TRUST DRAFTING: PROTECTION WITHOUT (TOO MUCH) DEAD … · ESTATE PLANNING & PROBATE DRAFTING COURSE October 29-30, 2009 Dallas CHAPTER 14 . TOBY MATTHEW EISENBERG ... powers of attorney

TRUST DRAFTING: PROTECTION WITHOUT (TOO MUCH) DEAD-HAND CONTROL

TOBY EISENBERG Bisignano & Harrison, L.L.P. 5949 Sherry Lane, Suite 770

Dallas, Texas 75287 (214) 360-9777, ext 26

[email protected]

© Bisignano & Harrison, L.L.P.

State Bar of Texas 20th ANNUAL ADVANCED

ESTATE PLANNING & PROBATE DRAFTING COURSE October 29-30, 2009

Dallas

CHAPTER 14

TOBY MATTHEW EISENBERG

Bisignano & Harrison, L.L.P. 5949 Sherry Lane, Suite 770

Dallas, Texas 75225 phone: 214-360-9777 ext. 26

email: [email protected] EDUCATION

Southern Methodist University, Dallas, TX Ph.D. Religious Studies – Expected December 2010 The University of Texas School of Law, Austin, TX J.D. – December 1999

Fuller Theological Seminary, Pasadena, CA M.A. Biblical Studies and Theology – August 1997

Rice University, Houston, TX B.A. Philosophy, Music Minor – May 1994

PROFESSIONAL ACTIVITIES AND CREDENTIALS Partner, Bisignano & Harrison, LLP Board Certified in Estate Planning and Probate Law by the Texas Board of Legal Specialization Member of the State Bar of Texas – admitted May 2000

PRACTICE CONCENTRATION

Estate Planning. All facets of estate planning, which encompasses the drafting and planning for the disposition of wealth through the use of various planning techniques, including lifetime gifts, and intra-family sales, life insurance and other complex trusts, family limited partnerships, limited liability companies, wills, health care designations, powers of attorney and directives to physicians, and related planning for the protection of assets from creditors.

Business Continuation Planning. Business continuation planning for owners of closely held businesses, including formation of closely held businesses, buy-sell agreements, split dollar life insurance agreements, business recapitalizations, and certain non-qualified deferred compensation agreements.

Charitable Gift Planning. Charitable gift planning, including charitable remainder trusts, charitable lead trusts, and creation of exempt organizations in connection with charitable planning.

Estate and Trust Administration. Administration of trusts and estates, including dependent, independent and ancillary probate procedures, guardianships, income tax planning, preparation of U.S. Estate and Texas Inheritance tax returns, audit negotiations with agents of the Internal Revenue Service and the Comptroller of Public Accounts of Texas, preparation of tax protests, private letter ruling requests and coordinating dissolution of partnerships and closely held corporations. Fiduciary Representation and Estate and Trust Controversy Matters. Representing fiduciaries and coordinating fiduciary litigation matters, including fiduciary liability issues, will contests, and trust modification and construction issues.

Marital Property Issues. Texas community property system and related marital property matters, including premarital and postmarital partition and/or property agreements between spouses.

Trust Drafting: Protection Without (Too Much) Dead-Hand Control Chapter 14

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TABLE OF CONTENTS I. INTRODUCTION ............................................................................................................................................. 1 II. OCCASIONS FOR LIFETIME TRUSTS ......................................................................................................... 1 A. Testamentary Planning ............................................................................................................................... 1 B. Education Planning .................................................................................................................................... 1 C. Life Insurance Planning ............................................................................................................................. 2 D. Asset Protection Planning .......................................................................................................................... 2 E. Wealth Transfer Planning........................................................................................................................... 2 III. SAMPLE DRAFTING PROVISIONS .............................................................................................................. 2 A. Maximizing Access and Control While Still Providing Protection From Third Parties ............................ 2

1. Co-Trustee, Then Sole Trustee ........................................................................................................ 3 2. Mentoring Provisions ....................................................................................................................... 3 3. Drip Trust ......................................................................................................................................... 4 4. Special Distribution Trustee ............................................................................................................ 5 5. Termination By An Independent Trustee ........................................................................................ 6 6. $5,000 or 5% Withdrawal Power ..................................................................................................... 7 7. Special Power of Appointment ........................................................................................................ 7 8. Contingent General Power of Appointment .................................................................................... 8

B. Incentive Provisions And Limited Control Or Access ............................................................................... 9 1. Moral Turpitude – Subjective Provision ........................................................................................ 10 2. Drug Abuse and Felonies ............................................................................................................... 10 3. Cap on Distributions ...................................................................................................................... 11 4. Income Matching Provision ........................................................................................................... 11 5. Bonuses For Education .................................................................................................................. 11 6. Trust Committee With The Power to Remove Child As A Trustee .............................................. 12 7. Subjective and Objective Standards For Removing A Child As A Trustee .................................. 12

C. Other Necessary Provisions ..................................................................................................................... 13 1. Spendthrift Trust Provision ............................................................................................................ 13 2. “HEMS” Standard ......................................................................................................................... 13 3. Distributions are Separate Property ............................................................................................... 14 4. No Distributions to Satisfy Legal Obligations ............................................................................... 14 5. Merger of Trusts ............................................................................................................................ 14 6. Severance of Trust ......................................................................................................................... 14 7. Rule Against Perpetuities............................................................................................................... 14

D. Drafting Pot Trusts ................................................................................................................................... 14 1. Augmented Estate .......................................................................................................................... 15 2. Trigger for Division Into Separate Trusts ...................................................................................... 16

IV. CONCLUSION ................................................................................................................................................ 16


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TRUST DRAFTING: PROTECTION WITHOUT (TOO MUCH) DEAD-HAND CONTROL I. INTRODUCTION

The purpose of this article is to provide an overview of some of the most important occasions and methods for drafting trusts for children and more remote descendants in a way that maximizes the protection of the trust assets without unnecessarily restricting access to them. With the estate tax exemption steadily rising over the last several years to the current $3.5 million exemption, fewer and fewer estates have required tax-planned documents. As a result, many practitioners have simply reverted to their existing “simple” documents for such non-taxable estates, very frequently passing assets to children or other beneficiaries receiving assets outright at age 30 or even younger (sometimes as young as age 18). Yet, with a higher estate tax exemption, many non-taxable estates are large enough to warrant more sophisticated planning than existing “simple” documents provide. When initially asked, most clients would prefer that their children not have to deal with trusts any longer than necessary. Once the children attain a certain age (usually around 25 or 30), they should receive the assets outright so that they can control the assets themselves and not have to worry about the complexities involved in the management of trusts. However, when asked if they would want larger inheritances to be protected from the creditors of their children and from division upon the divorce of a child, most clients would say yes. Providing such protection usually requires incorporating long-term trusts (frequently lasting for the lifetimes of their children) into the clients’ estate planning documents. Such long-term trusts must be carefully planned and drafted, taking into consideration a whole host of contingencies that might occur over the duration of the trust. When the clients’ have young children whose character development and financial futures are largely uncertain, the number of contingencies is obviously greater. Yet, even when the clients’ have adult children, careful planning and drafting of long-term trusts is still required. Even if no longer concerned about how their children might turn out, most clients want their children to be able to have as much control over and access to the trust assets as is possible without compromising the protection from creditors and from divorce that is possible from the trust. Striking the right balance among protection, access, and control can be tricky, especially if there are concerns about character development or about known abilities to manage trust assets.

This article will emphasize non-tax reasons for long-term trusts and provide some suggestions for drafting solutions for particular situations. While I do not claim to provide anything particularly innovative here, I do hope the reader finds value in this compilation of drafting examples of the more frequently used techniques and rationales for their use. Certainly, other drafting examples could have been included, and there likely are better versions of some of the examples provided here. Yet, my hope is that the examples provided might serve as a tool for practitioners looking to increase the level of sophistication in their planning and drafting of non-tax planned documents.

CAVEAT: All drafting examples given in the article should be used at the practitioner’s own risk.

