to be formally re-titled in the name of the trust for a transfer to be effective, see NY CLS EPTL § 7-1.18, making probate avoidance rather more cumbersome in New York than in states where, as noted above, merely listing the assets as owned by the trust can serve the required purpose. However, unfunded revocable trusts, used in conjunction with a pourover Will that names the revocable trust as the sole beneficiary of the decedent’s estate, are growing in popularity in New York, even though probate is not avoided at all if the revocable trust is unfunded. That popularity growth can presumably be attributed to certain advantages of revocable trusts becoming increasingly evident to drafting attorneys: (i) privacy— probated Wills are public documents, while revocable trusts are not—and (ii) obviating the need for Letters of Trusteeship.
Another widely touted benefit of trusts is creditor protection, with the most common creditors of beneficiaries being divorcing spouses. Assets of an irrevocable trust for the benefit of third parties (i.e., those other than the settlor or the trustee) are generally exempt from the claims of the beneficiaries’ creditors for the very basic reason that the beneficiaries do not legally own those assets. However, if the beneficiaries can freely alienate their beneficial interests in the trust, the fact that creditors cannot directly access the assets of the trust may not matter much, as the creditors can obtain the beneficiaries’ beneficial interests in the trust, and obtain indirectly what they could not obtain directly. The default law in New York is that trusts are “spendthrift” trusts—where beneficial interests are inalienable—only as to income, not principal, unless specified otherwise in the trust instrument. See NY CLS EPTL § 7-1.5. Therefore, it is generally advisable to include express spendthrift language in trust instruments to make beneficial interests in principal inalienable as well:
• “Each trust shall be a spendthrift trust to the maximum extent permitted by law and no interest in any trust hereunder shall be subject to a beneficiary’s liabilities or creditor claims, assignment or anticipation.”
A so-called self-settled trust, one in which the settlor is a beneficiary, does not offer any creditor protection under New York law. See NY CLS EPTL § 7-3.1. New Yorkers who want to create asset protection trusts, (i.e., self-settled trusts that cannot be reached by the settlor’s creditors) need to do so in an offshore asset protection jurisdiction, such as the Cook Islands, or a domestic asset protection jurisdiction such as Delaware or South Dakota. The efficacy of domestic asset protection trusts is a much-debated issue, and beyond the scope of this article, but suffice it to say that if you are contemplating drafting such a trust, it is advisable to obtain advice from local counsel in the given jurisdiction to make sure that the trust adheres strictly to the requirements of that jurisdiction’s asset protection laws.
What about a trust where the trustee is a beneficiary? Unlike a self-settled trust, a trust does not cease being a spendthrift trust merely because a trustee is a beneficiary. Nonetheless, a trustee with discretion to make distributions to him or herself could arguably be compelled by creditors to exercise that discretion to the greatest extent permitted under the trust instrument. For maximum creditor protection, it may therefore be prudent to name only non-beneficiaries as trustees, or to restrict a beneficiary-trustee from exercising discretion over distributions.
A robust discussion of creditors’ rights issues is beyond the scope of this article, but one additional point is worth making. Setting up and funding a trust to protect against claims of the beneficiaries’ creditors is a different matter entirely than setting up and funding a trust to place assets beyond the reach of the settlor’s creditors. Clients facing creditors’ claims may ask you to create irrevocable trusts for the benefit of their family members so the clients can transfer their assets to those trusts and thereby frustrate the claims of the clients’ creditors. Those transfers would likely be voidable as fraudulent conveyances, and if the client is in bankruptcy, could be deemed bankruptcy fraud. Moreover, your participation in the drafting process could expose you to claims of aiding and abetting that fraud. You should therefore be clear on your clients’ overall financial picture before assisting them with their trust planning.
