What You Must Know About Trust Fiduciaries
The Simple Old Days
In the simple days of yore a trust had a trustee. That trustee was the only “fiduciary” named. While that might have been simple, it wasn’t better. Much more flexibility, better tax results, improved asset protection and greater control can all be achieved with a broader mix of fiduciaries. Which additional fiduciaries, who should be named, and how you should define their roles will all depend on your goals and circumstances. This article will provide an overview of some of these concepts.
What is Simple
OK so you only want to name a single trustee to keep things “simple.” “Simple is as simple does.” Well, Forrest Gump wasn’t much of an estate planner. Simple is never an intelligent or appropriate goal. Never. Let’s redefine that issue. Try the following on for size. Why not identify your goals. What do you want to accomplish. Then, with professional guidance, evaluate your circumstances. Those zoom zoom ads may make it sound simple, but think of the car advertisements. “Professional driver on a closed course.” Once you have identified goals and your circumstances, then use the simplest plan that will meet your needs. Simplicity for simplicity sake will almost assuredly get you the wrong result.
Here’s another view on simplicity. What you really want is not a simple legal document or a simple plan, you want the results, what happens to you and your loved ones when your planning and documents are used to really be simple. That is an appropriate objective for simplicity, but it will often require a more intelligent and deliberate plan.
OK with the simplicity silliness eliminated, evaluate what different types of fiduciaries you might benefit from in your trust. Then apply the three bears method of planning. Pick what is just right for you, not too hot and not too cold.
Who Is Going to Manage Your Wealth
So you’ve put together a great estate plan. An irrevocable life insurance trust is established holding a large life insurance policy on your life. All the assets on the first death pass to the optimal mix of bypass (credit shelter trust, a trust that your surviving spouse and other heirs can benefit from) and marital (QTIP) trust (only for your surviving spouse). With an estate that might be taxable splitting of assets and funding trusts will avoid any federal estate tax, provide asset protection and control.
On the death of the surviving spouse the estate is distributed to lifetime trust for your children, both physicians and worried about asset protection. The kids could receive their inheritance free of estate tax and well protected from malpractice claims and divorce Pat yourself on your back for just assuring your largest client is history.
Who are your key family advisers to plan and implement this plan? Which of your advisers (attorney, wealth manager, trust officer, insurance consultant, CPA, etc.) is or should serve in the role of being the primary family confidant and quarterback of your team? You should make a concerted effort to pull together a team and keep key advisers in place to help your surviving spouse and heirs.
Banks and Trust Companies as Trustee
You had to love the Clint Eastwood movie The Good, the Bad and the Ugly. For inexplicable reasons most folks view naming a bank or trustee company as trustee as just the bad and the ugly, leaving out the good. Yes, they charge money, but remember the old adage that there is no free lunch. If you name uncle Joe to serve as trustee he may well charge a trustee fee as well. And regardless of what he does with his fee, he may not have the investment smarts you think. He may well buy high commissioned products, or make investments that have large build in fees. So is the bank really expensive? Often a professional wealth manager charging a fee based on assets only seems costly, but in reality may be less than what a friend or family member will actually cost you. And have you ever considered the appalling statistics on what individual investors have actually earned on their investments. Talk about a Little Shop of Horrors. So think again.
For many folks, complex personal situations (geographically dispersed family members, the disintegration of the family unit, multiple marriages, special needs child, etc.) naming banks and trust companies as the trustees. Professional fiduciaries are a natural choice to insert an unemotional, unbiased professional in the mix when you have children from various marriages, a later spouse, all with varying needs. But if you simply name a bank as trustee, that might not suffice. What if you have a family business as well as marketable securities? Can or should the bank manage the business? In most cases no. What checks and balances do you want on the bank?
“Delegation” versus “Direction” Much more than Mere Semantics
There are ways to structure a trust to secure the benefits of independent and professional financial management and trustee services without jeopardizing other important goals. For example, if you have real estate or family business interests your trusts should include an express mechanism to “direct” investment management by another person or entity you name in the role of “investment adviser” or “investment trustee.” A bit of jargon is important to understand at this juncture. It is often not merely enough to permit the trustee “delegate” investment decisions as that will leave the trustee liable for the investments. If that language is used in the trust document the professional trustee may not be willing to let the trust hold family investments. What you want is that the trust be what is referred to as a “directed” trust so that the investment adviser directs certain investments. Also, state law where the trust is formed will have to permit this distinction. This is why many trusts should be formed in one of the trust “friendly” jurisdictions like Alaska, Delaware, Nevada or South Dakota. Sounds complicated? Perhaps, but if it assures professional trust management and the succession of real estate or family business holdings, those could be really important objectives that cannot be achieved to the same degree of certainty any other way.