II. OCCASIONS FOR LIFETIME TRUSTS

Before turning to the sample drafting provisions provided below, it will be helpful to consider many of the common occasions when trusts lasting for the lifetime of the clients’ children and/or grandchildren (hereinafter, “lifetime trusts”) may be appropriate. Sometimes it is the planning context that might call for lifetime trusts, while other times the particular estate planning solution that calls for it. The occasions for lifetime trusts will be discussed from both perspectives.

A. Testamentary Planning

Of course, any time a client engages the practitioner to prepare a will (or a revocable living trust), lifetime trusts may be appropriate. Our firm almost universally recommends lifetime trusts for children under testamentary documents, except for the very smallest estates.

B. Education Planning

While Section 529 plans do offer attractive income tax savings, they are not very flexible in terms of investment opportunities or the use of funds for non-education purposes. Many clients instead create education trusts for their children or grandchildren intended to fund college or graduate education. Education trusts can be designed to provide greater control over investments and to allow distributions for purposes other than education. This is especially beneficial if any of the children or grandchildren obtain scholarships or attend less expensive schools than anticipated because significant assets may remain after all education has been paid for.

If the education trusts are designed to terminate at a particular age with assets passing outright to the then living children and/or grandchildren, it is entirely possible that significant wealth will pass outside of


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trust and thus be potentially subject to the descendants’ creditors or subject to division upon divorce. Of course, the assets would then also be added to the descendants’ taxable estates, potentially resulting in increased estate taxes at their subsequent deaths. Consequently, whenever a client seeks to establish education trusts, even with seemingly modest sums, the practitioner should always discuss the benefits of lifetime trusts.

C. Life Insurance Planning

Even if the client is not interested in a life insurance trust for potential estate tax savings (i.e., for excluding the life insurance from his or her taxable estate), the insurance proceeds may be substantial enough to warrant lifetime trusts for children or grandchildren. Even when the life insurance is designed for income replacement in the event of premature death of the client (and thus the amount of insurance is intended solely to provide for living and education expenses until the child attains a certain age), clients do tend to be conservative in their estimates when determining the amount of insurance to purchase. Also, future events may eliminate or reduce the total amount of insurance the children might actually need, such as the children obtaining scholarships or attending less expensive schools, significant asset appreciation, the death of a child, etc.

Therefore, as with education trusts, the practitioner should always discuss lifetime trusts with the client who has or intends to acquire significant life insurance. Of course, if the client has a taxable estate and is considering a life insurance trust, the inclusion of lifetime trusts for the client’s descendants in the insurance trust instrument is a fairly simple matter. If the client is not already considering a life insurance trust, it may be more difficult to convince the client that the added trouble and expense of drafting lifetime trusts is worthwhile.

D. Asset Protection Planning

While effective asset protection planning does not require the use of trusts, trusts are frequently incorporated into such plans. One common technique is for the high risk spouse (e.g., a surgeon or a corporate executive) to create an inter vivos credit shelter trust or marital deduction trust for the primary benefit of the other spouse (funded with the donor spouse’s separate property). Assuming there is no fraudulent conveyance to the trust and the trust is irrevocable and properly drafted, the assets held in such a trust are typically protected from either spouse’s creditors under Texas law. Because significant assets are typically transferred into such trusts and such trusts are irrevocable, the client must think long and hard

about how such assets are to pass upon the death of the donee spouse. So, the practitioner must look beyond the client’s asset protection objectives and take the time to discuss the inclusion of lifetime trusts for children into the trust instrument.

E. Wealth Transfer Planning

Whenever a client seeks to pass wealth downstream to descendants via lifetime planning techniques, lifetime trusts should always be discussed since significant wealth is usually in play in such transactions. Grantor Retained Annuity Trusts (“GRAT’s) are common techniques for transferring large amounts of wealth to children. However, for technical reasons, GRAT’s cannot be used to transfer wealth to grandchildren without potential generation-skipping transfer tax consequences, many practitioners commonly have the GRAT assets pass directly to the children upon the expiration of the GRAT term. The better practice is to have the assets pass into lifetime trusts for the children so that the assets can be protected from their creditors and from division upon divorce, even if there are no transfer tax advantages to having the assets pass into lifetime trusts.

Charitable Lead Annuity Trusts (“CLAT’s”) benefit a charity for a certain period of time with all assets remaining at the end of the CLAT term passing to the client’s descendants. Because of the gift and estate tax features of CLAT’s, it is possible to pass significant wealth to the client’s descendants for very little gift or estate tax cost. However, as with GRAT’s, CLAT’s cannot be used to transfer wealth to grandchildren without potential generation-skipping transfer tax consequences. As a result, many practitioners simply pass the assets directly to the children at the end of the CLAT term rather than to lifetime trusts for the children.

Even relatively modest transfers to children and grandchildren arguably should be given to lifetime trusts for their benefit rather than to them outright. It is always possible that a donee will want to save such gifts for future use, and multiple modest gifts can quickly accumulate and appreciate into sizeable sums.

III. SAMPLE DRAFTING PROVISIONS A. Maximizing Access and Control While Still

Providing Protection From Third Parties Since most clients walk into the office assuming

their assets will not linger in trust for their children any longer than is necessary (e.g., not longer than age 25 or 30), most clients will not want to restrict their children’s ability to access the assets when they desire and to manage and control the assets how they see fit. Accordingly, even if lifetime trusts do protect the assets from creditors and from division upon divorce,


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most clients will still not entertain the idea of lifetime trusts unless those trusts give sufficient access and control to the children. The drafting examples contained in this section are designed to provide such access and control without compromising the protection available under lifetime trusts. In each case, it is assumed that each child has his or her own separate trust. 1. Co-Trustee, Then Sole Trustee

The following example provides that each child may serve as a co-trustee of his or her own trust after attaining a particular age and as sole trustee of such trust after attaining a later age and having served at least 3 years of service as a co-trustee. The idea is that the child will be taught by a co-trustee how to administer a trust properly as well as the benefits of leaving the assets in trust until distributions are necessary. After such training, the child will presumably be better prepared to administer his or her own trust and is thus empowered to elect to serve as sole trustee of the trust after a certain amount of training. “6.1 Appointment of Trustee. A. General Appointment Provisions. The Trustee of each trust created hereunder is [Trustee]. If [Trustee] shall fail or cease to serve as a Trustee of any trust created hereunder, then...[Provisions for Successor Trustee]. B. Power of Child to Serve as Co-Trustee. Once the Child for whose primary benefit any trust is created hereunder attains the age of twenty-five (25) years, then the Child may elect at any time thereafter to serve as Co-Trustee of such trust to serve with the Trustee or Trustees then serving. This election shall be subject to the following terms and conditions: 1. Manner of Election. The Child shall make such election by filing a written notice of election to serve as Co-Trustee, signed by the Child, in the Deed Records of Dallas County, Texas and then delivering a file-stamped copy of such notice to the Trustee or Trustees then serving. Such election shall become effective thirty (30) days after delivery to the Trustee or Trustees then serving has been made. 2. Effect of Election on Trustee Succession. If, after such election becomes effective for any trust created hereunder, any Co-Trustee then serving with the Child shall fail or cease to serve as Co-Trustee of such trust, such Co-Trustee shall be succeeded by the next individual or entity named as successor trustee

under Subsection 6.1A, to serve with the Child as Co-Trustee of such trust. If the Child shall fail or cease to serve as Co-Trustee of any such trust, the Trustee or Trustees then serving shall serve as sole Trustee or Co-Trustees of such trust, as applicable, and shall be succeeded as Trustee(s) of such trust in accordance with the provisions of Subsection 6.1A. C. Power of Child to Serve as Sole Trustee. The Child for whose primary benefit any trust is created hereunder may elect to serve as sole Trustee of such trust at any time after the later to occur of (i) such Child attaining the age of thirty (30) years or (ii) when such Child has served as a Co-Trustee of such trust for three (3) years. This election shall be subject to the following terms and conditions: 1. Manner of Election. The Child shall make such election by filing a written notice of election to serve as sole Trustee, signed by the Child, in the Deed Records of Dallas County, Texas and then delivering a file-stamped copy of such notice to the Trustee or Trustees then serving. Such election shall become effective thirty (30) days after delivery to the Trustee or Trustees then serving has been made. 2. Effect of Election on Trustee Succession. If, after such election becomes effective for any trust created hereunder, the Child shall fail or cease to serve as sole Trustee of such trust, the individual or entity serving as Co-Trustee or sole Trustee, as applicable, of such trust immediately before such election became effective shall again serve as Trustee of such trust and shall be succeeded as Trustee of such trust in accordance with the provisions of Subsection 6.1A.” 2. Mentoring Provisions

