Being named to serve as the trustee of an ongoing trust created by a family member or close personal friend is often intended as a great honor. A family trustee holds a position of enormous responsibility, and it can be a source, potentially, of enormous liability.
Many who find themselves appointed to trusteeship aren’t entirely sure what responsibilities the role entails, and even those who are may not be entirely sure how to fulfill them. You may find yourself having these concerns—most new trustees do. Adopting a handful of basic principles and applying them in a rigorous and disciplined way will help you to successfully serve as a family trustee. We’ll take a closer look at each of these five principles in turn.
1. Understand the Terms of the Trust Document
Just because you’ve been named a family trustee doesn’t mean you are obligated to accept that appointment. Your sense of duty to the family and a desire to fulfill the wishes of the trust creator may make it difficult to say no, but declining is an option. Before you accept, get answers to the following questions:
- Will the trust be terminated at a predetermined time, or will it continue to exist indefinitely? For some trusts, the trustee’s duties are limited to estate administration, after which the trust assets are distributed outright to the beneficiaries. The trust then terminates, and the trustee has no further duties.
- What are the identities of the beneficiaries? At the very least, be sure you understand who you’ll need to be in contact with for the duration of the trust’s existence.
- Do any beneficiaries have particular health, maturity, or other relevant issues? These items can add complexity and become a source of stress if they’re not accounted for in advance.
- Are particular beneficiaries antagonistic to you, unsupportive of the existence of the trust in the first place, or difficult to get along with? It’s often the case a trust provides shares to some beneficiaries outright while retaining those destined for other beneficiaries for an extended period of time, perhaps due to perceived responsibility levels or other circumstances. This can result in hard feelings between beneficiaries and the trustee. Be familiar with the situation before you sign on. Problems also tend to arise when a sibling is both the trustee and the trust beneficiary, because there can be an actual or perceived conflict of interest.
- Do you have the power to make discretionary distributions, and, if so, is that power subject to a discretionary standard? Some trusts simply provide that the beneficiary is to receive only the income of the trust, which can make things simpler. However, the job can be much more difficult if the trustee is allowed to make distributions of principal at his or her discretion.
- Will the trust be holding any difficult-to-manage assets, such as small business interests or commercial real estate? These assets come with complex tax planning and compliance requirements, making their management considerably more demanding than other holdings.
- Does the trust document absolve you as trustee from liability for matters involving the exercise of judgment in the absence of gross negligence? Actions that would involve the exercise of judgment include decisions on when to make discretionary distributions, how to invest trust assets, and what advisors to enlist in the trust’s service.
Taking the time to get answers to these basic questions will help you better understand what you’re getting yourself into, making you all the more prepared to execute your duties well.
2. Assemble Your Team of Professionals and Get Organized
Even in the simplest cases, trust administration involves complex issues of administration, taxation, and investment—far more than you as a family trustee can likely master on your own. Regardless, you’re responsible for getting it right, and you risk personal liability if you don’t. There are some professional advisors that can help you overcome the technical aspects of your duties. In particular, it’s generally important to find an accountant, trust attorney, and investment advisor with specific skill sets.
The taxation of trust income is complex, so consider enlisting the services of a tax accountant with experience preparing trust income tax returns. You may periodically need the services of a trust attorney, and in fact retaining one and communicating with him or her regularly is one of the key ways you can keep your risk in check. This is particularly true if the trust has estate or generation-skipping transfer tax attributes that need to be managed or if you’re granted discretion in making distributions. Finally, you’ll need the assistance of an investment advisor who can help you invest the trust’s liquid assets in a way that fulfills the trust’s competing duties—to both the current income beneficiaries and future remainder beneficiaries—but also conforms to the requirements of your state’s version of the Prudent Investor Act.
3. Adopt a Formal Process of Administration
If you don’t have a process in place to help ensure everything is done correctly and in a timely fashion, you may be headed for difficulties. When trustees are sued by their beneficiaries, it usually isn’t because they’ve done anything wrong per se, but rather because the trustee’s lack of organization and process resulted in unresponsiveness or a misunderstanding. If you were to find yourself in court, the law holds all fiduciaries, including trustees, to a very high standard of care. If you can’t demonstrate an organized and disciplined trust administration, the court will likely resolve all uncertainties against you, again, regardless of whether you actually acted inappropriately.
The cornerstone of your process should be regular meetings with some or all of your team of advisors. As a baseline, hold meetings at least semiannually, with interim meetings as dictated by the circumstances. In the beginning, as you’re getting your feet under you, quarterly meetings may make sense. Your team of advisors should participate as follows:
- Income tax accountant. Ideally your accountant would attend the semiannual meetings, though you may have more regular one-on-one contact if quarterly estimated income tax payments are required.
- Trust attorney. In the absence of any specific issues, meeting annually with the attorney is in most cases sufficient, assuming the attorney has provided comprehensive guidelines on how the trust should be administered.