Your understanding this technique will equip you to understand and secure this slightly more sophisticated plan that may serve your needs much better than more “traditional” trust planning.
Changing Nature of the Trustee.
Trustees use to be simple, traditional, and as interesting as watching paint dry. A typical trust arrangement had been, or for many unfortunately remains, a family member named as trustee and another family member as successor. In some instances a bank was named to serve as trustee. When this was done, the bank was often named to serve for the duration of the trust with no mechanism short of a court proceeding to change the bank.
Many Types of Professional Trustees
First, there are many different types of professionals you can choose from to serve different roles for your trust. In many cases a combination of professionals may be used. This is more like the Baskin-Robbins 31 flavors then just naming Aunt Jane or Big City Bank:
A bank. This offers the advantage of affording your trust an incredible array of financial and related services from lending on commercial real estate your trust may own to a range of other matters.
Trust companies that specialize in serving as professional trustees. Some may not offer all the products or services a large bank trust company may, but the more “boutique” feel and environment may offer you a more personal service.
Odd as it may sound every professional firm (bank, trust company, wealth manager) has its own personality. If you interview a number of different institutions you may find a clear comfort level with one that fits your personality.
Financial services have become stratified. Many institutions have minimum levels of net worth or investment assets they require to accept you as a client. Sometimes you may benefit from moving up the ladder to work with an institution that specializes with clients in your wealth strata. This should not be about ego (gee I use “Bit Shot Wealth Managers”) but rather about selecting professionals that have the best skill set for your needs. In many cases the investment and estate planning needs you have will correlate with your wealth level. An institution that has a $250,000 minimum is not likely to have the same degree of estate tax planning expertise an institution with a $10 million minimum has. Choose what works best for your needs (and within that group, the institution whose “personality” fits your comfort or style.
In recent years a new genre of professional trustee has arisen, the administrative trustee. These are institutions, generally organized in a trust friendly state (that may provide you access to better laws, and favorable tax and other benefits) that does not provide the full array of trust services, but focuses on the administrative aspects of trust administration. Many do a remarkably good job at this niche they have selected. So if your estate is entirely comprised of family business or real estate holdings you might name an administrative trustee to serve as trustee to garner more professional trust management than naming a family member, and all the benefits of the trust friendly jurisdiction where that trust company is based. You can then name family members to serve as investment trustees and let them handle investment decisions for the family business. This similar structure can be used if you have a long time wealth manager you want to retain as a family adviser but the wealth manager does not provide trust services. You can structure a directed trust naming an institution (or individual if state law permits) as administrative trustee and designating an investment adviser to delegate investment management to the wealth manager of your selection.
You can use the Ginsu knife approach of slicing and dicing the fiduciary functions into an array of positions. Some of these are discussed below.
Historically when a person or institution was named as trustee, they were responsible for all trustee duties. Generally only one person or entity was named trustee, although sometimes multiple trustees were named. That was about the scope of fiduciary complexity. There may have been some tailoring of the powers given the trustee, but in most cases whatever was in the form was more often than not used. Traditionally, one of the primary functions of the trustee was to make investment decisions, so whoever was trustee handled this as well. Although this began to change decades ago, it is only in recent years that building in more flexibility became more common. That said, most trusts still are probably drafted the more traditional way in spite of the myriad of advantages modern trust drafting can afford, especially as to how it relates to trust investments.
Modern portfolio theory concepts, including trustees delegating investment and money management functions, have been embodied in the Prudent Investor Act which has been adapted in varying form by many states. So in more trusts, whether by the trustee’s decision (e.g., Aunt Sally as trustee hires a wealth manager to invest the trust’s assets), or as provided for in the trust instrument (“Wild Ride Investment Adviser, LLC shall be used to manage trust investments”), investment management can be handled by someone other than the trustee.