The following example is intended to work in tandem with the previous example, explicitly stating the client’s desire that their children be mentored before serving as sole trustees and outlining specific mentoring objectives and activities. “D. Co-Trustee To Serve as Mentor For the Child. Settlors intend and desire that, after such election becomes effective for any trust created hereunder, any Co-Trustee then serving with the Child should actively mentor the Child regarding the administration of the trust and the management of the assets of the trust, including, without limitation, actively mentoring the Child with respect to the following:

1. The nature and scope of the Trustee’s duties under the terms of this trust


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instrument, including the fiduciary duties owed to current and future beneficiaries;

2. Modern portfolio theory and the benefits

of diversification; 3. Appropriate risk tolerance and asset

allocation for the investment of the assets of the trust given the purposes of the trust and the needs of the current and future beneficiaries of the trust;

4. The tax consequences of making

distributions or failing to make distributions of income and principal of the trust in any particular year;

5. The Trustee’s duty to provide a periodic

accounting in accordance with the terms of this instrument; and

6. Any other practice, skill, or body of

knowledge that would be beneficial in preparing the Child to serve as sole Trustee of the trust.

The primary purpose of these mentoring provisions is to provide the Child with the opportunity to obtain the training and knowledge necessary for the successful administration of the trust. Accordingly, the Co-Trustee then serving with the Child shall make reasonable efforts to offer the Child the training described above, and Settlor requests that the Child fully avail himself or herself of such training. However, the Co-Trustee then serving with the Child shall incur no liability for acting or failing to act with respect to these mentoring provisions, and nothing in such provisions shall affect the Child’s election to serve as sole Trustee of the trust under the provisions of Subsection 6.1C.” 3. Drip Trust

Like the first example of this section, the following example is designed to provide each child the opportunity to learn how to administer his or her own trust properly. However, instead of the child being mentored by a co-trustee for a period of time before serving as sole trustee, the example allows the child to “sink or swim” each year with a small portion of the trust while the experienced trustee manages the rest of the trust. The idea is that the child will learn best by administering a small portion of the assets and comparing his or her own administration of those assets with how the experienced trustee manages the rest of the assets. Rather than giving the child full

reign over the entire trust all at once (i.e., upon meeting certain requirements for serving as sole trustee of the entire trust), the child eases into service as sole trustee over a period the 15-year period during which the trust assets “drip” into the portion of the trust he or she controls. “4.1 Provisions for Descendants.

*********** B. Separate Trust or Trusts for Child. Each separate trust share set aside at the Settlor’s death for a then living Child shall be retained and administered in trust for the primary benefit of that Child in accordance with the following provisions: 1. Child Under 25. If the Child is living at the Settlor’s Death but has not then attained the age of twenty-five (25) years, the Trustee shall retain and administer the Child’s entire separate trust share in a Child’s Trust A for the primary benefit of the Child in accordance with the provisions of Section 4.2. 2. Child Over 25 but Under 40. If the Child is living at the Settlor’s death and has then attained the age of twenty-five (25) years but has not then attained the age of forty (40) years, the Trustee shall divide the Child’s separate trust share into two (2) separate shares, “Part B” and “Part A,” respectively, in accordance with the following provisions:

(a) Part B. Part B shall consist of a portion of the Child’s separate trust share equal in value to the amount obtained when the Child’s separate trust share is multiplied by a fraction, the numerator of which is the Child’s age (in years) at the Settlor’s death less twenty-five (25), and the denominator of which is fifteen (15). The Trustee shall retain and administer Part B in a Child’s Trust B for the primary benefit of the Child in accordance with the provisions of Section 4.3.

(b) Part A. Part A shall consist of that

portion of the Child’s separate trust share remaining after Part B is subtracted from it. The Trustee shall retain and administer Part A in a Child’s Trust A for the primary benefit of the Child in accordance with the provisions of Section 4.2.

3. Child Over 40. If the Child is living at the Settlor’s death and has then attained the age of forty (40) years, the Trustee shall retain and administer the Child’s entire separate trust share in a Child’s Trust B


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for the primary benefit of the Child in accordance with the provisions of Section 4.3.

*********** 4.2 Child’s Trust A. Any share of any trust created hereunder required by this instrument to be retained in a Child’s Trust A for the primary benefit of a Child shall be retained in trust for the primary benefit of that Child, to be held, administered, and distributed as follows: A. Distributions to Child. The Trustee may distribute to the Child as much income and principal of the trust estate as will provide for the Child’s health, support, maintenance, and education, after taking into consideration, to the extent the Trustee deems advisable, any other income or financial resources known to the Trustee to be available to the Child. B. Annual Distributions To Child’s Trust B. In addition to the foregoing, after the Child has attained the age of twenty-five (25) years, the Trustee of the Child’s Trust A shall make an annual distribution on or about the Child’s birthday of an Annuity Amount (hereinafter defined) to the Trustee of the Child’s Trust B for the Child, to be retained and administered as part of the Child’s Trust B in accordance with the provisions of Section 4.3. The “Annuity Amount” shall consist of an amount of income and principal of the trust estate equal in value to the amount obtained when the value of the trust estate on the Applicable Date (hereinafter defined) is multiplied by a fraction, the numerator of which is one (1), and the denominator of which is forty (40) less the age of the Child on the Applicable Date. For purposes of this Subsection 4.2B with respect to any Child’s Trust A, the term “Applicable Date” means later of (i) the date of the Settlor’s Death or (ii) the date when such Child attains the age of twenty-five (25) years. Furthermore, once the Child attains the age of forty (40) years, the Trustee of the Child’s Trust A shall distribute all of the remaining trust estate to the Trustee of the Child’s Trust B, to be retained and administered as part of the Child’s Trust B in accordance with the provisions of Section 4.3.

*********** 4.3 Child’s Trust B. Any share of any trust created hereunder required by this instrument to be retained in a Child’s Trust B for the primary benefit of a Child shall be held, administered, and distributed as follows...”

4. Special Distribution Trustee While the examples above give the child

increased control over the trust assets by allowing the child to serve as sole trustee of the trust, the following example gives the child increased access to the trust assets after the child is serving as sole trustee. Whenever a trustee is also a beneficiary of a trust, that trustee cannot make distributions to or for his or her own benefit unless those distributions are limited to an ascertainable standard (i.e., for health, support, maintenance, or education). If the trustee can make distributions to or for his or her own benefit that are not limited to an ascertainable standard, then the trust assets lose their protection from creditors and from division upon divorce (and are also includible in the trustee’s estate for estate tax purposes). However, a different trustee may be given the power to make distributions to the child for any purpose (i.e., no need to limit distributions to health, support, maintenance, and education) without compromising the protected status of the trust assets. “3.1. Separate Trust for Child. Each separate trust share set aside at the Settlor’s death for a then living Child shall be retained and administered in trust for the primary benefit of that Child in accordance with the following provisions: A. Distributions. The Trustee may distribute to the Child as much income and principal of the trust as will provide for the Child’s health, education, maintenance, or support after taking into consideration, to the extent the Trustee deems advisable, any other income or financial resources known to the Trustee to be available to the Child. Additionally, the Special Distribution Trustee may distribute to the Child as much income and principal of the trust as will provide for the Child’s health, education, maintenance, support, welfare, comfort, and happiness or for any other purpose, and in such amounts as the Special Distribution Trustee deems advisable in its sole and absolute discretion.

