Drafting for Incapacity, with 4 Clauses

Determination of incompetency, withdrawal procedures after incompetency, selecting the assets, and forms

by N. Dean Hawkins

Excerpted from Texas Trusts & Clauses

The possibility of the future incompetence of one or both of the settlors raises special issues. In the event that one spouse might become incompetent, the trust must address:

• How to determine whether the spouse is incompetent and who makes the determination?

• What procedures will be followed for withdrawals to be made on behalf of the incompetent spouse?

• What class of marital assets will be used to support the incompetent spouse?

Determination of Incompetency

Without a trust, a guardianship proceeding must be filed in the probate court for an individual to be declared legally incompetent.

However, for purposes of administering a revocable trust, this proceeding is too expensive and time-consuming. Consequently, the trustee is usually given the power to determine competence. Of course, a finding of incompetence cannot be completely arbitrary.

Most trust agreements will either define incompetence or will allow the trustee to rely upon the opinion of physicians. However, a judicial determination of incompetence should not be required.

Withdrawal Procedures After Incompetency

After a spouse has become incompetent it is not practical to continue the procedure of requesting distributions because two different third parties become involved:

• An attorney-in-fact, acting pursuant to a durable power of attorney (executed prior to the incompetency), requests the distribution.

• The trustee, after receiving, reviewing and approving the request, makes the requested distribution.

To make the procedure simpler, it is recommended that the trust provide that distributions will be made to the incapacitated settlor to the extent that the trustee shall consider such distributions necessary for the health, maintenance and support of such incapacitated settlor.

Selecting the Assets

The issue of which assets should be used to support the incompetent spouse may be particularly important if the incompetent spouse has children from a prior marriage and has transferred both separate property and joint management community property to the revocable trust.

In most instances, clients want to preserve their separate property. Therefore the property interests of the incapacitated spouse are generally used in the following order for his or her support:

• First, his or her share of any joint management community property (after obtaining the consent of the competent spouse).

• Second, the sole management community property of the incompetent spouse.

• Third, the separate property of the incompetent spouse.

FORM: Trustee Determines Incapacity

A sample clause allowing the trustee to determine incapacity is as follows:

An adult individual beneficiary under this Agreement, including any settlor who shall be a beneficiary hereunder, shall be considered “incapacitated” upon a good faith determination made by the fiduciary charged with making such evaluation that such individual lacks the physical or mental capacity, personal stability or maturity of judgment needed to effectively manage his or her personal or financial affairs (whether by reason of a medical condition, substance abuse or dependency, or any other reason).

FORM: Trustee Obtains Opinions of Physicians Regarding Incapacity

This sample clause provides that the trustee may rely on the opinion of two physicians to determine incapacity:

An adult beneficiary under this Agreement, including any settlor who shall be a beneficiary hereunder, shall be considered “incapacitated” if the beneficiary is a person for whom a guardian of the estate could be appointed under Texas law. The fiduciary charged with making such determination shall not be required to obtain a court adjudication of incompetence, but may rely on the written opinion of two licensed physicians who are not related by blood or marriage to the settlors or any beneficiary of this trust.

FORM: Distribution to Incapacitated Spouse When Trust Holds Separate Property

This form is to be used when the trust holds joint management community property of the spouses and separate property of the incompetent spouse. To use this form, the trust must provide that each class of marital property will be treated as a separate trust or sub-trust.

If the assets of the incapacitated spouse are completely exhausted, this form does not provide that the incapacitated spouse can access the separate property of the competent spouse. If the incapacitated spouse were allowed to access the separate property of the competent spouse, the trust would be granting property rights that did not exist prior to the formation of the trust, and the rights of the creditors of the incompetent spouse might be increased.

However, the competent spouse can access his or her separate property if he or she chooses to do so.

In the event the trustee shall consider (Name Settlor 1) or (Name Settlor 2), as applicable, to be incapacitated, the trustee shall distribute to the persons and from the sources or sub-trusts as set forth below so much or all of the income and principal of this trust (or sub-trusts of this trusts), even if such distributions of income and principal shall exhaust the specified portion of this trust (or sub-trusts of this trust), as the trustee shall consider or deem advisable for the comfortable maintenance, health and support of (Name Settlor 1) or (Name Settlor 2), as applicable:

• To or for the benefit of (Name Settlor 1), if incapacitated, from the following and in the following order of priority:
  • The share of (Name Settlor 1) in any joint management community property; provided, however, that (Name Settlor 2) shall consent in writing to the distribution;
  • The sole management community property of (Name Settlor 1); and
  • The separate property of (Name Settlor 1).
• To or for the benefit of (Name Settlor 2), if incapacitated, from the following and in the following order of priority:
  • The share of (Name Settlor 2) in any joint management community property; provided, however, that (Name Settlor 1) shall consent in writing to the distribution;
  • The sole management community property of (Name Settlor 2); and
  • The separate property of (Name Settlor 2).

FORM: Distribution to Incapacitated Spouse When Trust Holds Joint Management Community Property

This form (in conjunction with the distribution form) is to be used when the trust does not own any significant amount of property other than joint management community property.

This form allows the assets of the trust to be completely exhausted if either spouse becomes incapacitated. However, the consent of the spouse who is not incapacitated is required due to the prohibition against unilateral partitioning. [See Tex Const art XVI §15.]

In the event the trustee shall consider (Name Settlor 1) or (Name Settlor 2) to be incapacitated, the trustee shall distribute, after obtaining the consent of the spouse who is not incapacitated, so much or all of the income and principal of this trust (even if such distributions of income and principal shall exhaust this trust) as the trustee shall consider or deem advisable for the comfortable maintenance, health and support for whichever one (or both) of (Name Settlor 1) or (Name Settlor 2) as shall be or become incapacitated.

N. Dean Hawkins has a general tax practice in Dallas, including estate planning, business tax planning, and tax controversy and litigation.  Mr. Hawkins has an LL.M. in Taxation from New York University, and is the author of Texas Trusts & Clauses, from which this article is excerpted.