You’ve been appointed as trustee on a trust.
Please accept my congratulations; this is a great vote of confidence in your abilities and judgment.
Please accept my condolences, as well; you will have responsibilities, tasks and difficulties for which you are unlikely to be sufficiently compensated or duly appreciated.
A recent case that came into my office reflects some of the challenges of acting as trustee. A man had died relatively young leaving a business and a son in his early 20s. He had appointed two family members as trustees. They were having trouble winding down the business and dealing with the son who was on the wild side and quite demanding. They also had some ideas on how they might get involved in the business themselves.
I had to counsel them that no matter how difficult the son was, as fiduciaries they had to put his interests first. They had to be dispassionate and not take his criticisms, complaints or demands personally. In terms of the business, their involvement certainly had the appearance of a conflict of interest. It would be difficult for them to establish that they were the best people they could find to manage the business.
Not unsurprisingly, the trustees with the difficult beneficiary didn’t like my advice and discharged me as their counsel. But here’s what I would have told them about the duties of trustees if they had consulted with me before getting involved.
Trustees are fiduciaries, meaning that they must put the best interests of the beneficiaries first. If they don’t, they can be personally liable. They must avoid any conflict of interest. It also means that they must consider the interests of all beneficiaries and cannot favor some over others.
Accounting, communication and transparency
Trustees must be able to account for all their actions and provide regular, usually annual, accounts to beneficiaries. They must provide beneficiaries with copies of the trust document itself. We also find that meeting with beneficiaries at least once a year is useful in terms of building relationships, answering questions, and making sure distributions continue to be appropriate. Trustees should err on the side of too much disclosure rather than too little. Lack of transparency can quickly lead to distrust and suspicions which can undermine the relationship between the trustee and beneficiaries. This can in turn lead to extra costs for the trust, especially if litigation arises.
Irrevocable trusts require the annual filing of a 1041 income tax return. However, they rarely pay taxes because any income that is distributed to beneficiaries gets taxed to them. Revocable trusts usually don’t have to file tax returns because they use the grantor’s social security number.
Your investment of trust assets must be prudent and reasonable. This means a conservative approach that balances risk and growth, usually a mix of stocks and bonds. It would be imprudent to invest totally in bonds because historically they have not grown nearly as fast as investments in stock, and these days they’re producing very little interest. And it would be imprudent to invest totally in stock since their value can fluctuate dramatically.
Sometimes trusts hold interests in real estate or in small businesses. From a strictly investment point of view, it may be advisable to sell these interests in order to better diversify the trust holdings. But there may be other overriding factors that argue for keeping these investments. A trust beneficiary may live in a house owned by the trust. Family members may work in a small business. Some trusts in fact explicitly direct the trustee to continue holding interests in particular investments.
Often trustees have discretion on whether or when to make distributions to beneficiaries. The trust may say that income must be distributed but that principal may be distributed as needed by the beneficiary. Often trusts include language referred to as the “HEMS” standard because it only permits distributions for the health, education, maintenance and support of the beneficiary. This would seem to be a very broad standard, but it’s sufficiently limited to provide certain tax benefits to the trust.
Where the trustee has discretion, it must take into account the needs of the beneficiary seeking a distribution as well as other beneficiaries, both those who have a current right to distributions and those who may in the future. It must also consider both current and future needs. A good rule of thumb is to limit distributions to 3% of trust assets per year. That way, the trust can continue to grow with inflation and have reserves for unanticipated needs.
Yet, it often seems incongruous for beneficiaries that they cannot receive larger distributions from what seems to them like a very big trust. The beneficiary of a trust holding $1 million in investments might not understand why the trustee is limiting distributions to $2,500 a month even though larger distributions would erode the buying power of the trust over time.
One problem with trusts that give the trustees considerable discretion is that they often provide little guidance. The trustee ends up imposing his or her judgments and values on the beneficiaries. Often these are consistent with those of the trust grantor, which is why the grantor chose the particular trustee in the first place, but not always. Where the trust does not provide specific guidance, it can be helpful if grantors write a letter to the trustees saying why they created the trust and how they would like the funds used.
I receive more questions on my website about trustee compensation than about any other estate planning issue. Professional trustees typically charge annual fees of between 1.0 and 1.5% of trust assets, a higher rate for smaller trusts and a lower rate for larger ones. This would mean the fee for managing a trust holding $1 million would normally be between $10,000 and $15,000 a year.
Many clients balk at paying a fee year after year and prefer to name family members. (They are also often uncomfortable with having nonfamily members involved in their business.) I try to explain to them that this is money well spent to make sure the trust is properly managed. It can often help avoid strain within families when one child is managing assets on behalf of others.
For instance, for many years the brother of a family friend has been managing a trust left by their father. He was very upset when our friend and her sister asked for more information about the trust and questioned his handling of it, damaging their sibling relationship.
When nonprofessionals are named as trustees, their compensation is often unclear. All trustees are entitled to “reasonable” compensation. But just like beauty, “reasonable” can be in the eye of the beholder. Trustees often put in a lot of time managing trust assets and are entitled to be compensated, but usually not at the same rate that professionals providing the same services would charge. Otherwise, it’s a fair question to ask why the trustee in effect hired himself rather than someone who habitually provides the same service. For instance, if a trustee manages a rental property for a trust, can he prove that he did a better job than a professional property manager? (Of course, I’ve seen both good and bad property management companies, which further muddies the water.) It would be better to charge less in order to justify the decision to not hire an outside company to provide the service.
Trusts for the benefit of individuals with special needs raise their own set of issues. There is an even greater necessity for the trustee to understand the beneficiary’s needs. In addition, the beneficiary may depend on public needs programs such as Supplemental Security Income, Medicaid and subsidized housing to provide necessary support, requiring the trustee to make sure that distributions do not affect eligibility. The work-arounds can be complicated. As a result of the extra work involved, some professional trustees refuse to take on special needs trusts.
Others do so, but we often advise clients that it makes sense for special needs trusts to have both a professional and a family-member trustee. That way, the professional trustee can take care of all the administrative functions described above and the family-member trustee can attend to the beneficiary’s living situation and needs. This can also help when the beneficiary fails to understand why the trust can’t distribute more money or pay for items or services that may be inadvisable. The family member can, in effect, blame the independent trustee.
Finally some good news: While trustees are held to a very high fiduciary standard in their role, if they take care to do their jobs, they have little risk of liability. Courts are unlikely to hold trustees liable for decisions that turn out to be wrong in retrospect as long as they took due care in making the decision. So, a trustee who kept making distributions to a beneficiary for years with no contact may be liable if it turns out the beneficiary’s roommate was stealing the money. But the same trustee who met with the beneficiary annually and allowed him to continue to live in the family home will not be held liable if the value of the home drops over time. The decision to keep the home and let the beneficiary stay there was a judgment call that the trustee made after taking appropriate steps to consider all the relevant factors
Acting as trustee can be very fulfilling. It allows you to serve the beneficiaries. But make sure that you have the time and fortitude to take on this role and understand that you are unlikely to be entirely compensated for the time you put in.
Next time: 7 trust traps you need to know about
Harry S. Margolis is a Massachusetts estate and elder law planning attorney. He answers consumer questions about estate planning at AskHarry.info and most recently published The Baby Boomers Guide to Trusts: Your All-Purpose Estate Planning Tools.