*********** 5.2 Appointment of Special Distribution Trustee. Settlor hereby appoints [Spec. Dist. Trustee] as Special Distribution Trustee of each trust created hereunder for the primary benefit of Justin. If [Spec. Dist. Trustee] (or any other Special Distribution Trustee hereinafter designated) fails or ceases to serve as Special Distribution Trustee of any such trust, then the Trust Committee for that trust shall appoint a person or entity who meets the qualifications of an Independent Trustee to serve as successor Special Distribution Trustee of


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that trust. If the Trust Committee fails to appoint a successor Special Distribution Trustee, then a majority of the adult beneficiaries of that trust who are entitled to have income distributed to them or accumulated for their benefit shall appoint a person or entity who meets the qualifications of an Independent Trustee to serve as successor Special Distribution Trustee of that trust. If there are no adult beneficiaries of that trust or if the adult beneficiaries fail to appoint a successor Special Distribution Trustee, then upon written request of any interested person, the judge of any federal court or statutory probate court located in Dallas County, Texas, acting as an individual and not in any judicial capacity, and without liability for acting or failing to act, shall have the power to appoint a person or entity who meets the qualifications of an Independent Trustee to serve as successor Special Distribution Trustee of that trust. Any person or committee entitled to appoint a successor Special Distribution Trustee shall have the power to make such an appointment for a period of thirty (30) days after receiving written notice of such vacancy before that person or entity shall be deemed to have failed to make that appointment. Notwithstanding anything herein to the contrary, the Special Distribution Trustee shall have no powers, duties, rights, or responsibilities hereunder other than the distribution powers described under the provisions of Subsection 3.1A. Furthermore, upon the Child’s death, the then serving Special Distribution Trustee shall cease to serve in that capacity, and no successor Special Distribution Trustee shall be appointed.” [ALTERNATE PROVISIONS] 5.2 Appointment of Special Distribution Trustee. Notwithstanding anything herein to the contrary, the Child shall have the discretionary power by written instrument, acknowledged and signed by the Child, and delivered to the Trustee, (1) to appoint a Special Distribution Trustee (herein so called) of the Child’s Trust created for the Child’s primary benefit hereunder at any time and for any reason, and/or (2) to remove a Special Distribution Trustee for such trust and appoint a successor Special Distribution Trustee; provided, however, any Special Distribution Trustee appointed by the Child must either be a corporate Trustee meeting the qualifications of Subsection 5.13A hereof or an Independent Trustee. The Distribution Trustee shall have no powers, duties, rights, or responsibilities hereunder other than the distribution powers described under the provisions of Subsection 3.1A. Furthermore, any Distribution Trustee so appointed shall serve until the Child fails or ceases to serve as Trustee of such trust, at which time such Special Distribution Trustee

shall cease to serve and no other Special Distribution Trustee shall thereafter be appointed.

*********** 5.13 Corporate Trustee and Independent Trustee. A. Qualification of Corporate Fiduciary. Notwithstanding any other provision of this instrument, any corporate Trustee appointed hereunder shall be required to have trust assets under administration valued at not less than one hundred million dollars ($100,000,000) and shall be (a) a bank having banking and trust powers organized under the laws of the United States or any state or (b) a private trust company, having trust powers only, organized under the laws of the United States or any state. B. Independent Trustee. All references in this instrument to an "Independent Trustee" shall mean an individual or entity that can possess the powers vested exclusively in a Trustee under this instrument without (a) causing trust income or principal to be attributable to Settlor, a Trustee, or a trust beneficiary for federal income, gift or estate tax purposes prior to the distribution of that trust income or principal to the beneficiary, if the presence of someone else in the office of Trustee would avoid that result, and (b) causing a Trustee or Settlor to be treated as an owner of the trust for federal income, gift or estate tax purposes if the presence of someone else in the office of the Trustee would avoid that result. As used in this instrument, the term "Independent Trustee" means a Trustee who meets the requirements of this section. Notwithstanding anything herein to the contrary, no individual may serve as an Independent Trustee if that individual is "related or subordinate" to Settlor within the meaning of Section 672(c) of the Code. 5. Termination By An Independent Trustee

Sometimes, clients do not want to “lock up” assets in lifetime trusts unless someone has the power to unlock those assets and distribute them outright and free of trust.

“5.16 Termination of Trust by Independent Trustee. Notwithstanding anything herein to the contrary, an Independent Trustee of any trust created hereunder shall be empowered at any time to terminate such trust in the Independent Trustee’s sole and absolute discretion, by an instrument in writing signed by that Independent Trustee and acknowledged before a notary public. Such termination shall be effective when that Independent Trustee files such signed and


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acknowledged instrument in the Deed Records of Dallas County, Texas. Upon termination, the Independent Trustee shall distribute the trust assets of such trust as follows: A. Child’s Trust. If the trust to be terminated is a Child’s Trust established pursuant to Section 3.1 hereof, the trust assets shall be distributed by the Independent Trustee to the Child who is the primary beneficiary of such trust. B. Contingent Trust. If the trust to be terminated is a trust established pursuant to Section 3.4 hereof, the trust assets shall be distributed by the Independent Trustee to the Ward who is the primary beneficiary of such trust. C. Any Other Trust. If the trust to be terminated is any other trust created hereunder, the trust assets shall be distributed equally to the persons (or, if applicable, solely to the person) for whose primary benefit, in the Trustee's reasonable judgment, the trust is being held, and any such decision by the Trustee shall be binding upon all persons whomsoever. The Independent Trustee shall not be liable for terminating or failing to terminate a trust or share thereof as authorized by this section.” 6. $5,000 or 5% Withdrawal Power

Some clients desire that their children have a unilateral power to withdraw assets from their own trusts, regardless of whether they are serving as trustees of such trusts. They typically view this power as enabling the child to have some amount of access to the trust assets without having to ask a trustee for permission to receive the distribution. Such a power may make the child less resentful that he or she is an “adult” (say, age 22) but still has to ask for large distributions. It also allows the child to “sink or swim” with a small amount of money before allowing the child full control over the trust assets at a later date. As long as the withdrawal right is limited to the greater of $5,000 or 5% of the trust assets, the existence of the power will neither expose the trust assets to inclusion in the child’s estate for estate tax purposes nor subject the assets to the claims of the child’s creditors or the child’s spouse upon divorce. “B. Withdrawal Power. The Child shall have a special withdrawal right with respect to this trust in accordance with the following provisions: 1. Amount of Withdrawal Right. At any time during the month of December in any calendar year the

Child shall have the right to withdraw cash or property from this trust up to, but not exceeding, the greater of five thousand dollars ($5,000) or five percent (5%) of the fair market value of the principal of the trust as determined on December 1st of that year. 2. Withdrawal Right Noncumulative/Lapse of Withdrawal Right. The foregoing withdrawal right is noncumulative. Accordingly, if a withdrawal right is not fully exercised during the month of December of a particular calendar year, that unexercised right as to that year shall lapse and shall not be exercisable thereafter. 3. Limitation on Amount of Withdrawal Right. Notwithstanding the foregoing provisions, the withdrawal right granted to the Child in each calendar year shall under no circumstances exceed the amount of the withdrawal right the lapse of which would cause the Child to have made a taxable gift for federal gift tax purposes or to have released a general power of appointment for federal estate tax purposes. 4. Exercise of Withdrawal Right. The Child may exercise the foregoing withdrawal right by an acknowledged written instrument signed by the Child and delivered to the Trustee within the applicable withdrawal period.” 7. Special Power of Appointment

If a client initially desired leave assets outright to children at a particular age but is considering lifetime trusts for children, then allowing each child to choose how his or her own share of the inherited assets will pass when the child dies (i.e., giving the child a power of appointment) usually sweetens the client on lifetimes trusts even more. Sometimes, the client desires that his or her children be able to leave property to anyone. In that case, it is usually best to exclude the child’s creditors, the child’s estate, and the creditors of the child’s estate, allowing the child to give trust assets to anyone else. This will prevent the trust from being includible in the child’s estate for estate tax purposes and will not cause the trust assets to be subject to the child’s creditors.

