Many people leave money on the table and holes in their estate plans when they use the traditional approach to creating and planning trusts.
The traditional approach is to name one trustee to manage every-thing about the trust. Sometimes this is a professional trustee, such as a bank or trust company, but it also could be an accountant, attorney or other financial professional.The trustee also could be a family member or friend. Most often it’s the oldest child, but other family members or friends might be named depending on the family situation.
The problem with the traditional model is that today most trusts and families are too complicated for one trustee to handle all the functions well. Even in relatively modest estates, different knowledge and skill sets are required to meet all the goals.
Most estates now have at least one trust. The success of an estate plan often is determined by the choice of trustee. Yet, that choice isn’t discussed often or fully enough.
Mismanaged trusts result insignificant problems for loved ones long after the trust creator is gone. Problems include excess costs,poor investments, low payouts and unresponsiveness to a family’s needs.In many states, beneficiaries are not entitled to regular reports from the trust, so they don’t learn about problems until it is too late. When beneficiaries take legal action against the trustee, the trust fund assets pay the legal expenses of the trustee.
Instead of the traditional approach, consider splitting the trustee duties.
You first need to determine the purposes of a trust and how long it is expected to exist. Also consider the types of assets owned by the trust and how distributions to beneficiaries are determined.
When the trust will exist for only a few years and doesn’t have or need a sophisticated investment strategy,then naming a single trustee and perhaps a friend or family member as trustee still could be the best route for you.
More and more often, the best solution is to name multiple trustees or one trustee with several sub-trustees or advisors assigned particular functions. The group often is a combination of professionals and family members or friends. Adding one person or even more individuals to oversee the trustee also can be a good idea, as we’ll discuss.
When the trust is likely to exist for a while, a professional to handle the record keeping and tax returns could be important. Trust accounting and tax rules can be complicated, especially when the trust isn’t distributing all its income and gains each year.
You also might want to name a separate investment professional to manage the trust’s portfolio. The longer you expect the trust to generate income and gains to support one or more beneficiaries, the more you want to consider a specialized investment manager. You also might want a specialized advisor when the trust owns complicated or unique assets such as business interests, real estate or concentrated stock positions.
When the trustee has some discretion over distributing income and principal, you might not want the decisions made by a stranger who’s a professional trustee. Instead, you can name a group of people who know the family well to set the distributions.
Your trust might have other features or assets for which a specialized trustee or advisor makes sense.While multiple trustees or advisors can enhance your estate plan, they also can have disadvantages.One potential disadvantage is cost.Some friends and family members will take on those roles for little or no fees, but the professional advisors and trustees will charge fees. You might pay higher total fees by splitting the functions than you would by bundling all the functions with one professional trustee.
A surprising potential disadvantage is state taxes. Many states have caught on to the popularity of multiple trustees. The rule used to be that a trust was considered to be resident,and taxed, in the state where the main trustee was located. States now are expanding their taxation and control of trusts.
A portion of trust income might be taxed by any state in which a trustee or advisor to the trust is resident.A pro rata portion of the income is taxed based on the number of trustees and advisors. If a trust has three trustees and advisors who are located in different states and one of them lives in a state with the aggressive approach, then one-third of the trust income would be taxed in that state.
Naturally, the high-tax states primarily are those who take this approach.
That means, in addition to considering a potential trustee’s skill set,knowledge of your family and assets,time available and other factors, you also should consider if naming a person as trustee or advisor would increase state taxes.
There are other steps you can take to modernize your trust and over come some shortcomings of the traditional approach. Provide for trustee removal. Things change. This is especially true of trustees, whether they are professionals or family members and friends.
Consider allowing a beneficiary, or all beneficiaries acting together, to remove the trustee and hire a new one. Otherwise, their only option is to ask a court to take action, and that means the trustee can use trust funds to pay for their defense.
You probably want some limits on trustee removal, since you set up the trust at least partly to limit the beneficiaries’ control of the assets. You could allow removal no more often than every five years. Or allow the beneficiaries to remove a trustee, but you establish a group of non-beneficiaries to select a new trustee. Talk with your estate planner about options.
Until 1995, the tax law generally killed the tax benefits of many trusts if a trustee could be removed by beneficiaries. That no longer is a
Try a protector.
This concept is borrowed from some foreign trusts and is becoming more popular in domestic trusts. A protector has access to and reviews all records and actions related to the trust. When the protector doesn’t like what’s being done, he can make key changes, including changing one or more of the trustees. This strategy is not available in all states. It is worth considering if your state recognizes a protector.
Be sure the trust agreement states how a successor trustee will be selected. This is especially important if individuals are named trustees.
Standard trust agreements indicate that the trustee may charge its published rates, whatever they are. You can limit the fees in your agreement. Of course, not every professional trustee will accept the assignment in that case.
Instead of a specific fee limit in the trust agreement, you can set up an approval process. Have a co-trustee, protector, or other person or committee empowered to negotiate and approve fees.
Write a letter.
You can’t foresee everything when writing a trust agreement, and not all your wishes can be put in a trust agreement. To provide some guidance and leave a record of your intentions, write a letter to the trustee or trustees outlining your goals and the actions you would prefer the trustee to take in certain circumstances.
In a number of states, your trust can include a clause requiring all disputes be submitted to mediation or arbitration. This should be faster and cheaper than litigation. If your state allows, consider adding such a clause to your trust.
Require extra reporting.
Basic trust law in most states doesn’t require trustees to tell beneficiaries much. Consider specific reporting requirements in the trust agreement. Perhaps you want regular reports (which can be simply copies of financial account statements) sent to adult beneficiaries and guardians of minor beneficiaries. You also could have reports sent to knowledgeable outsiders, such as your estate planning attorney, accountant, or key family members. Reports should be made annually at a minimum.