Modern directed trusts offer added flexibility and control regarding investment management and distributions, combined with less fiduciary liability.
South Dakota is one of the few states with a unique “directed” trust statute; in fact, South Dakota has one of the oldest and highest rated directed trust statutes in the United States. With a directed trust, a family is offered the tools to tailor the trust to their needs with asset allocation, diversification, investment management, and distributions, all while significantly increasing liability protection.
Typical Modern South Dakota Directed Trust Structure
with a Trust Protector Promoting Flexibility and Control:
Trust Protector (Fg. 4)
(Family, Friends or Advisors)
(Fiduciary, Not Trustee)
Powers Include:
- Terminate the trust
- Modify or reform the trust
- Veto or direct trust distributions
- Veto or direct investment decisions
- Add or remove beneficiaries
- Change situs and/or governing law of the trust
- Appoint successor trustees & fiduciaries
- Replace trustees and fiduciaries
- Amend the trust as to the administrative and dispositive provisions
- Approve trustee accounts
Distribution Committee (Fg. 3)
(Fiduciary, Not Trustee)
Directs Administrative Trustee
Re Distributions
- Independent Committee
(Tax sensitive distributions) - Family Committee
(Non-tax sensitive distributions)
Investment Committee (Fg. 2)
(Family & Family Advisors)
(Fiduciary, Not Trustee)
Directs Administrative Trustee
Re Investments
- Stocks & bonds
- Insurance
- Art
- FLPs
- LLCs
- Real estate
- Private equity
- Closely-held stock
Administrative Trustee (Fg. 1)
(i.e., South Dakota Trust Company LLC)
- Ownership of assets
- Establish & maintain trust bank account
- Prepare & sign trust tax return
- Trust statements
- Make distributions
- Receive contributions
- Take direction from:
- Investment Committee
- Distribution Committee
*Combine all functions > Full Trustee
Why a “Directed Trust”? Simply put, a directed trust combines flexibility and control with the skills of the client’s own trusted investment advisors or family members, while also utilizing the favorable trust, asset protection, privacy and tax laws of the directed trust state, like South Dakota.
Any type of trust can be established as a directed trust, including both revocable and irrevocable trusts. Specifically, a directed trust allows individuals, who establish a trust with an administrative trustee in the directed trust state, to appoint a trust advisor or investment committee, who in turn can select an outside investment advisor(s) and/or manager(s) to manage the trust’s investments. Multiple advisors may be chosen based upon different asset classes/diversification. This allows a family to effectively utilize and deploy Harvard or Yale Endowment-type asset allocation, which they might not otherwise be able to do with most states delegated trust statutes, as a result of laws, risks, time and costs.
The typical directed trust structure has an administrative trustee, i.e., South Dakota Trust Company (SDTC), and/or custodian (see Figure 1 above), with an outside investment advisor/manager of the client’s choice being responsible for the trust’s investment management. SDTC does not have any products or investment management services. There are many different ways of structuring each scenario based upon the client’s desires and needs.
The trust’s investment committee or trust advisor, which is typically comprised of the client’s family members, selects who will be responsible for the investment management of the trust assets (see Figure 2 above) or directs which illiquid assets will be held by the trust. The trust advisor/investment committee and selected investment manager(s) then directs the administrative trustee as to how the trust will be invested and generally invests pursuant to an Investment Policy Statement. SDTC titles all investment accounts to the trust.
Additionally, a distribution committee may be established to determine when trust distributions should be made and directs the administrative trustee accordingly (see Figure 3 above). Family members can serve on these distribution committees and determine all distributions of income and principal for “health, education, maintenance and support” (HEMS). Any additional distributions would be tax sensitive and require an independent trustee (i.e., SDTC as administrative trustee, CPAs, and/or Attorney etc.). South Dakota is one of only a few directed trust states with statutes allowing the administrative trustee to accept “direction” regarding distributions, as well as investments. The administrative trustee can typically be removed at any time and, alternatively, if desired the administrative trustee can step into any of the committee functions.
Trust Protector
In 1997, South Dakota became the first state to enact a trust protector statute. The trust protector is being utilized more and more with domestic trusts to supplement the investment and distribution committees of a directed trust. Currently, a few states have also enacted trust protector statutes. Additionally, advisors are also drafting the trust protector function into the trust documents in states without specific statutes. Not surprisingly, this is not as strong as drafting trust protector functions into a trust domiciled in a state, such as South Dakota, with a trust protector statute. Some of the powers often given to a trust protector are as follows:
- Modify or amend the trust instrument to achieve favorable tax status or respond to changes in the Internal Revenue Code, state law, or the rulings and regulations there under;
- Increase or decrease the interest of any beneficiaries in the trust;
- Modify the terms of any power of appointment granted by the trust. However, a modification or amendment may not grant a beneficial interest to any individual or class of individuals not specifically provided for under the trust instrument;
- Remove and appoint a trustee, trust advisor, investment committee member, or distribution committee member;
- Terminate the trust;
- Veto or direct trust distributions;
- Change situs or governing law of the trust, or both;
- Appoint a successor trust protector;
- Interpret terms of the trust instrument at the request of the trustee;
- Advise the trustee on matters concerning a beneficiary; and
- Amend or modify the trust instrument to take advantage of laws governing restraints on alienation, distribution of trust property, or the administration of the trust.
Investment Management LLC
A directed trust also promotes administrative efficiency through the use of an investment management LLC. South Dakota as a directed trust jurisdiction has excellent supporting LLC statutes that allow for a sole member LLC; thus, the trust can be the sole owner of the LLC. The South Dakota LLC statutes also provide for advantageous LLC asset protection with charging order protection as the sole and exclusive remedy. Note that a charging order only gives a creditor a distribution right of an LLC interest and doesn’t give a creditor any voting rights. It’s simply a right to a distribution, if one is ever made; however, it doesn’t give the creditor a right to force a distribution.
A grantor can sometimes be the manager of the LLC without incurring estate tax or state income tax issues. However, it’s best for a grantor not to serve as the manager of the investment management LLC, particularly with asset protection trusts. A better alternative is to appoint a family member or family advisor as the manager of the investment management LLC owned by the trust as the sole member. The investment committee of a directed trust would generally direct the administrative trustee to hold the investment LLC, which in turn provides the investment management for the trust. The investment accounts are titled to the LLC, which in turn is titled and owned by the trust as the sole member. Consequently, these investment management LLCs are excellent for administrative efficiency purposes by streamlining the investment management for the trust, reducing trustee fees, as well as providing a beneficial second layer of asset protection for the trust assets.
Directed Trust
Trust company in South Dakota
Administrative Directed Trustee
Directed Trust:
- Administrative Trustee: Trust company providing trust administration in South Dakota
- Distribution Committee: Family, family advisors, and/or trustee make distribution decisions
- Investment Committee: Family directs trust company to hold investment management LLC
Trust Assets
South Dakota Investment LLC
(South Dakota Trust Company – Member)
(Family members or other – Manager)
Investment Management