The past few years have been quite busy in the financial and wealth planning world. With the federal transfer tax exemptions currently at $11.7 million1, many clients have considered making gifts for future generations utilizing a variety of structures. The primary focus is on trusts and the options available in that arena. Trusts can be extremely effective estate planning vehicles that can help high net worth individuals and their families preserve and maximize wealth.
There are a number of options to consider when creating a trust, including the general structure, distribution standard, selection of trustee, spousal access during his or her lifetime, and the place of administration for the trust. However, this last decision—the state where the trust is established and administered—can have a tremendous impact on the overall plan, and has the potential to provide significant tax and asset protection benefits.
Several states have created trust-friendly laws and offer benefits to those looking to establish long-term trusts. The states that generally top that list are South Dakota, Nevada, Alaska, Wyoming and Delaware. Depending on the specific situation, any of these jurisdictions may offer great benefits to an individual creating a trust. However, Delaware is often considered one of the best jurisdictions for trusts due to the state’s well-established and flexible trust and tax laws. Depending on how the structure, a Delaware trust can be a powerful tool that can help wealthy families manage and protect assets while also creating a lasting legacy for generations to come.
Below are five reasons to consider a Delaware trust for your family:
1. Flexibility. Sometimes the terms of a trust can become outdated and no longer serve the needs of the grantor or beneficiaries. In Delaware, the terms can be changed if the original provisions of the trust prove to be too restrictive or too broad for the family’s current circumstances.
A trustee can modify an irrevocable trust by distributing trust assets into a new trust. This is called “decanting” a trust. Decanting is a relatively easy, cost-effective way to update a trust as a family’s needs change or as their goals evolve. Delaware also offers an alternative path to modify trust terms via a nonjudicial settlement agreement. Either option provides great planning flexibility.
In addition, in Delaware, there is no limit on how long a trust can last and, as a result, a trust can last in perpetuity. This means assets held in a trust, including any appreciation and accumulated income, can pass from one generation to the next free from gift, estate, and generation-skipping taxes. These trusts are drafted with flexible terms because no one knows what the future may bring.
2. Greater control. Delaware was the first state to permit directed trusts, which allow the grantor to split the traditional responsibilities of a trustee between two or more fiduciaries. This approach gives the grantor more flexibility and control with respect to investments.
In addition, discretionary distribution decisions can be directed by the family or assigned to a third party who may be more familiar with the family and are in a position to better understand their needs and intentions.
The ability for some part of the family (or another trusted advisor) to control the investments or distributions of the trust has been the deciding factor for many individuals selecting a jurisdiction like Delaware. This is especially true for those where wealth is concentrated in a privately held investment or other unique asset.
3. Enhanced privacy and confidentiality. In most states, a trustee has the duty to inform beneficiaries of their interest in a discretionary trust. But grantors may not always want their beneficiaries to know about the extent or nature of the trust. For example, a parent or grandparent who creates a trust for children or future generations may fear that the knowledge of significant wealth may undermine productivity, erode values or otherwise harm (rather than help) their beneficiaries.
Delaware is one of a handful of states that allows quiet trusts. A quiet trust limits or restricts notification to the beneficiaries regarding the trust for a specified period of time. By delaying disclosure of the trust, the beneficiaries can learn about the trust at a time when it could potentially have a more constructive impact on their lives.
4. Tax savings. The rules for state taxation on trusts vary greatly and can reach as high as 10% in some states. Establishing a trust in a jurisdiction such as Delaware that allows trust assets to grow free of fiduciary income tax can provide a significant economic advantage for nonresident beneficiaries.
As long as the trust’s beneficiaries do not live in Delaware, income generated by the trust is exempt from Delaware state income tax, including capital gains tax. However, trust distributions may still be subject to taxation in the beneficiary’s hands, and the trust may be taxed in the grantor’s home state. You should consult with your tax advisor to determine the impact on your personal tax situation.
5. Protection from creditors. Traditionally, an individual could not create an irrevocable trust for his or her own benefit while also protecting those assets from creditors. However, in Delaware, an asset protection trust (APT) can help a grantor retain trust benefits and protect assets from not just the grantor’s creditors, but also the creditors of their beneficiaries.
While APTs can effectively shield assets from many types of claims, it is important to note that certain creditors (such as the Internal Revenue Service, the Securities and Exchange Commission, and spousal and child support claims) may still be able to reach assets held in an APT.
APTs are helpful risk management tools for anyone engaged in high-risk business activities, or professionals in highly litigious fields, such as law and medicine, who want to shield family wealth from malpractice claims. Furthermore, there are planning opportunities available utilizing the APT structure. One such opportunity includes a springing domestic asset protection trust that, if structured correctly, offers the opportunity for an individual to make a completed gift to future generations with limited potential to access the assets in the future.
There are many reasons why Delaware is an attractive jurisdiction of choice for a personal trust. This is the first in a three-part series exploring the advantages of Delaware trusts. You can also learn more about Delaware trusts by contacting your CIBC Private Wealth advisor or by visiting the CIBC Delaware Trust Company resource page.