Use of trusts for creditor protection can basically be described as saving beneficiaries from third parties, but often clients are more interested in using trusts to protect beneficiaries from themselves. For young beneficiaries, paternalism is relatively easy to justify: how many 18-year-olds or even 21-year-olds are mature enough, either emotionally or financially, to handle a large inheritance? As beneficiaries get older, however, balancing out paternalism with encouraging autonomy becomes more complex. Some beneficiaries may never be sufficiently mature, emotionally or financially, to handle significant wealth, but many are quite responsible by age 30 or 35. Moreover, receiving some assets outright may actually help beneficiaries become financially mature by requiring them to manage their own money. (Alternatively, allowing beneficiaries to become co-trustees once they reach a certain age can have similar benefits from a financial education perspective.)
For various reasons, some T & E attorneys routinely recommend trusts to last for the lifetimes of all beneficiaries, but that might not be appropriate for all clients. The best course of action for you as an attorney is to discuss in detail with clients when they think their children/grandchildren ought to receive assets outright. Factors you should consider include the amount of wealth at stake—massive wealth militates in favor of keeping assets in trust—and how well the clients know their beneficiaries. You could, for example, draft a client’s Will or revocable trust to include lifetime trusts for their children when their children are very young and their financial maturity is inherently unknowable, but if the children seem to be maturing normally, and assuming the clients are still alive and still have capacity, revise the Will or revocable trust later on so that the trusts end at age 35, or in stages at ages 30, 35, and 40, for example. Or you could keep the lifetime trusts but encourage the clients to suggest to the trustee that she/he exercise her/his discretion to distribute assets liberally to the beneficiaries, including all of the assets of the trust, if the beneficiaries are financially mature enough to handle it.
One aspect of paternalism where New York has not gone as far as certain other jurisdictions concerns so-called “silent trusts.” In some jurisdictions, including Delaware, clients have the option of incorporating into trust instruments provisions specifically prohibiting the trustee from informing the beneficiaries about the existence of, or assets in, the trust. Presumably the clients are concerned that mere knowledge of the trust could discourage beneficiaries from leading productive lives. New York does not permit silent trusts, as the basic fiduciary duty to keep the beneficiaries informed, and the resulting ability of the beneficiaries to enforce the trust to keep the trustee “in line,” is presumably deemed more important than not spoiling the beneficiaries. See NY CLS SCPA § 2306.
A client may not be particularly concerned about protecting a beneficiary from creditors or from the beneficiary’s own financial mismanagement but may merely feel that a trustee would do a better job managing assets than the beneficiary would do herself or himself.
As a corollary, a client may create and fund a revocable trust for his or her own benefit primarily so that if/when he or she becomes incapacitated, the successor trustee named in the trust agreement can assume the role of trustee and commence managing the assets of the trust for the settlor’s benefit. There are, of course, other ways of addressing asset management in case of incapacity; for example, a legal guardian could be appointed for the client, or an attorney-in-fact under a power of attorney could manage the client’s assets. But a guardianship proceeding is time-consuming and expensive, and an attorney-in-fact does not have the same fiduciary duties as a trustee. (An attorney-in-fact is a fiduciary, and therefore, when acting, must act in the best interests of the principal. However, an attorney-in-fact is not compelled to act, while a trustee is under an affirmative obligation to administer the trust’s assets.) Consequently, incapacity planning, which is analytically a sub category of asset management, is an oftencited benefit of revocable trusts.
Asset management can be an important objective for irrevocable trusts as well. For example, a settlor may want assets that would otherwise pass to multiple beneficiaries to be managed as a single pool. That can be particularly important where the assets consist of real property used by multiple family members or interests in a family business, where the centralized management afforded by a single trust could be advantageous.
New York law facilitates efficient asset management, though it is far from unique in that regard. For example, New York, like most jurisdictions, permits trustees to employ custodians, including broker-dealers, and to maintain securities in the “street name” of such broker-dealers rather than in registered form. See NY CLS EPTL § 11-1.10. New York also permits trustees to delegate investment discretion. See NY CLS EPTL § 11-2.3. Trustees can therefore open accounts with brokers, bankers, or investment advisors, and thereby access more or less the entire range of asset management options the financial services industry has to offer.