More frequently, however, clients do prefer to exercise a little “dead hand control” over the trust assets by limiting the scope of child’s power of appointment. The main concern usually is that the child will leave assets to the child’s spouse who might then leave what were the client’s assets to kids from a prior or subsequent marriage or to a subsequent spouse. The following example allows the child to benefit the spouse through a trust over which the spouse has no


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control and no direct access, as well as benefit the child’s descendants and/or charities. “D. Termination and Special Power of Appointment. If not earlier terminated by distribution of the entire trust estate under the foregoing provisions, the Child’s Exempt Trust shall terminate upon the death of the Child for whose primary benefit it was established, at which time the remaining trust estate shall be distributed as follows: 1. Special Power of Appointment. On termination, the Trustee shall distribute the remaining trust estate, or any part thereof, to the limited class consisting of Settlor’s descendants (other than the Child), any one (1) or more Charities, and a Spouse’s Trust (described below), in those amounts and proportions and, except as required with respect to a Spouse’s Trust, upon those terms and conditions, either outright or in trust, as the Child shall appoint by a will or a codicil signed and taking effect after the Surviving Settlor’s death that specifically refers to this power and expresses the intention to exercise it. Nothing herein shall be construed as authorizing the Child to appoint to the Child, the Child’s creditors, the Child’s estate, or creditors of the Child’s estate, nor may this power of appointment be exercised in a manner that will violate the rule against perpetuities or any other law restricting the period of time for which property may validly be held in trust. For purposes of the special power of appointment granted under this paragraph, the term “Spouse’s Trust” shall mean a trust for the primary benefit of the Child’s spouse that has the following restrictions: the Child’s spouse is prohibited from serving as the trustee; distributions of trust principal to the Child’s spouse may be made only for the health, support, and maintenance of the Child’s spouse after considering other financial resources available to that spouse; and, upon termination of the Spouse’s Trust, the then remaining trust estate may only be distributed to any one (1) or more of the class consisting of Settlor’s descendants, if any, and Charities. 2. Distribution of Remaining Property. The remaining and unappointed trust property not distributed pursuant to the foregoing provisions shall be distributed to the Child’s then living descendants. If no descendant of the Child is living upon the termination of the Child’s Exempt Trust, the Trustee shall distribute the then remaining assets of the Child’s Exempt Trust to Settlors’ then living descendants. If, however, any part of the Child’s Exempt Trust is distributable to a person for whose primary benefit a trust is then being administered under this instrument, that part may be added to that trust and administered

according to its terms. If no descendant of Settlors is living upon the termination of the Child’s Exempt Trust, the Trustee shall distribute the then remaining and unappointed estate of the Child’s Exempt Trust in accordance with the applicable provisions of Article VI, as if the Surviving Settlor died immediately after the termination of the Child’s Exempt Trust.” 8. Contingent General Power of Appointment

With the increasing use of trusts that last for the lifetime of the child, it may be very useful to grant the child a general power of appointment in a trust that is fully nonexempt (i.e., has an inclusion ratio of 1) in order to attract the estate tax rather than the GST tax on the death of the child. That is, if the child has a general power of appointment, then the trust estate will be includible in the child’s gross estate for estate tax purposes upon the child’s death (rather than subject to GST taxation as a taxable termination). Under current law, there is a flat estate tax rate of 45%, and the GST tax rate is also 45% (because under IRC §2641(a), the GST tax rate is defined as the maximum estate tax rate). So, this technique currently is of limited use. However, as was the case in the past, it may again be the case in the future that there are graduated estate tax rates that would result in a smaller estate tax bill if the child’s trust is includible in the child’s estate than the GST tax bill that would be due if the trust is not includible in the child’s estate.

Given the uncertainty of the estate and GST tax rates, it would certainly seem prudent to include a general power of appointment in any lifetime trusts for children. But, what if in the year the child dies the GST tax bill would not be higher than the estate tax bill? In that case, it would be better if the trust did not include a general power of appointment since such a power would enable the child’s creditor’s to gain access to the trust principal and might enable the child to leave trust property to anyone (and not just grandchildren).

Accordingly, the best approach is to include a contingent general power of appointment that is effective when it is needed and is not effective when it is not needed. Such a power can be limited to the creditors of the child’s estate (as the sample language below is) and yet still qualify as a general power of appointment. See IRC §2041(b)(1). Such a provision should call for the payment of any estate taxes that may result due to the existence of such power. The contingent general power of appointment can be in addition to a special power of appointment. An example of such a power included in a joint living trust is as follows:


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“1. Contingent General Power of Appointment: Generation-Skipping Transfer Tax. Notwithstanding anything herein to the contrary (and in addition to, and not in lieu of, the testamentary special power of appointment granted to the Child under the paragraph immediately above), the Child shall have a testamentary general power of appointment, exercisable by will or codicil signed by the Child and taking effect after the Surviving Settlor’s death, to direct the Trustee to pay and distribute to the creditors of the Child’s estate that portion, and only that portion, of the Child’s Nonexempt Trust estate which, were it not for the existence of this general power of appointment, would be subject to, and would result in the actual payment of, as a result of the Child’s death, a generation-skipping transfer tax, and with respect to which, as a result of the existence of this general power of appointment, the maximum graduated federal estate tax rate attributable to any part of such portion will be less than the actual rate of tax which would otherwise be imposed upon such part for purposes of the federal generation-skipping transfer tax. For the purposes of making the above comparison of rates of taxation, it shall be assumed that any such portion of the Child’s Nonexempt Trust estate is in addition to those assets otherwise included in the taxable estate of the Child for federal estate tax purposes and will, accordingly, be subject to estate tax rates equal to or in excess of those rates which would be applicable to such taxable estate but for the operation of this paragraph.

2. Payment of Taxes. Unless the Child

specifically directs to the contrary by the Child’s will, the Trustee shall distribute from the principal of the unappointed trust estate directly to the appropriate taxing authority, or to the legal representative of the Child’s estate, as the Trustee deems advisable, the amount, if any, by which the federal estate and state death taxes assessed by reason of the death of the Child shall be increased as a result of the inclusion of the Child’s Nonexempt Trust in the Child’s estate. The Trustee shall be entitled to rely entirely upon the written certification of the representative of the Child’s estate as to the amounts required and those entitled thereto. Neither the selection of assets to be sold nor the tax effect of that selection shall be subject to question by any beneficiary.” B. Incentive Provisions and Limited Control Or

Access While most clients want to leave their assets to

their descendants in a manner giving them maximum control and access, there are of course some clients who have concerns about their descendants having

such control or access. Other clients worry that leaving large sums of money to their young descendants might discourage them from developing into productive, ethical members of society. In such cases, the practitioner must be prepared to advise the client about the advantages and disadvantages of various types of provisions for exercising such “dead hand” control.

As a general rule, dead hand control should be used strategically and sparingly. Unless the client expresses concerns about the character development of their descendants or provides other facts indicating a need to limit control or access to assets, the practitioner should avoid suggesting any special dead hand control provisions. Such provisions can often send a message to the client’s descendants that they were not trusted. Even worse, if overly restrictive or otherwise poorly drafted, such provisions can end up unnecessarily limiting access to trust assets in circumstances where the client would never have intended such limitations. And, poorly drafted provisions can paralyze a well-meaning trustee who is uncertain just how to act, sometimes even leading to the necessity of court involvement to clarify how the trust is to be administered.

In most cases, the best course of action is to select a trustworthy and competent trustee and then give that trustee broad discretion over distributions and the administration of the trust. If the client expresses particular concerns about the character or capacity of their descendants (whether existing or potential concerns), having the client write an informal letter to the trustee about those concerns can be all that is needed. If the client has more serious concerns, they also typically have spent time thinking of particular trust provisions that they think will satisfy their concerns. The practitioner will often need to play devil’s advocate, spending time walking the client through concrete situations which might produce unwitting results if the client’s particular trust provisions were implemented. Of course, the practitioner must also have better solutions and be able to explain why such solutions are better.

What follows are some of the “dead hand” control provisions that our firm has implemented for our clients. Our firm tends to favor the provisions containing subjective standards (giving the trustee guidance as to the client’s concerns) over the objective standards (directing the trustee to take certain actions when certain criteria are met). Particularly in lifetime trusts but also true of other trusts, it is generally better to rely on the judgment of a trustworthy and competent trustee who can assess the facts and circumstances at the time action needs to be taken than it is to dictate a course of action in advance. Nonetheless, objective


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standards do have their place. When they are used, they must be narrowly drafted and tailored to meet very specific concerns and circumstances, leaving other decisions in the discretion of the trustee.

