Choosing a Trustee for a Winning Estate Planning Strategy

Trusts are an important component of many estate planning strategies. Once used only by the wealthy to reduce taxes, trusts now meet a variety of needs for estates of all sizes. A trust can be used to avoid probate, hold life insurance, preserve assets for beneficiaries, and meet a range of other goals.

The unfortunate fact, which is not discussed often enough, is the success of your estate planning often is determined by the choice of trustee. The trust is managed and administered by your trustee, often with little or no oversight. The best-drafted Estate Planning Strategy is little good when it isn’t implemented well. There are many cases of trustees mismanaging assets, depriving beneficiaries of funds, or distributing funds to beneficiaries who wasted them.

When your estate planning strategy has one or more trusts, spend a lot of time choosing the trustees. The choice is at least as critical as the structure of the estate planning and the terms of the trust. The basic choices are a family member, a family friend, an estate planning advisor (such as a lawyer or accountant), or a professional trustee (such as a trust company). Each has advantages and disadvantages.

The best choice for trustee depends on the purpose of the trust and sometimes the details of its terms.

Family and friends can be best as trustees when the purpose of the trust essentially is to transfer assets over time to children or grandchildren. The job of the trustee is to preserve the trust principal, distribute enough to maintain the standard of living of the beneficiaries, and transfer the principal to the beneficiaries when they are old enough. In this case, you want the trustee to be someone who knows the family. They’ll to know the appropriate life style to support and also have some idea of what you would want in different situations. The investment decisions for this type of trust often are straightforward.

Most attorneys recommend that in this situation the trustee not be among the people with custody of the beneficiaries and the responsibility for taking care of them. That could create a conflict of interest.

Suppose the trust holds complicated or illiquid assets, such as real estate, a family business, or a valuable collection. You’ll probably have trouble finding a corporate trustee to serve. These assets require ongoing active management with special knowledge and expertise. Most trust companies don’t have the expertise. At best they’ll agree to be trustee but will hire a consultant, at the expense of the trust, to help make decisions.

This is another situation when you’re likely to need a trustee from the family, friends, or professional advisors.

When considering a non-professional trustee, there are several qualities the person needs.

Of course, the trustee should have the financial expertise and any other knowledge needed to manage the assets. The exact qualities needed depend on the assets in the trust. When your family business is in the trust, you need someone who knows the business well and the experience to oversee its management. A trust that contains traditional investments, such as mutual funds and stocks, needs less specialized expertise but does need someone who will either manage the portfolio well or seek good advice.

The trustee also needs non-technical skills. Most trusts give a trustee at least some discretion over the amount of money to distribute. A beneficiary, or the beneficiary’s guardian, often asks for additional distributions, and the requests can become frequent and heated. A trustee needs to be able to patiently explain why additional distributions are not being made, either because they would violate the trust terms or would in the trustee’s view not be in the beneficiary’s best interests. The trustee also needs to be able to make these decisions without being influenced by past feuds, biases, or other personal history.

When you suspect these conversations could be frequent, choosing a non-family member probably is the best idea. You want someone who is familiar with the family but who isn’t a member, so intra-family relations won’t be harmed by the trustee’s decisions.

Professional trustees have their advantages. When a trust has complicated terms, a professional has the support to be able to administer it properly. A professional trustee has accounting systems, tax advice, and efficient custodial services that sometimes are necessary or helpful.

Another advantage of a professional trustee is continuity. The professional trustee tends to be a corporate entity, so it will survive any individual. Professional trustees also are regulated, having their books and practices periodically reviewed and audited. Professionals also are likely to have deep pockets that can be tapped if the trustee acts improperly and costs the trust money.

There can be disadvantages. A professional (whether it’s a bank, trust company, financial advisor, or someone else) isn’t likely to have the family knowledge that may be helpful. A corporate trustee also could have frequent personnel changes that make it less likely the individual acting as trustee will have much family knowledge or even firsthand knowledge of your intentions. If that kind of knowledge is important, a professional trustee is a disadvantage.

Whether you select a professional trustee or someone else, plan on compensating the trustee for all but the simplest trusts. Being a trustee is a lot of responsibility and involves keeping records, filing tax returns, investing assets, and making distributions. Most trustees receive a fee of about 1% of assets annually, though the rate declines as the value of the trust assets increases.

The best option might be to choose both professional trustee and non-professional trustees. In some trusts, co-trustees have to agree on all decisions. In other trusts, co-trustees have separate duties and have sole authority in their areas.

There are three main areas over which the trustee duties can be divided: administration, asset management, and distributions. You could choose a corporate trustee to keep the records, prepare the tax returns, and hold custody of the assets. An investment manager could serve as co-trustee handling only the investment decisions. A friend, family member, or professional advisor could be a third co-trustee who decides how much to distribute and makes any other decisions. In some trusts, the first two sets of duties in one professional trustee and the non-professional decides on distributions and other matters.

Another route that could increase protection for both your wealth and your family is to have more than one person deciding on the distributions and any other non-technical issues. Two or three family members, friends, or advisors can be a committee of co-trustees and have to agree on all decisions.

Whichever route you choose, consider two additional issues.

Give thought to trustee succession. Most trusts allow the trustee to choose the successor. Some trusts now allow the beneficiaries to change a trustee under limited circumstances. Some trusts also establish trust protectors that can change trustees. A proctector can be an individual or group that reviews the trust and has discretion to change the trustee.

Another provision requires extra reporting by the trustee. Reports should go to the beneficiaries or their guardians as well as one or two others, such as knowledgeable family members or family advisors. Reports should be annually at a minimum, and probably less comprehensive but more frequent reports would be good.

RW December 2010.