- Investment advisor. Because of the relatively dynamic and technical nature of investments, your investment advisor should participate in quarterly meetings to discuss how market movements may impact your portfolio.
It may feel like overkill to adopt such a formal process, but the fact that you’re imposing order will force you to regularly review the basic issues you’re responsible for as opposed to missing them by default. It will also help you avoid missteps, provide credibility against frivolous claims, and help ensure your tax and investment situation maintains alignment with your overarching goals.
4. Adopt an Investment Policy Statement
Of all the tasks you’re responsible for as a family trustee, the investment function can be one of the most problematic. Investing is highly technical and requires the application of a good deal of discretionary judgment. It can also demand substantial time and attention, given the dynamic nature of investments. If the trust owns assets such as commercial real estate or closely held business interests, monitoring those investments can become a full-time job. All this considered, when it comes to the investment of marketable securities, the touchstone for advancing prudent investment practices is the development of an investment policy statement (IPS).
An IPS is an agreement between you and your investment advisor that sets forth an agreed-upon investment model and parameters. Your IPS should also contain essential facts about the trust and its beneficiaries that inform that model, tax policy relevant to the trust, and how its performance is to be measured over time. In most cases your investment account will be a discretionary account, in which your investment advisor will be able to make investment decisions on your behalf without your prior authorization. While that arrangement is in most cases advantageous, you want something in writing setting general boundaries.
5. Adopt a Distributions Policy
Trusts benefit beneficiaries, and beneficiaries benefit through distributions. Some beneficiaries are entitled to mandatory distributions. For example, a surviving spouse may be entitled to receive the trust’s net income annually. In that case, all you’ll need to do as the trustee is calculate (with the assistance of your accountant) the net income each year and make sure the beneficiary receives it in the manner and time frame specified in the trust document.
Discretionary distributions, however, are an entirely different matter. These require you to exercise judgment in situations where there is often no good answer. They may also require you to say no from time to time, which for a family trustee can strain or even damage a relationship with the beneficiary making a request.
When it comes to discretionary distributions, judges are reluctant to substitute their judgment for that of the trustee. When a judge does, however, it’s often for one of two reasons: one, because the judge feels the trustee’s communication with the beneficiaries has been inadequate, or two, because the trustee is unable to demonstrate through documentation that he or she acted prudently, even if he or she in fact did.
As with all other aspects of trust administration, in order to manage discretionary distributions prudently and keep yourself out of court, you need to adopt a process. The outline of such a process might look like this:
- Understand the terms of the trust. Know precisely what discretion you are provided under the trust document, what standards, if any, bind that discretion, and the class of beneficiaries eligible for such distributions.
- Understand the scope of your discretion. The trust document may limit the trustee’s power to make discretionary distributions to a standard. For example, the trust might provide that discretionary distributions may be made for beneficiaries’ “health, education, maintenance, and support.” Each of these terms has a specific legal meaning, so make sure your attorney provides guidance on what the terms of the standard actually mean.
- Know whether certain beneficiaries should be preferred over others. Some trusts describe a general class of beneficiaries but indicate that preference should be given to one or more. An example is a trust created for the benefit of the grantor’s husband, children, and other descendants, but in which special preference is given to the husband, even if doing so exhausts the trust estate during his lifetime. In this case what qualifies as a prudent discretionary distribution to the grantor’s husband is broader than what would be prudent for the grantor’s issue.
- Develop a process for evaluating beneficiary requests. In cases where a large class of beneficiaries is eligible for discretionary distributions, the decision of whether to approve a distribution request will require balancing a number of different factors. You’ll want to think about the beneficiary’s personal circumstances as well as how they compare to other beneficiaries’. For example, does the beneficiary have other available resources that should be taken into account? Does the beneficiary have a risk of creditors such that an outright distribution might end up in the hands of someone other than the beneficiary? This might be the case if the beneficiary works in a high-risk profession, is in bankruptcy, or is faced with an impending or possible divorce. Finally, consider whether granting the requested distribution will compromise the trust’s ability to meet the future needs of the other beneficiaries.
It’s good practice to require all beneficiary requests be made in writing and document your thought process in approving or denying the request. It’s also important to respond to all requests in a timely manner. It’s hard to overstate the value of happy beneficiaries. If there’s one thing that aggravates beneficiaries the most, it’s being ignored, especially if the ultimate response to their request is negative.
The decisions you make as a family trustee can have profound consequences for your family, either positive or negative. But if you’re well-informed of your responsibilities and approach your administrative duties thoughtfully, you’re in a position to provide an invaluable service to your family, creating a positive impact that can benefit numerous individuals for generations. These five principles will go a long way toward helping you accomplish it.
To learn more about your fiduciary responsibilities as a trustee, or for information on other items related to trust and estate planning and administration, contact your Moss Adams professional.