When clients express concerns about their descendants’ character or capacity, after explaining the pitfalls of “dead hand” control provisions, we first suggest a broad, subjective standard for addressing those concerns. Most clients are satisfied with the first example below, but if not, then we turn to one of the other examples below containing objective standards. 1. Moral Turpitude – Subjective Provision

“Special Provisions to Encourage Socially Responsible and Productive Behavior. At the time of execution of this instrument, Settlor is pleased with the intellectual and moral development of each of the Children. Settlor expects each such Child will continue to maintain high intellectual and moral standards and will eventually be a productive and contributing member of society. However, Settlor is also aware, in connection with other families Settlor has observed, that the availability of large amounts of cash and other assets from a trust created for a descendant could prove to be a deterrent to that descendant’s productive behavior and development as a total person. Settlor is also aware that a descendant who has the availability of large distributions of income and other assets may lose an incentive to be a productive member of society or may also make life choices that prove to be detrimental to that descendant and other members of his or her family. Accordingly, notwithstanding any distribution provisions of any trust created hereunder, Settlor hereby empowers the Trustee to limit or withhold distributions to or for the benefit of any of Settlor’s descendants under those provisions in the manner and to the extent the Trustee deems advisable, in the sole and absolute discretion of the Trustee, if the Trustee determines, in the Trustee’s sole and absolute judgment, that the conduct and deportment of that person would not have met Settlor’s approval during Settlor’s lifetime. By way of guidance and not by way of limitation, the conduct and deportment of a person that would not meet with Settlor’s approval includes, without limitation, alcohol and/or substance abuse, dishonesty, the commission of a felony, and moral turpitude. However, such guidance should not be taken to preclude distributions for such expenses as treatment for alcohol or substance abuse, nor should it be taken as suggesting that immoral or illegal behavior should permanently preclude all future distributions to or for the benefit of the descendant, particularly when the descendant subsequently shows signs of reform. By way of further guidance and not by way of limitation, Settlor would not approve of any

of Settlor’s descendants forsaking the pursuit of gainful employment and instead relying for support on any trust created by Settlor. Settlor’s intention with respect to this guidance is not to encourage Settlor’s descendants to seek employment that would produce the largest financial rewards but rather to encourage Settlor’s descendants to be productive and socially responsible, and the provisions of this paragraph should be construed in light of that intention.” 2. Drug Abuse and Felonies “A. General Distribution Provisions. The Trustee may distribute to the Child as much income and principal of the trust estate as will provide for the Child’s health, support, maintenance, and education, after taking into consideration, to the extent the Trustee deems advisable, any other income or financial resources known to the Trustee to be available to the Child. Notwithstanding the foregoing, no distributions shall be made to the Child under this Subsection A if the Child is then within either a Drug Abuse Probationary Period or Criminal Probationary Period as described in Subsection B below. B. Distributions To Child During Probationary

Periods. 1. Permitted Distributions. Notwithstanding any other provision of this section, while a Child is within a probationary period (hereinafter defined), then no distribution shall be made to that Child from the Child's Trust, except as follows:

(a) Distributions for Health Needs.

The Trustee may distribute to the Child as much of the income or principal of the Child's Trust as will provide for the Child's health needs, to the extent not covered by health insurance. This shall include, without limitation, distributions for the Child's medical care, hospitalization, drug or alcohol rehabilitation, psychiatric care, and other similar expenses and costs that the Trustee determines, in the Trustee's sole and absolute discretion, should be incurred for the Child's mental and physical health.

(b) Basic Amount. In addition to the

foregoing, the Trustee shall also distribute to the Child from the Child's Trust, in equal monthly installments, fifty thousand dollars ($50,000.00) per annum, adjusted for inflation by 3% per year from the year 2009.


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2. Probationary Periods. For all purposes under this instrument, the term “probationary period” shall include two types of periods: (1) a “Drug Abuse Probationary Period”, and (2) a “Criminal Probationary Period”.

(a) Drug Abuse Probationary Period. A Drug Abuse Probationary Period shall begin with respect to a Child upon the occurrence of any of the following events:

(i) The Child tests positively

for the use of an illegal drug or narcotic;

(ii) Two (2) licensed

physicians determine, through commonly accepted tests or procedures, that the Child is addicted to or abusing drugs (whether or not illegal), barbiturates, alcohol or any other controlled substance and is a danger to himself or herself and to others; or

(iii) The Child refuses to

comply with a request by the Trustee that the Child subject himself or herself to medical examinations to determine if either of the conditions (i) or (ii) above apply.

A Drug Abuse Probationary Period shall end with respect to a Child when the Child establishes, through regular tests, to the reasonable satisfaction of the Trustee, that neither of the conditions described in I. or II. applies and that the Child has refrained from the use of illegal drugs or narcotics for a period of three (3) years.

(b) Criminal Probationary Period. A

Criminal Probationary Period shall begin with respect to a Child upon the conviction of the Child, or the entering of a guilty plea by the Child, for any felony, as defined by the statutes of the jurisdiction where the conviction or guilty plea is entered. A Criminal Probationary Period shall end with respect to a Child upon the last to occur of (a) the expiration of three (3) years after the conviction or entering of a guilty plea or (b) the completion of the period of incarceration with respect to such felony. Furthermore, the Child shall be deemed to be in a Criminal

Probationary Period during the period of the Child's incarceration because of such conviction or entering of a guilty plea even if that Child was returned to jail or prison after three years on parole or probation.”

3. Cap on Distributions

“Limitations on Distributions to Child. Notwithstanding anything herein to the contrary, the total distributions made by any Trustee (other than Settlor) to the Child under the terms of this instrument shall not exceed during any calendar year one hundred thousand dollars ($100,000.00), as adjusted annually for inflation at a rate of three percent (3%) per year from the base year 2009. For purposes of calculating the limit described in this paragraph, distributions for the Child’s heath shall not be taken into account.” 4. Income Matching Provision

“In addition to the foregoing distributions, within the first six (6) months of each calendar year of this trust, with the exact time of such distribution to be determined by my Trustee, my Trustee shall distribute to my Child an amount of cash or property (as determined by my Trustee) equal in value to one hundred and twenty percent (120%) of the aggregate of my Child's Earnings during the previous calendar year. For this purpose, the term “Earnings” shall mean all salaries, wages, bonuses, commissions or other compensation for personal services actually paid to my Child during the prior calendar year.” 5. Bonuses For Education

The following provisions are designed to incentivize children to pursue undergraduate and graduate level degrees. The provisions were taken from an actual client situation where the clients’ primary goal was to ensure that all their children had ample funds for post-secondary education as well as an emergency fund for health care needs. Accordingly, the clients desired a “pot trust” that would expire when their youngest child turned age 27 – a point when the clients felt their children should be done with all post-secondary degrees if they were working hard enough (some might think a later date advisable). Also, the client declined to have assets retained in separate lifetime trusts for their children after the termination of the common trust, against their attorney’s urging.