As illustrated above, when the trustee delegates investment functions, the trustee’s responsibility for investments may be reduced to more of an administrative role. However, mere delegation will have the trustee remain responsible to some degree to monitor the performance of whoever is handling the investments. The degree of this exposure may vary depending on state law and the specific language in the trust document. A more pronounced and secure separate of trustee administrative responsibilities and trust investments would be if instead the trust delegates investment responsibility to an investment adviser. This separation of trustee and investment functions can enable you to obtain the professionalism and management expertise an institutional trustee can offer, while continuing the involvement of a long time trusted financial professional in managing family wealth.
More Flavors of Fiduciaries
To address the complexity of financial and estate planning, as well as the growing sophistication of asset protection and other planning techniques, a modern trust management function today may be fulfilled by an institution serving as general and administrative trustee, an investment adviser named to either manage investments or designate who should do so, a separate distribution committee to make distribution decisions (although it may be best to relegate this to the independent institution named as administrative trustee), a trust protector (given certain significant but limited powers or veto rights such as to change trustees, change governing law, etc.), and more.
Additional Fiduciary and Non-Fiduciary Positions
In addition to these trustee-type roles many trust instruments include several other special positions that often are intended to accomplish specific tax oriented goals. For example a person may be designated to hold a power to loan assets to the settlor who created the trust (e.g., you), add charitable beneficiaries to the trust, or to swap trust assets for non-trust assets. These positions and roles may facilitate the characterization of the trust as a grantor trust for tax purposes. A grantor trust might afford a number of valuable tax opportunities:
Certain insurance transactions can be consummated without triggering adverse tax consequences (such as the transfer for value rules that might make insurance proceeds subject to income tax).
Appreciated assets can be swapped out of the trust back into your estate with no capital gains tax cost. This may facilitate obtaining a step-up in income tax basis for those assets on your death if they are then included in your estate. This step-up or increase in tax basis, the amount on which gain and loss is calculated, to the fair value of the assets on death can eliminate income tax when that asset is sold.
You pay the income tax on trust income even if the income stays in the trust. This can reduce your estate saving estate taxes and can possibly enhance asset protection benefits.
You may be able to sell assets to the trust to remove future appreciation from your estate without triggering capital gains on the sale.
There are other roles that may also be incorporated into a trust document. For example, you may set up a trust in a trust friendly state and give a person the power to add a class of beneficiaries to the trust that might include you. This may provide a mechanism for you to benefit from a trust you set up without triggering trust assets being reached by your creditors or included in your estate.
Butter Knives are Good but a Leatherman Might be Better
So Forest “Simple is as simple does” but do you really want to hike in the trust woods with a butter knife if you can care a slick Leatherman? You can name Uncle Joe as trustee, and that might make sense if you have a small trust for a well-adjusted child and simply want to safeguard the money for a short period of time. But if you are seeking to take advantage of income and estate tax planning, asset protection, preserve a family business, and more, the butter knife approach, albeit simple, won’t accomplish any of your goals.
What compensation is appropriate for a trust protector who has very important functions, but functions which may require only sporadic attention and limited time commitment. As investment advisor you will likely expect your typical money management fee, but what fee should then be paid to the administrative trustee who may still wish to exercise some degree of oversight over the investment advisor? In aggregate all of these fees must still be reasonable relative to the size of the trust and the services performed. These issues should be addressed at the drafting and planning stage. What type of compensation is appropriate to a person serving as investment trustee who has responsibility to determine whether to hold in trust an interest in a family business? Would your answer change if the person was also employed in and paid by the business?
The growing trend of using institutional and/or professional trustees, lifetime or perpetual trusts, tiers of different fiduciaries, including other roles that may not always be held in a fiduciary capacity, if properly planned for can enhance your planning. Focus on what will serve you best to achieve your goals. If you proactively address these concepts, you can tailor a trust to include the appropriate amount of complexity necessary to achieve your objectives. Creative use and adaption of these different fiduciary roles can infuse incredibly flexibility into your planning.
