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Does your trust need a protector?

Trusts can serve a variety of tax and estate planning purposes, such as avoiding probate and minimizing gift and estate taxes. Typically, to achieve the greatest tax savings, trusts must be irrevocable. But it can be disconcerting to relinquish control over assets you place in a trust, particularly if you believe Congress will continue to modify the tax laws.

One potential solution is to appoint “trust protector" to oversee the trustee's activities and to provide flexibility to adapt the trust to changing laws and circumstances.

The protector's role

A trust protector is to a trustee what a corporate board of directors is to a CEO. A trustee manages the trust on a day-to-day basis. The protector oversees the trustee and weighs in on critical decisions, such as the sale of closely held business interests or investment transactions involving large dollar amounts.

There’s virtually no limit to the powers you can confer on a trust protector. But it's important to clearly define the protector's role in the trust documents.

It may be tempting to provide a protector with a broad range of powers, but this can hamper the trustee’s ability to manage the trust efficiently. The idea is to protect the integrity of the trust, not to appoint a co-trustee.

Many trusts limit a protector's power to removing and replacing the trustee or acting as the "tie-breaker" in the event of a deadlock between co-trustees. Another approach is to limit the protector's authority over investment decisions to transactions above a specified dollar amount.

Benefits offered

Trust protectors offer many benefits. If the trustee develops a conflict of interest or fails to manage the trust assets in the beneficiaries' best interests, for example, a protector can remove and replace the trustee. The protector may even have the authority to step in as trustee until a permanent replacement can be found.

A protector with the power to modify the trust's terms can correct mistakes in the trust document or clarify ambiguous language. Or, if you desire, you can give a protector the power to change the way trust assets are distributed if necessary to achieve your original objectives.

Suppose, for example, that your trust provides that assets will be distributed to your son after he graduates from college and is gainfully employed. After college, however, your son decides to spend two years in the Peace Corps. If that doesn't meet the trust's strict definition of "gainfully employed" because he isn't earning a certain amount, yet your son did well academically and has demonstrated an ability to manage money responsibly, the trust could authorize the protector to modify the trust to allow for early distributions.

A trust protector is to a trustee what a corporate board of directors is to a CEO.

Who should act as protector?

Choosing the right trust protector is critical. Given the power he or she has over your family's wealth, you'll want to choose someone you trust and who's qualified to make investment and other financial decisions. Many people appoint a trusted advisor – such as an accountant, attorney or investment advisor – who may not be able or willing to serve as trustee but can provide an extra layer of protection by monitoring the trustee's performance.

Appointing a family member as protector is possible, but it can be risky. If the protector is a beneficiary or has the power to direct the trust assets to him, or herself (or for his or her benefit), this power likely will be treated as a general power of appointment, exposing the protector to gift and estate tax liability and potentially triggering other negative tax consequences.

Plan carefully

If you're considering a trust protector, ensure that his or her powers and duties are consistent with your estate planning objectives. Trust provisions should be drafted carefully so that there are no misunderstandings regarding the protector's role and authority and to avoid the need to resolve any uncertainties in court.

It's also important to consider relevant state laws, if any. Although protectors are common in offshore trusts, their use with domestic trusts is a relatively recent phenomenon. Some states' laws expressly contemplate trust protectors, but many are silent on the issue. Talk to your advisor about whether a trust protector can help you achieve your goals.
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