Understanding Pennsylvania's New Directed Trust Act

In a significant development for estate, trust, and elder law practitioners, Pennsylvania, the 20th state to do so, has recently enacted the Directed Trust Act, which promises to streamline and enhance the management of trusts. This legislation, effective in October 2024, introduces several pivotal changes that are set to benefit both trustees and beneficiaries alike. The new law will be found in Chapter 77 of Title 20, Section H.1 (20 Pa. C.S. § 7780.11-7780.27).

The Directed Trust Act allows for a more flexible and efficient approach to trust administration by enabling the segregation of fiduciary responsibilities among different parties. Typically, a trustee is the sole individual responsible for the management of the trust, based on prevailing fiduciary duties. Under the new law, a trust can designate separate individuals or entities to handle various aspects of trust management, such as investment decisions, distributions, and administrative functions. The new Act similarly allows for the bifurcation of fiduciary duty and liability amongst the parties holding different powers. A “trust director” and a “directed trustee” now have clear guidelines.

What is a Directed Trust?

Under Section 7778 of the PEF Code, a “directed trust” results when a person who is not a trustee can direct a trustee to take (or not) specified actions. The grantor or beneficiary (with certain reserved rights) will define the roles of a trust director and directed trustee. Per the instrument, a trust director and directed trustee should have their liability bifurcated, and each should indemnify the other against their actions.

Section 7780.22 even provides that the two counterparts have no duty to monitor each other, and liability will not be imputed. A directed trust, however, should not be confused with what may be termed a “delegated trust”, where the trustee may delegate specific functions, such as investment management. In a delegated trust, the trustee is ultimately responsible–and liable–for the acts they delegate.

The Role of the Trust Protectors

For many years, planners have appointed “trust protectors” with varying degrees of authority, often in a non-fiduciary advisory role. (Judges in various counties across the Commonwealth had differing opinions on whether a trust protector was or was not a fiduciary.) This role is now redefined under Section 7780.17. The Code merely suggests the different roles a trust protector may take. Under many of the suggested roles, the trust protector appears to be a fiduciary, with the directed trustee immune from liability. When drafting trusts with protectors, counsel should review their language to ensure that they are not appointing individuals in fiduciary roles who may not handle that duty of care competently.

Understanding Liability

The elder law and special needs planner should recognize the Medicaid payback language. For example, in a First Party (d)(4)(A) Special Needs Trust, timely repayment to the Medicaid agency must be made. The trustee is liable for this payback in a traditional Special Needs Trust. It stands to reason that in a directed trust, a trust director, a directed trustee, and possibly a trust protector, could all be liable for the payback, depending on the scope of their role. The scrivener should be certain that the language controlling the Medicaid payback, and whose responsibility it is, is unambiguous.

Directed trusts are likely valuable for a few typical situations, which may include:

A grantor has a trusted investment or financial advisor, and they want continuity in managing their assets. However, the investment advisor may lack the knowledge or ability to take on a fiduciary role. This is common with modern brokerage firms, where financial advisors are not allowed to serve as fiduciaries. A directed trust could bifurcate these powers.

A grantor has unique assets, such as business interests or virtual currencies, which a corporate trustee is unable or unwilling to take custody of and responsibility for, but who is otherwise able to manage the remaining trust assets. A trust director may be able to retain control of these assets.

Akin to the old “family office,” a grantor has a close friend or family member whom they want to empower to modify the terms of an irrevocable trust to respond to changes in the client’s family and tax laws. The grantor may not be able to retain those powers without some adverse tax or legal consequences. A directed trust affords flexibility, and employing a trusted friend may reduce management costs.

A grantor may envision a future need to modify beneficial interests. Still, the grantor cannot reserve these powers for themselves without facing adverse tax consequences (under IRC 2041 or 2514, for example). A trust protector or distribution director may be given exclusive authority to exercise the power of appointment, without the need to notify beneficiaries, terminating the trust and distributing the assets per the grantor’s instructions.

A trustee or grantor feels that an outside individual is better equipped than the directed trustee to manage unique administrative aspects of the trust. These issues may include dealing with business interests, taxation, or managing distributions for beneficiaries facing special needs or public benefits implications. Outsourcing these tasks may lessen the burden on the trustee, while providing better outcomes for the beneficiaries.

Directed Trusts and Crummey Trust Administration

In the context of a Crummey trust, it may be advantageous to give this ongoing administrative responsibility to a directed trustee who is trained to ensure the strict requirements are met.

While the new law implements a comprehensive framework, practitioners should be aware of some deficiencies. Many trustees in Pennsylvania and abroad do not yet have internal policies or guidelines on whether and how they will serve as directed trustees (or perhaps trust directors). This is especially so in elderly law and special needs, where trust funding may be relatively small, making fiduciaries less willing to break the mold and take on new risks.

Limited Caselaw and Judicial Familiarity

Critically, the caselaw on directed trusts is lacking in Pennsylvania and amongst the adopting states. Does the judiciary have an adequate understanding of directed trusts? Without guidance, it is unknown whether practitioners will feel comfortable writing and administering directed trusts.

Implications for Elder Law and Special Needs Planning

In the elder law context, attorneys are often tasked with drafting complex asset protection and special needs trusts. These documents attempt to thread the needle and afford grantors and beneficiaries great flexibility without running afoul of tax or public benefits requirements. Employing a directed trust will likely allow practitioners to draft documents and implement plans that better meet a client’s or beneficiary’s unique needs. Contact us online now to hear more about the Trust Act.