Typically individuals serve as their own trustees while they are healthy and cognitively intact. But they need to appoint successor trustees in the event of incapacity or if they are creating an irrevocable trust. The irrevocable trust may be created for tax planning or asset protection purposes, to provide for a beneficiary’s special needs, or to in the event the beneficiary is still a minor and not ready to manage the trust property themself.
When choosing a successor trustee, or the original trustee of an irrevocable trust, grantors need to decide between recruiting a family member or friend or using a professional trustee such as a bank, trust company or attorney. Many grantors are reluctant to use a professional trustee due both to the cost and a sense of loss of control in bringing in an outsider. The loss of control may be mitigated by having personal and a professional co-trustees.
In terms of cost, professional trustees usually charge a percentage of the value of the investments and property in the trust. This is usually in the range of 1.0% per year, but often more for smaller trusts (those holding less than $1 million) and less for larger trusts (those holding more than $2 million). So the fee can well be $10,000 a year for a $1 million trust. This may seem like a stiff price, but in our opinion professional trustees earn it many times over by providing the following services:
- Investment management. Trustees must invest according to the “prudent” investor standard. This typically means investing in a diversified mix of low-risk stocks and bonds. Trust funds are unlikely to to do as well as high-flying stocks in an up market, but also will not lose as much in a down market. Trustees may be faulted for investing in risky stocks or business ventures.
- Accounting. Accounting has two meanings in the context of trusts. First, there’s normal bookkeeping in terms of keeping good records of trust income and expenditures. Second, trusts need to report to certain beneficiaries and in some cases to courts. This can take the form of very formal annual accounts showing all income, expenditures and changes in value of trust assets. Or it may simply mean sharing year-end statements from banks or investment companies.
- Ability to say “no.” Sometimes the most important function of a trustee is the ability to say “no” to requests for distributions, payments, loans or investments. Whether coming from the beneficiary themself, family members, or friends, trust funds are sometimes seen as sources of needed funds. The trustee must follow the rules of the trusts and interests of the beneficiaries, both current and future. This last sentence has two meanings in that the trustee must consider both the current and future needs of both existing beneficiaries and future beneficiaries. Often it can be difficult for a trustee who is a family member or friend of a beneficiary to refuse requests. Even putting a family member in the position of controlling funds can strain family relations. It can be easier for a non-family member to say “no” because they’re less likely to take any expressed displeasure personally. They’re just doing their job and the fact that not everyone is happy with their decisions just comes with the territory.
- A recent experience in this regard: We had a meeting with a long-time trust beneficiary and her husband who questioned distributions we had made decades earlier to help support her grandmother who had raised her as a child. We did this in order that the beneficiary have a stable home. Over the years, it added up to a large sum, but we felt it was money well spent. At the same meeting, the beneficiary asked for a distribution to pay for something for her nieces and nephews who are not beneficiaries of her trust. We had to say “no” even though we understood the sentimental reasons she wanted to make the payment. In the end, the beneficiary was questioning our saying “yes” in the past, and “no” now, even though we felt we could support both decisions.
- Experience. Everyone learns with experience. This is true for the role as trustee as with any other. Having seen the same or a similar situation or challenge in the past will help inform the trustee’s response in the future. Of course, too much experience sometimes can shade over into boredom, lack of attention or a jaded attitude. That’s too be avoided and if it arises, a change of trustee may be in order.
- Ability to say “yes.” While it’s sometimes important to turn down requests for distributions, sometimes it’s equally important to be flexible and approve distributions that on their face may seem questionable. Too much rigidity can undermine the purpose of a trust. For instance, should a trust for educational purposes support a backpacking trip through Europe or South American during a beneficiary’s study abroad? Or should a special needs trust pay rent for an apartment that would mean a reduction in the beneficiary’s monthly SSI payment? A strict reading of the trust may argue against doing so, even though it could mean a much better living situation for the beneficiary.
- Tax preparation. Revocable trusts generally do not have to file tax returns. The trust simply uses the grantor’s Social Security number and any trust income is taxed to the grantor. Irrevocable trusts, in contrast, must obtain their own tax identification number and file an annual 1041 tax return. They may or may not actually pay taxes on income they earn. In general, if income retained in the trust is taxed to the trust and income distributed to or used on behalf of beneficiaries passes through to them. In the latter case, the trust issues K-1 reports to the beneficiaries which they report on their returns like 1099s from banks and investment companies.
- Public benefits knowledge. In the case of special needs trusts, a knowledge of and sensitivity to the eligibility rules and benefits available from public benefits can be vital to building the best possible life for the beneficiary. The trustee can have this knowledge themself or may hire qualified advisors.
- Tax knowledge. Tax knowledge can be important in making decisions about trust investments and distributions. This can often be relevant at the end of the year when it may make sense to balance capital gains and losses or accelerate or delay distributions in order to gain a favorable tax result. As with public benefits expertise, it’s not necessary that the trustee have this knowledge if they have qualified advisors with whom they can work.
- Fiduciary duty. A lot of the above is subsumed under the concept of the “fiduciary” duty that the trustee owes the beneficiaries. This means that the fiduciary must always put the beneficiaries’ interests first. While an error by a trustee will often be forgiven by a court if the trustee took due care and carried out their duties to the best of their ability, a violation of their fiduciary duty can lead to sanctions.
- No conflict of interest. Related to fiduciary duty is a similar duty to avoid conflicts of interest. Not all conflicts can be avoided. For instance, a trustee may also be a beneficiary of a trust. But they must be avoided if possible and acknowledged where they exist. Where they do exist, the conflict may not influence the trustee’s judgment. For instance, where a trustee is a beneficiary or perhaps is married to a beneficiary, they cannot favor themselves or their spouse over other beneficiaries.
As this list demonstrates, acting as trustee is a significant responsibility and professional trustees bring a lot to the table. A lot of what they do bring can be replaced by hiring professional advisors, usually trust attorneys, accountants and investment advisors. The costs in most instances will be comparable, whether paid out as a trustee fee or as professional fees to advisors. Each grantor will have to decide what combination of personal and professional trustees and advisors works best for them.
For more information about trusts and the role of trustees, take a look at my book, The Baby Boomers Guide to Trusts.
If you have any questions about serving as trustee or engaging one of our attorneys as a trustee, let us know.
