Escape Hatches For Estate Planning Trusts

It doesn’t take much to foil even the greatest estate planning efforts. Many great estate planning strategies, completed with careful work and good intentions, turn to disasters because of one simple decision – the wrong trustee was selected. Instead of being grateful that their parents and grandparents worked hard to provide for them, heirs become bitter and even resentful.

Selecting a trustee often is an afterthought when a trust is created. The tax benefits and trust terms seem more important. Or the trustee might be suggested by the lawyer, who has a referral relationship with the bank. But you need to give this decision as much thought as any other part of your estate planning.

It used to be that only the super rich worried about trusts and trustees. But many estate planning strategies now have some kind of trust. The average trust in the U.S. contains only about $250,000, not exactly Rockefeller territory.

What could go wrong with a trustee? There are so many problems that there is an organization that discusses the problems and how trust beneficiaries might solve them (Heirs Inc. Box 292, Villanova, PA 19085; 610-527-6260).

Often a local bank trustee is selected because of a personal relationship with the trust creator and is fully briefed on the creator’s wishes. But that trustee might die, change banks, or take a different job at the bank. Or a local bank might be merged into ever larger banks until the trustee becomes someone in a large trust department in another city who has 250 or so trusts to manage. A “revolving door trustee” can’t be expected to know you, your heirs, or your intentions very well.

Perhaps bigger problems with trustees are investment performance and fees. Bank trust departments historically over-invested in bonds or put together stock portfolios that generated below-average returns.

These days, the trust department is more likely to channel the trust into mutual funds maintained by the bank. That gives the bank one fee for managing the trust and another for managing the mutual funds. Banks also are raising their trust fees and adding new fees all the time. Those fees eat into income and principal.

Before giving you some ideas about preventing these problems, let me say a few kind words about bank trustees. Many banks have improved their investment performance in recent years. More importantly, administering a trust can be difficult. The tax and accounting rules are not easy, even in the simplest trusts. If you have some complicated trust provisions, simply complying with the rules can be a chore. A good bank trust department can be worth its fee because it has the experience and systems to handle those issues.

A bank or corporate trustee also will always be around. An individual trustee can die, become disabled, or simply quit. A bank always has other people ready to step in. And if the trustee does something really wrong with the trust, the bank usually has enough resources behind it to make the trust whole. Experience, continuity, technology, and financial stability all count when you want a trust to last for a generation or more after you.

Also, trustees are not always the real problem. There is a natural tension in a trust set up to last several generations. The current generation of income beneficiaries (your children) wants to maximize income payouts, while the trustee also is charged to protect principal for the following generation (your grandchildren). The trustee cannot make everyone happy in that situation. Also, beneficiaries complain that they are treated like children long into adulthood. But that’s not the trustee’s fault; the trustee is just following the terms of the trust.

To avoid all these problems, you have to set things up right, because trust beneficiaries don’t have much power under state law. Courts are hesitant to remove a trustee that you appointed, except for gross negligence. Your beneficiaries can sue, but they won’t have as much money as the bank. And the trustee can use trust funds to pay its legal fees unless it loses the case.

Just as it doesn’t take much for a trustee to ruin a good estate planning strategy, it doesn’t take much to put in some safeguards.

Separate tasks.

A bank trustee naturally wants to sell you the whole package of its trust services. But you can unbundle the package. You can select the bank to handle the custody, administration, record keeping, and tax reporting for the trust. Then you can have a separate provision in the trust that selects the investment manager or managers. You might name specific investment managers or select a firm or individual that will oversee the investments and decide who will manage the money.

Multiple trustees.

Many a corporate trust officer cannot know your family and your wishes for them. But a family member, adviser, or close friend can. You can name such an individual (or several individuals) as co-trustees. Again, you’ll have the bank to handle all the technical matters. Then the bank will have to consult with or take direction from the co-trustee(s) when deciding how to invest the trust and how much money to pay to beneficiaries. The co-trustees also can have a hand in negotiating fees.

Limit the fees.

Too often the standard estate planning trusts prepared by lawyers, at least in the past, allowed the trustee to charge basically whatever it wanted for its services. You can and should be more sophisticated than that. You might state the maximum fees clearly in the trust agreement and provide that a co-trustee or someone other than the bank trustee has to approve increases.

Remove the trustee.

Many trustees don’t allow the trustee to be removed. For many years, the IRS said allowing the beneficiaries to remove the trustee took away all the tax benefits of the trust. But the IRS reversed itself a few years ago. Beneficiaries can change the trustee without losing the tax benefits as long as they also cannot direct the trustee to change the trust payout.

But you might not want to let your beneficiaries go “trustee shopping.” Presumably you have a reason for putting the property in a trust instead of giving the it outright, and trustee shopping could subvert that purpose. One option is to limit the number of times that a trustee can be changed (say, once in five years), and also not allow the beneficiaries to change trustees until they reach a mature age.

Another option is to allow the beneficiaries to change trustees but limit the choice to a list of trustees selected by you. Still another route is to appoint co-trustees to serve with the bank, and allow those co-trustees to change the bank trustee. Or you can give power to change the trustee to a committee of non-beneficiaries you have confidence in.

Don’t make your choice of trustee an afterthought; that could leave your beneficiaries prisoners of high fees, bad investments, or uncaring management. Give a lot of thought to the initial trustee, the level of fees, and the ability to change the trustee. Your wishes are more likely to be followed.