Is a directed trust right for your estate plan?

Everybody needs an estate plan, regardless of the size of their estate. But not all estate plans are created equal. Because you have unique assets, needs and ideas about generational wealth transfer, it’s important that your estate plan has the right structure and uses the proper legal tools for your individual circumstances.

Using a directed trust

Directed trusts form a legal relationship in which you, as the “grantor,” assign a person or a firm, known as the “trustee,” the right to manage property or assets for the benefit of a third party like a spouse, sibling or child, known as the “beneficiary.”

However, the role of the trustee is not passive. In fact, by law, a trustee has a fiduciary duty to make decisions and manage the assets of the trust in the best interests of the beneficiaries. That includes the duty to diversify assets. A trustee who fails to do so can be held personally liable.

This can be problematic in situations where the trust holds a concentrated asset that the grantor would like the trust to continue to hold. For example, the grantor may place a large single stock position, a piece of real estate, or a unique or complex type of business into the trust.

Many people won’t be willing to act as a trustee of a trust holding a concentrated position because of the personal liability they assume. Additionally, these individuals may lack the specific skills required to manage a unique or complex asset held by the trust, such as a business.

A directed trust has the potential to solve this problem.

With a directed trust, you can create a trust agreement that appoints an advisor – a person or firm – who has the authority to direct the trustee regarding investment decisions.

This relieves the trustee from virtually all liability for investment decisions directed by the advisor.

It also relieves the trustee from their fiduciary duty to diversify, enabling the grantor to place concentrated assets in the trust and keep them intact.

In situations where the trustee is directed by advisors, they are often referred to as an “Administrative trustee,” whose role is then limited to activities like record-keeping, preparing tax returns, ensuring the safety of the trust’s assets, communicating with beneficiaries and other noninvestment-related responsibilities.

A directed trust is an irrevocable trust, which means that the grantor is not able to change the trust agreement once it is created, and for all practical purposes, gives up 100% of control. However, a grantor cannot act as the trustee of their own irrevocable trust without creating estate and gift tax issues.

When considering a directed trust, it’s important to understand that it’s not designed to be an ad hoc or independent strategy, but a part of an overall comprehensive estate plan. And like estate planning itself, the rules for creating and administering a directed trust are complex.

If you have questions about a directed trust and the role it can play in your estate plan‚ or anything else related to your integrated wealth plan, connect with an Edelman Financial Engines planner today. We’re here to help.

Frequently asked questions about directed trusts

What is the purpose of a directed trust?

A directed trust is designed to provide greater flexibility and control over the management of trust assets. Unlike traditional trusts, where the trustee has full discretion over the trust’s administration and investments, a directed trust allows the grantor (the person who creates the trust) to appoint specific advisors or committees to direct the trustee on investments. This setup is particularly useful for managing complex assets or investments, as it enables the grantor to leverage the expertise of specialized advisors.

How are powers divided in a directed trust?

The duties within a directed trust are typically divided among multiple parties:

Directed trustee: This trustee follows the instructions provided by the appointed advisors or committees. This is also sometimes known as an administrative trustee.

Trust director: A person other than the directed trustee who has power to make investment decisions for the trust. What’s the difference between a trustee and a directed trustee?

In a traditional trust, the trustee has comprehensive control over all aspects of the trust, including investment decisions, distributions and administrative duties. They act as a fiduciary responsible for managing the trust in the best interests of the beneficiaries.

In contrast, a directed trustee operates under the guidance of appointed advisors or committees. The directed trustee’s role is more limited, focusing on executing the directives provided by these advisors.

How many states allow directed trusts?

As of 2024, 20 states have adopted the Uniform Directed Trust Act, which provides a consistent legal framework for directed trusts. However, many other states have a statute that addresses directed trusts.

The information regarding estate planning should not be construed as tax or legal advice and is for general informational purposes only. The use of trusts involves a complex web of state laws, tax rules and regulations. Consider enlisting the counsel of your legal and tax advisors prior to implementing any estate planning strategy. Edelman Financial Engines estate planning specialists cannot provide guidance on service-related items, help with account paperwork or give guidance on custodian processes.