Trustees can make or break an estate plan. That’s why a growing number of estate plans now include the directed trust, an innovative way to use multiple trustees.
There are two traditional options for selecting trustees.
The first option is to appoint one or more family members or friends as trustees. This approach can reduce or eliminate trustee fees and ensure the trust is controlled by people who know the trust grantor’s intentions and family.But this option doesn’t ensure a trustee is competent, objective and can handle conflicts fairly.
Non-professional trustees might have difficulty keeping proper records, filing trust tax returns, handling other administrative duties and investing well.
For those reasons, many people choose the second option, the professional or corporate trustee. A professional trustee usually is a bank or trust company that has many people handling trust duties. They keep the books, file the income tax returns and ensure compliance with the trust agreement and the applicable laws.
There can be disadvantages to the corporate trustee. Of course, the trustee fees can be expensive. In addition, corporate trustees are less likely to really know the family and the trust grantor’s intentions and preferences. That can be a problem when the trustee has discretion in making distributions.
Also, the investment performance of many corporate trustees isn’t competitive with other investment managers. A corporate trustee also might not know how to manage unique assets that were transferred to the trust, such as collectibles, commercial real estate, ranches and oil and gas properties.The solution developed over the last couple of decades is to split the trustee duties in what has become known as a directed trust.
In a typical directed trustee arrangement, a professional or corporate trustee is named as trustee. (One advantage of the directed trust movement is the rebirth of independent trust companies to compete with banks and other large conglomerates for which trust management is a sideline.)
But the trust agreement says that on certain matters, particularly investing the trust assets, the trustee must follow the choices or directions of an outside advisor. The trust agreement might name a particular outside advisor, or it might appoint a person or group of persons to select the outside advisor and replace the advisor, if necessary.
Other duties also might be separated. For example, when the trustee has discretion over distributions to beneficiaries, the trustee might be directed to follow the decisions of a particular person or group of people who know the beneficiaries well.
The main advantage of the directed trust is that it allows the different entities and people to concentrate on what each does best. The professional trustee can focus on administration, custody of the assets, preparing tax returns, record-keeping, reporting and similar matters. One or more outside investment firms can focus on investing the trust assets. Other outside advisors can focus on their specialties.
For a long time, the directed trustee arrangement was difficult to implement. Many corporate trustees would accept only all-or-nothing assignments.
The common law of trusts didn’t allow the appointed trustee to delegate responsibility for any of its duties. A trustee could hire or consult with others, but the trustee ultimately had the full legal liability for the results.
Many corporate trustees were unwilling to share duties with outside advisors selected by the trust creator or others when the trustee bore the legal liability for the decisions and results.
Fortunately, states began enacting directed trust statutes that override the common law of trusts. The first states to do so were Alaska, Delaware, Nevada, New Hampshire, South Dakota and Tennessee. Florida recently enacted its version.Under these statutes, there generally are two ways the trust duties can be separated.
One way is known as the delegated trust. In this type of trust, the grantor, or creator, of a trust can choose to allow the trustee to delegate investment responsibilities to someone else. The trustee chooses the investment manager, but is legally liable for the actions of the investment manager only when the trustee engages in willful misconduct.
The details vary from state to state, but in a delegated trust the professional trustee can’t simply engage an investment advisor, even one named by the trust grantor, and be done. The trustee has to conduct due diligence on the investment manager before engaging it. Then, the trustee must perform ongoing management and supervision of the investment process and results.
In a delegated trust, the trustee basically is subcontracting the investment functions. But the trustee is responsible for properly hiring the investment manager and supervising the manager after hiring.The other way of separating duties is the directed trust.
In the directed trust, the trust grantor usually appoints in the trust agreement both the trustee and the investment advisor. Investing the trust assets is separated from the other duties of administering the trust.
The trustee isn’t required to monitor and supervise the investments. Both the trustee and the investment advisor are fiduciaries. It is called a directed trust because if the trustee has custody of the assets, the trustee is directed to follow and implement the investment recommendations of the investment advisor.
Most directed trust statutes also allow the grantor to appoint a distribution advisor to the trustee. The distribution advisor directs the trustee to make or withhold distributions to the beneficiaries, and the trustee follows those directions.
A directed trust also enables the grantor to appoint other fiduciaries as special trustees to handle particular duties. A trust protector also can be appointed. The trust protector oversees all the trustees and advisors and can take actions such as removing a trustee or advisor, reap-pointing a replacement, moving the trust to another state and other actions named in the trust agreement or state law.
Companies that specialize in being trustees for directed trusts often don’t take custody of the trust assets.
Instead, the assets usually are held at a major brokerage firm. The custodian of the assets can be a broker the investment advisor already has a relationship with, allowing the advisor to invest with the same services and efficiency as for non-trust clients.
The trustee receives information about the trust assets electronically from the broker and uses it to prepare reports, tax returns and administer the trust.
Another advantage of a directed trust is each trustee or advisor bills its fees separately. With a traditional corporate trustee, all the services are provided for one fee. The trust grantor and beneficiaries don’t know what each service costs.
With a directed trust, the costs of services are separately stated and can be separately negotiated with the trustee, an investment advisor and any others providing services.
Even if you already created an irrevocable trust, it might not be too late to change to a directed trust. Many states allow irrevocable trusts to be amended so they can operate as directed trusts.