“A. Common Trust. Any share of any trust created hereunder required by this instrument to be distributed under this article shall be retained and administered in a Common Trust (herein so called) for the benefit of Settlors’ Children in accordance with the following provisions:


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1. Distributions for Health. The Trustee may distribute to a Child so much income and principal of the Common Trust as will provide for that Child’s health. 2. Distributions for Support, Maintenance, and Education. The Trustee may also distribute to any Child who is under the age of twenty-seven (27) years so much income and principal of the Common Trust as will provide for that Child’s support, maintenance, and education, after taking into consideration, to the extent the Trustee deems advisable, any other income or financial resources known to the Trustee to be available to the Child. 3. Special Distributions. If and when a Child obtains a bachelor’s degree from an accredited university, the Trustee shall distribute twenty-five thousand dollars ($25,000.00) to that Child from the Common Trust. If and when a Child obtains a graduate or professional degree from an accredited university or professional school, the Trustee shall distribute fifteen thousand dollars ($15,000.00) to that Child from the Common Trust. 4. Distributions need not be equal. Distributions under this subsection need not be equal among the beneficiaries; and distributions to a beneficiary shall not be charged against the distributive share of that beneficiary. 5. Termination. The Common Trust will terminate when the youngest Child attains the age of twenty-seven (27) years. Upon termination, the remaining trust assets shall be divided into separate shares, equal in value, with one (1) share for each then living Child and one (1) share for the then living descendants, collectively, of each deceased Child. The Trustee shall distribute each share allocated to a then living Child to that Child. The Trustee shall distribute each share allocated to the then living descendants of a deceased Child to that deceased Child’s then living descendants. If no descendant of the Settlors is then living, the Trustee shall distribute the remaining trust estate to the American Cancer Society.” 6. Trust Committee With The Power to Remove

Child As A Trustee

“6.15 Trust Committee. A. Appointment of Trust Committee. Settlor hereby appoints a Trust Committee (herein so-called) for each trust created hereunder, and that committee shall be composed of [3 Members]. If membership in a

committee is ever reduced to less than three (3) individuals, the remaining member or members of that committee shall appoint a sufficient number of individuals to bring the total membership of the committee to a total of three (3) individuals. Under no circumstances shall any Trustee who is removed by a Trust Committee serve on any Trust Committee hereunder. It is the Settlor’s intention that there shall always be at least three (3) members serving on each Trust Committee hereunder. B. Powers of Trust Committee. The Trust Committee for each trust created hereunder shall have the discretionary power, by majority vote, to remove at any time a Trustee of that trust (including a Child with respect to any trust created hereunder for that Child’s primary benefit) and/or, in its discretion, appoint a successor Trustee. The powers granted under this subsection must be exercised by acknowledged instrument, signed by those members of the committee intending to exercise those powers, and delivered to the Trustee being removed and, if applicable, to the successor Trustee being appointed. No Trustee or member of the Trust Committee for that trust shall be liable for the exercise or failure to exercise of that committee’s discretionary powers granted hereunder. Any Trustee appointed by a Trust Committee must be an Independent Trustee.” 7. Subjective and Objective Standards For

Removing A Child As A Trustee “A. Removal Without Cause. If a Child is serving as a Trustee of any trust created hereunder, the Trust Committee may remove that Child from service as a Trustee of such trust without cause, in the sole and absolute discretion of the Trust Committee. Settlor requests but does not require that the Trust Committee, in the exercise of their sole and absolute discretion under this Subsection A, take into account whether or not, at the time of such determination, such Child sought to be removed:

(a) is guilty of bad faith, fraud, willful misconduct, gross negligence, or a pattern of ordinary negligence,

(b) is not acting competently, (c) is not engaging in sound and prudent

investment practices, (d) is, or has been at any time, a substantial

user of or addicted to a substance the use of which might adversely affect one’s ability to serve as a Trustee,


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(e) is suffering from any physical, mental, emotional, or other condition that might adversely affect one’s ability to serve as a Trustee,

(f) is engaging in behavior detrimental to

any business under the management of the Trustee,

(g) has demonstrated financial instability

and/or an inability to manage, invest, and conserve one’s own property,

(h) is going through a period of emotional,

marital, or other stress that might affect one’s ability to serve as a Trustee, and

(i) is under the influence of any one (1) or

more individuals or organizations who or which might successfully endeavor to induce one to part with assets under the management of the Trustee.

B. Removal For Cause. If a Child is serving as a Trustee of any trust created hereunder, the Trust Committee may remove that Child from service as a Trustee of such trust for cause in accordance with the following terms and conditions: (a) Violation of Removal Standard and Determination By Simple Majority. In order to remove a Child from service as a Trustee for cause, two (2) conditions must be met: (1) such Child must be in violation of the Removal Standard (hereinafter described), and (2) a simple majority of the Trust Committee members must concur in a determination that such violation of the Removal Standard is grounds for removal. (b) Removal Standard. For purposes of Paragraph (a) above, violation of the Removal Standard shall consist of any one (1) or more of the following:

(i) One (1) or more convictions of a felony; (ii) Two (2) or more convictions for

criminal acts relating to intoxication, including without limitation convictions for criminal acts described under Chapter 49 of the Texas Penal Code;

(iii) Refusing to submit to a drug test in compliance with the terms of any such request by a majority of the Trust Committee members; or

(iv) Testing positive on a drug test for the

presence of any illegal or controlled substance, unless possessing a valid prescription for such substance.

C. Other Necessary Provisions

Because lifetime trusts can last for a very long time, such trusts should include certain safeguards and flexibilities. The following example provisions should be included in every lifetime trust. 1. Spendthrift Trust Provision “Spendthrift Trust Provisions. Each trust created hereunder is a spendthrift trust. Accordingly, no beneficiary of any trust created hereunder shall have the right or power to anticipate or in any manner impair, by assignment or otherwise, his beneficial interest in the principal or income of the trust estate; nor shall any beneficiary have the right or power to sell, transfer, encumber, or in any way charge his interest in the trust estate prior to actually receiving same. Prior to distribution hereunder, neither the income nor principal of any trust established hereunder shall be subject to any execution, garnishment, attachment, bankruptcy, claims for alimony or support, other legal proceeding of any character, legal sequestration, levy or sale, or in any other event or manner be applicable or subject, voluntarily or involuntarily, to the payment of a beneficiary’s debts. The Trustee shall make distributions to or for each beneficiary according to the terms hereof, notwithstanding any purported sale, assignment, hypothecation, transfer, attachment, or judicial process.” 2. “HEMS” Standard Whenever a beneficiary is to serve as a trustee of his or her own trust, the trustee must be constrained by an ascertainable standard (i.e., health, education, maintenance, or support) or else the trust will lose any protections from creditors or division on divorce and will also be included in the trustee-beneficiary’s estate.

“Distributions. The Trustee may distribute to the Child as much income and principal of the trust as will provide for the Child’s health, education, maintenance, or support after taking into consideration, to the extent the Trustee deems advisable, any other income or financial resources known to the Trustee to be available to the Child.”


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3. Distributions are Separate Property “Distributions are Separate Property. Any distribution of income or principal from any trust created hereunder to a beneficiary of that trust shall be the sole and separate property of that beneficiary.” 4. No Distributions to Satisfy Legal Obligations “Limitations Re Legal Obligations and Support. Notwithstanding any other provision of this instrument, neither income nor principal of any trust created hereunder shall be used to discharge in whole or in part the personal contractual obligations of Settlor, any spouse of Settlor, or a Trustee, or the personal legal obligations to support any of the beneficiaries of such trust owed by Settlor, any spouse of Settlor, or a Trustee (i.e., a personal legal obligation that Settlor, any spouse of Settlor, or the Trustee might have under applicable state law to use his or her own funds to provide for a beneficiary’s support and/or education). The purpose of this section is to avoid adverse estate and income tax consequences to Settlor, any spouse of Settlor, and the Trustee, and any question about the scope of this section should be answered in light of that purpose. When determining the legal obligations of any person to support any of the beneficiaries of such trust, the existence of such trust and funds made available by it shall not be taken into consideration.” 5. Merger of Trusts