Appendix A: Glossary
Investment Advisor: The assets of a trust you create can be managed by a trustee, or anyone to whom the named trustee delegates the role of managing those assets. If delegation is not mandated in the trust agreement this will only be in the trustee’s discretion, with the trustee remaining responsible for the actions of that person. Alternatively, the trust may, if state law permits, formally include a fiduciary role for an investment adviser and name someone in that capacity. A trust can expressly provide powers, rights and other details governing a person designated as investment adviser, coordinate those decisions with the provisions governing the trustee and other fiduciaries. These provisions should address compensation, whether you can use proprietary funds, investment allocation matters, any restrictions on investments, reporting, and so forth. In many instances the trustee or a related person may handle some or all investments so your trust agreement may need to expressly permit these types of transactions. In many trusts the investment advisor role is bifurcated. A professional wealth manager may be appointed to manage marketable securities and a different person, sometimes a family member, and in some instances even you as the settlor creating the trust, may serve as investment advisor for a family business interest held by the trust.
Delegated Trust: If a trustee “delegates” investment management that trustee is not absolved from responsibility for investment decisions. Certainly the act of delegating trust investment management to relieves the trustee of much of the investment responsibility, but there remains a liability for the trustee to monitor the person to whom investment authority was delegated and perhaps even actual investment performance.
Directed Trust: If the trust document mandates that the Trustee must follow the “directions” of a third party as to investments, and state law permits the trustee to be so “directed” the trustee should have no liability for investment decisions. This is a much more secure position for the trustee and would likely be the optimal approach for some types of trusts. While the trustee should not have any liability, some modest precautions might still be taken. If the investment plan or direction violates the terms of the trust, or violates a fiduciary duty of the trustee, there may be liability for the trustee. Fiduciary duties might include such basic concepts as: diversification, acting prudently, etc. This may require more than just a rubber stamp approval of whatever the investment adviser does. While this is much more secure for the trustee then merely a delegation of investment management, it may not be without risk. The degree of protection for the trustee may vary depending on state law. Delaware law, for example, provides significant protection for the trustee of a directed trust. States that have enacted the Uniform Trust Code (“UTC”) provisions, are not as protective. Caution is in order because many states adopt their own variations of uniform laws. That means less interference and oversight for you if a directed trust under a state with favorable laws is set up, instead of directed trust in a state with less favorable laws. In all, cases you can expect less oversight if the trust is a directed trust, rather than a delegated trust. Since these concepts are still relatively new, the law will likely develop in years to come so those relying on the protection of a directed trust should “stay tuned.”
Sub-Trust: A trust can consist of more than one component. Trusts are commonly divided on the death of a second parent into separate trusts for each child or other heir. When endeavoring to optimize estate tax planning benefits trusts have commonly been divided up into parts that are exempt from the generation skipping transfer (“GST”) tax and those portions that aren’t. If you have real estate or business interests there is a technique that can be very useful in managing these trust assets. Include language in the trust document permitting someone, perhaps the administrative trustee or perhaps the investment trustee, to create sub-trusts (separate recordkeeping for parts of the same trust) for business and marketable investments. The business sub-trust can have a business partner or family member as investment adviser. The investment assets of the trust can then be managed by a professional wealth manager. This will enable you to assume an investment management role even if the client still retains some business assets which you cannot manage. It will also help insulate you from liability (see above) on the investment decisions on the business assets. The trust protector could be used to shift funds between the two sub-trusts to avoid issues. This might mitigate any issues of self-interest if the investment adviser were given this role.
Trust Protector: The trust protector role has been commonly used in many foreign trusts and is becoming more common in modern domestic trust agreements. The trust protector is a fiduciary (although some experts suggest that the protector can operate as a non-fiduciary) that can provide additional safeguards to the trust. The trust protector typically has a limited, but important, role. The obligations and powers of the protector should be clearly defined in the trust instrument. Some attorneys draft trust protector powers in the “negative”. They cannot take any affirmative action, only veto actions the trustees wish to take. Others, draft specific powers that might include the right to remove an institution or even non-institutional co-trustee or sole trustee, changing the governing law or situs of the trust, changing the designated investment advisor, and occasionally additional limited powers as well. In an insurance trust perhaps the trust protector can hold the power to negate the trustees ability to use income to pay insurance premiums. According to some commentators this might provide a necessary prerequisite to turning off grantor trust status if that becomes desirable.
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