Estate planners love trusts. They solve many problems and help achieve goals. In recent years, trusts have moved from the estate plans of the very wealthy into the plans of many families. Too often, however, trusts operate as bombs that explode and shred estate plans. Fortunately, there are simple steps that will avoid the common problems.
Three factors cause most of the problems with trusts: lack of coordination with other financial plans; disregard of the goals of family members; and failure to adapt to changing circumstances. Many trust problems are caused by the trustees or problems between the trustees and the beneficiaries. Trust creators need to pay closer attention to trustees than most do.
One way to avoid snafus is to have all financial advisors review and contribute to the plan to ensure that parts of the financial picture are not overlooked. This might cost more in the short run but should pay off in the long run. Another solution is to build flexibility into a trust; we will review some specific examples shortly.
Also, review the estate plan and all trusts every couple of years. Most trusts are not funded until after the estate is processed, so their terms can be changed before then. Be sure to review the plan with some key factors in mind. Have asset values changed? As children and grandchildren get older and their demonstrated levels of responsibility change are the trust terms appropriate? Has your net worth changed?
Specific trust provisions can either solve or cause problems. Let’s delve into these key provisions.
Avoid specific bequests. Trusts eventually distribute their assets. Some trusts provide that specific assets will go to certain beneficiaries. This usually is done to balance the distributions. It might have been a good idea when conceived, but things can change. If assets do not appreciate at the rate expected, the distributions might be disproportionate. Or the presence of a specific bequest might prevent the trustee from selling an asset when it should be. Except in rare cases, bequests or other directions about specific assets should be avoided.
Provide for redomicile. It makes sense to have the trustee located near the trust creator or a beneficiary. Trusts are supposed to last for many years, however, and people and trustees move. A trust can end up with the trustee in Florida and the beneficiaries in California. State taxes on trusts also can change.
In most states, a trust cannot change its state of domicile without court action unless the trust documents authorize a change. Be sure your trust allows a change of domicile without court action.
Make payouts flexible. The income distributions to beneficiaries often are firm. Some trusts say only income (and not capital gains or principal) will be distributed. Others fix a dollar amount of income to be paid. While the provisions were adequate at the time, they can impoverish beneficiaries in the long term. Interest rates and dividend yields can fall, or the cost of living can climb steeply. Betters terms are to pay a percentage of trust assets each year or to fix the dollar amount but allow the trustee to make higher distributions to ensure the beneficiary’s needs are met or at its discretion.
Allow for withholding of assets. Many trusts provide that assets will be distributed when the beneficiary is a certain age, regardless of the circumstances. The beneficiary might have a substance abuse problem, still not be mature enough to handle the money, or be at risk of losing the assets in a divorce or bankruptcy. Sometimes there are tax or other reasons that a distribution is not a good idea. To preserve the assets in such situations, the trustee can be empowered to delay distributions under certain circumstances or at its discretion.
Careful trustee selection. Often the estate planning lawyer or a trust company suggested by the lawyer is appointed trustee without much thought. In such cases, the trustee is someone unfamiliar with details of the family and the creator’s plan and also has inflexible terms concerning fees and the way the trust will be administered. Professional trustees often are needed because of the recordkeeping and tax reporting required, but trustees also need to know about the family and your plans. Trustee selection should be undertaken with care. Interview potential trustees. Ask about fees, investment records, customer service, turnover, and the ability to change trustees. Determine if the potential trustees are interested in your family’s details.
Try co-trustees. While professional trust companies and banks have benefits, they also have shortcomings. The individual handling the trust can change frequently, and the company itself can change and move because of mergers. One solution is to name an individual or group of individuals who are familiar with the family as co-trustees. The trust company handles the records, administration, and investments. The co-trustee has access to all the records. The co-trustee can be given veto power over fees, investment decisions, and other key actions. He might have sole authority over distributions or share it with the corporate trustee. This arrangement ensures the family dynamics are considered in decisions.
Split trustee duties. You can name a friend or family member as trustee with the authority to hire a firm to handle investment management, recordkeeping, and administration. Those duties can be split further, with one firm managing the money and another handling administration. (Not all trust companies will agree with this split; they want the money management fees.) The trustee negotiates fees, monitors investment performance, and ensures administrative duties are performed. The trustee also is in closer touch with the family and with your goals.
Provide for trustee changes. When a trustee is not meeting the needs of beneficiaries, it can be appropriate to change trustees. The trust agreement can empower the beneficiaries to make the change. The key is to not give the beneficiaries enough power that the trustee will ignore your wishes in order to keep the business. You want the trust company changed only if it is delivering poor investment performance, charging high fees, or ignoring the needs of the family. You can balance these competing interests by putting limits on trustee removal. Say that it can be done no more than every five years. Or appoint non-beneficiaries empowered to remove the trustee and select a new one.
Try a protector. Much of the flexibility needed in a trust is possible by using this concept borrowed from some foreign trusts. A protector is not a trustee, but he watches the trustee’s work. The protector is empowered to review all documents and can move the trust to another trust company or make other key changes. Usually, complaints from the protector about high fees or other problems are enough to get things fixed. This strategy is not available in all states.
Successor selection. The trust agreement should state how a successor trustee will be selected, especially when individuals are named trustees. Work with your estate planner to decide the best process for you.
Limit fees. Standard trust agreements say that the trustee may charge its published rates, whatever they are. You can limit the level of fees in your agreement. (Of course, not every trust company will accept the assignment in that case.) As an alternative to having a specific limit in the trust agreement, set up an approval process. Have a co-trustee, protector, or other person or committee empowered to negotiate and approve fees.
Write a letter. We have seen that giving the trustee some discretion makes sense. To provide some guidance and leave a record of your intentions, write a letter outlining your goals and the actions you would prefer the trustee to take in certain circumstances.
Talk to people. Trust law litigators will tell you that most court cases have their origins in hurt feelings and surprises. If wealth is to be left in trust for loved ones instead of outright, they should know that ahead of time and be told why and the trust terms. In addition, if the beneficiaries understand the trust terms and your goals, they can spot when a trustee is not doing what you expected.