“Merger of Trusts. To combine the assets of separate trusts under this instrument for the purpose of more convenient administration or investment for any period of time, preserving the separate character of the beneficiaries’ proportionate shares. Furthermore, the Trustee of each trust created hereunder is hereby empowered to merge the assets of such trust with those of any other trust, by whomsoever created, which is maintained for the same beneficiaries upon substantially the same terms. However, the Trustee shall not effect a merger under this subsection until the Trustee examines the generation-skipping transfer tax consequences of such a merger.” 6. Severance of Trust “Division Into Separate Trusts. Settlor authorizes and directs the Trustee, with respect to any trust which is to be created hereunder and which is expected to have an inclusion ratio, as defined in Section 2642(a)(1) of the Code, of neither one (1) nor zero to create two (2) separate trusts in lieu of that single trust and/or to divide that trust into two (2) separate trusts in order that the federal generation-skipping transfer tax inclusion ratio for each such trust as determined pursuant to Chapter 13 of the Code shall be either one (1) or zero. Specifically, the two (2) trusts created

shall contain the following: (a) one (1) of the separate trusts created shall contain property to which the Trustee (or, if applicable, the executor of Settlor’s estate) shall allocate a sufficient amount of the available exemption under Section 2631 of the Code so as to result in the entire trust being exempt from federal generation-skipping transfer tax (the “GST Exempt Trust”) and (b) one (1) of the separate trusts shall contain property to which the Trustee (or, if applicable, the executor of Settlor’s estate) shall not allocate any such exemption (the “Non-Exempt Trust”). Each separate trust created by the Trustee shall be administered in accordance with the same terms contained in the trust that, but for this provision, would have been created except that, in making distributions of corpus, the Trustee shall make distributions first from the Non-Exempt Trust until the corpus of that trust is exhausted, and second from the GST Exempt Trust. Further, the property transferred to each trust shall be fairly representative of the net appreciation or depreciation in the value of all property available for such use between the date of valuation of that property in Settlor’s estate for federal estate tax purposes and the date or dates of distribution.” 7. Rule Against Perpetuities “Maximum Duration of Trusts. If not sooner terminated pursuant to the other provisions hereof, each trust created hereunder that has not theretofore vested in such a manner as to avoid the application of the rule against perpetuities or any other law restricting the period of time for which property may validly be held in trust shall terminate not later than twenty-one (21) years after the death of the last survivor of Settlor, Settlor’s Spouse, Settlor’s descendants living at the time this trust instrument is executed, and any individual specifically identified by name in this instrument who is living at the time this trust instrument is executed. The assets of a trust terminated pursuant to this section shall be distributed equally to the primary beneficiaries thereof as determined by the Trustee, and the Trustee’s decision shall be binding.” D. Drafting Pot Trusts

Most of this article has assumed that the client creates separate trusts for each child and his or her descendants since this strategy is generally to be preferred over “pot trusts” for multiple beneficiaries. With a pot trust, if one child needs a distribution but others do not, then problems arise. The trustee could make equal distributions to all children whenever one child needs a distribution. However, this unnecessarily removes assets from the protected status of the trust (i.e., the distributions to the children who did not need the distributions). Alternatively, the trustee could


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make unequal distributions so that only the particular child who has a need receives a distribution. However, after any unequal distributions are made, it is never possible to produce a truly equal division of assets among the children. Even if the children who did not receive a distribution are given a larger share later, such factors as the time value of money and fluctuations in asset values mean that only rough justice can ever be done. These unsatisfactory alternatives (i.e., equal distributions or unequal distributions) are even more disappointing when distributions can be made to multiple generations.

Despite the drawbacks of pot trusts, they are sometimes appropriate given a client’s particular objectives. Some clients are less concerned with an equal division among descendants and more concerned that descendants who have greater needs are fully provided for. For example, one child might receive a full scholarship to college or attend a public university while others might attend private colleges. Also, one child might be faced with significant medical expenses, thus depleting his or her share of the assets in a separate trust scenario. If a pot trust is used, the following example provisions provide roughly equal shares for the client’s descendants. 1. Augmented Estate

“4.2 Family Trust. If my Spouse survives me and if any descendant of mine survives me, my Trustee shall retain and administer the Credit Equivalent Gift in a single trust (the “Family Trust”), in accordance with the following terms and conditions: A. Primary Purpose. The primary purpose of the Family Trust is to provide for my Spouse's health, support, and maintenance. B. Distributions to My Spouse. My Trustee may distribute to my Spouse as much income and principal as will provide for my Spouse's health, support, and maintenance in my Spouse's accustomed manner of living, after taking into consideration, to the extent my Trustee deems advisable, any other income or resources known to my Trustee to be available to my Spouse. C. Distributions to Descendants. My Trustee may also distribute to my Children and my other descendants as much income and principal as will provide for the beneficiaries' health, support, maintenance, and education after taking into consideration, to the extent my Trustee deems advisable, any other income or financial resources known to my Trustee to be available to the beneficiaries. Distributions need not be equal among

the beneficiaries; however, any distributions under this subsection to a beneficiary shall be charged against the ultimate distributive share of that beneficiary as provided in Subsection 4.2D below. D. Termination and Special Power of Appointment. If not earlier terminated by distribution of the entire trust estate under the foregoing provisions, the Family Trust shall terminate upon the death of my Spouse and the remaining trust estate shall be distributed as follows: 1. Special Power of Appointment. My Trustee shall distribute the remaining trust estate, or any part thereof, to the limited class consisting of my descendants and/or Charities, in those amounts and proportions and upon those terms and conditions, either outright or in trust, as my Spouse shall appoint by a will or a codicil thereto executed and taking effect after my death that specifically refers to this special power of appointment and expresses the intention to exercise it. The special power of appointment granted under this subsection shall not be (a) construed as authorizing my Spouse to appoint to my Spouse, my Spouse's creditors, my Spouse's estate, or creditors of my Spouse's estate; (b) exercisable in a manner that will violate the rule against perpetuities or any other law restricting the period of time for which property may validly be held in trust; (c) exercisable by my Spouse with respect to any life insurance policy on the life of my Spouse that is part of the trust; or (d) exercisable by my Spouse to discharge any of my Spouse's legal obligations, including, without limitation, my Spouse's legal obligations to support any beneficiary of the trust. 2. Distributions On Default of Appointment. Any property remaining in this trust on the death of my Spouse and not appointed by my Spouse in accordance with the special power of appointment shall be distributed as follows:

(a) My Trustee shall assume that my Trustee has Family Trust property equal in value to the sum of (i) the fair market value of the then remaining Family Trust estate and (ii) the fair market value, as of the date or dates of distribution, of all prior distributions from the Family Trust to or for the benefit of my descendants. This assumed trust estate shall hereinafter be referred to as the “Augmented Trust Estate.”

(b) My Trustee shall then divide the Augmented

Trust Estate into as many equal shares as


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there are then living Children and deceased Children who have descendants then living. My Trustee shall then allocate for the benefit of each then living Child cash or property of the Family Trust equal to that Child’s share of the Augmented Trust Estate reduced, but not below zero (0), by the fair market value, on the date or dates of distribution, of all prior distributions from the Family Trust to or for the benefit of that Child or that Child's descendants. Each Child's share of the Family Trust as heretofore determined shall be retained in a separate trust for that Child in accordance with the provisions of Section 7.2.

(c) My Trustee shall likewise allocate for the

benefit of each deceased Child with any then living descendants cash or property of the Family Trust equal to that deceased Child's share of the Augmented Trust Estate reduced, but not below zero (0), by the fair market value, on the date or dates of distribution, of all prior distributions from the Family Trust to or for the benefit of the deceased Child or any of the descendants of that deceased Child. Each deceased Child's share of the Family Trust as heretofore determined shall be distributed to that deceased Child's then living descendants.

(d) If none of my Children or my Children's

descendants shall then be living, the then remaining trust estate shall be distributed to The Dallas Foundation.”

2. Trigger for Division Into Separate Trusts

If a pot trust for children is used, it may be good to have that pot trust terminate into separate trusts when its objectives have been achieved (e.g., when all the children have had a reasonable opportunity to obtain a college degree). The following example provides a trigger for such a termination and division into separate trusts and would replace the first paragraph of Subsection 4.2D in the previous example. “D. Termination and Special Power of Appointment. If not earlier terminated by distribution of the entire trust estate under the foregoing provisions, the Family Trust shall terminate when the youngest then living child attains the age of twenty-five (25) years, and the remaining trust estate shall be distributed as follows:”

IV. CONCLUSION The necessity of using long-term trusts for

children and grandchildren for non-tax reasons is steadily increasing due to the increases in the estate tax exemption. Traditional “simple” documents and planning for non-taxable estates simply will not get the job done in an increasing number of cases. The strategies and example provisions provided above certainly are not the only viable solutions for meeting client objectives, but hopefully they will be useful for stimulating the reader’s own thinking regarding how best to address this growing need for long-term trusts in non-taxable estates.

Documents

TRUST DRAFTING: PROTECTION WITHOUT (TOO MUCH) DEAD … · ESTATE PLANNING & PROBATE DRAFTING COURSE October 29-30, 2009 Dallas CHAPTER 14 . TOBY MATTHEW EISENBERG ... powers of attorney