Trust Administration by Trustee
Trustees play in indispensable role in estate planning. A trust can be extremely useful in allowing a Grantor to put conditions on how, when, and in what way assets are managed or distributed to beneficiaries. In spite of the Grantor being the creator of the trust, he or she is not the one fulfilling the terms of the Trust; the Trustee is the one who makes sure that the Grantor’s wishes come to fruition by fulfilling custodian, administrative, investment, and distributive functions. While a Grantor’s choice of a Trustee should be that of a financially savvy, fiscally sophisticated and honest person, there are a number of safeguards in common law, as well as various statutes, that dictate various Trustees’ fiduciary and managerial duties to assist the Trustee in navigating the proper management of Trust assets, as well as protecting beneficial ownership of the trust assets.
Originally rooted in trust common law, a Trustee’s fiduciary duties are codified by statutes of various states or by the Unified Trust Act adapted by many states. Generally, when a trust is created, certain preexisting duties, powers, and obligations may be modified or waived by a trust instrument. However, there are certain fiduciary duties – such as the duties of loyalty, prudence, and impartiality – that are so deeply engrained in trust law that they cannot be completely removed by an agreement between a trust creator and a trustee.
A Trustee must act as a manager to manage the assets of a trust and, in doing so, is obligated to act prudently, in good faith, and in the sole interest of the beneficiaries. This entails a few things. First, as custodian, the trustee must take custody of trust property and properly safeguard it. For instance, a trustee of a trust that holds real estate will likely be required to maintain the property in good condition, maintain adequate insurance, and pay all bills in connection with the property, such as property taxes, insurance, and utility bills. It does not mean that the Trustee has to wear different hats and become a plumber, an electrician, an insurance broker and an accountant; but it does mean that the trustee needs to hire skilled, licensed and competent professionals to fulfill those responsibilities.
Let’s consider an example of a trust containing property that generates rental income. Fulfilling the role as a manager, the Trustee, as any landlord, must collect rent, pay all bills in a timely manner, keep adequate records of the rental activities, and ensure proper maintenance of the property.
Moreover, a trustee has a duty to maintain accounts of all major underlying trust transactions. As a general matter, keeping an accounting ledger is not enough; a trustee must keep receipts of major transactions as proof of their validity, keep records of insurance policies and bank account statements. When a trustee is not a close family member of the beneficiaries, but rather a professional, such as lawyer or an accountant, such a trustee needs to present an accounting to the beneficiaries on an annual or less frequent basis to account for the income, expenses, losses and gains, and trust distributions to the beneficiaries of the trust. It is good practice to have clear records of all underlying transactions of the trust in the event they are challenged or questioned by the beneficiaries. It is also recommended to have beneficiaries release the trustee upon review of the records for past transactions and obtain a consent from beneficiaries before a major transaction is to take place.
Besides simply keeping record of all transactions and preparing periodic accountings, a trustee must also file necessary tax returns. However, not all trusts are subject to income tax filings and the trustee must seek the advice of a tax professional to ascertain whether the trust which he or she manages requires an annual tax filing.
A trustee must have a good understanding of the provisions of the trust agreement, be able to identify beneficiaries of the trust, and be capable of ascertaining the assets of the trust. In other words, a trustee must familiarize him or herself with trust terms and assets well enough to understand the purpose behind the trust in its entirety. Once a trustee has done so, he or she is able to distribute the trust funds (income, principal or both) in accordance with the trust agreement, always taking the intent of the Grantor into consideration.
It is a good practice to physically split trusts in sub trusts when the trust has more the one beneficiary, as each beneficiary may have his or her needs when it comes to distribution from principal of the trust.
Sometimes, a Trustee can give a loan to the beneficiaries instead of making an outright distribution. This is particularly recommended for trusts which are intended for asset protection from a beneficiary’s creditors. Thus, instead of making an outright distribution where creditors can attach the assets or funds that are being distributed, the trust can provide a secured loan where those assets are used as collateral for the repayment of the funds back to the trust. For a trustee who is not careful, even a seemingly simple act like making a loan to a beneficiary can lead to liability. It is necessary for a trustee to become familiar with the terms of the trust agreement as it pertains to the making of the loan to the beneficiaries.
Duty of Prudence
A trustee is charged with a duty of prudence when it comes to making decisions or taking actions on behalf of the trust. This duty encompasses the duty of diversification and the duty to monitor trust assets. As a prudent investor, a trustee must exercise reasonable care and caution, must diversify the trust portfolio, and in doing so, must exercise reasonable skill and care in pursuing a necessary investment strategy. The trustee must implement a prudent investment program after reviewing the potential of trust assets. Such an investment program must be in accordance with an overall strategy reasonably suited to the purpose of the trust and must take into consideration the circumstances of the beneficiaries. For example, if a trustee is investing large amounts of trust funds into extremely risky and volatile stocks, that might be considered as breach of the duty of prudence. In laymen’s terms, a trustee must balance a strategy of investment in risky investments with safe investments and must make sure that in doing so, the overall cost of such actions would not overwhelm the funds of the trust.
The duty of prudence directs a trustee to periodically review the investment portfolio of the trust and invest in such investments with expectation to achieve maximum yield for the beneficiaries of the trust. For instance, if a Grantor had funded the trust with shares of stock from various companies and one of the companies is no longer successful, the trustee must reconsider whether it would be best to liquidate such shares and reinvest in a more profitable asset. Similarly, a trustee has a duty to make sure that trust property is being productively held in the trust. For instance, if there are three houses in a trust, and the beneficiary is only using one of them, then the other two houses must be managed in a way as to make sure that they produce income or shall be disposed of and reinvested in the better yielding investments.
Importantly, however, a trustee does not have to possess the skill and knowledge of an investment advisor or an accountant to satisfy such a prudent investor standard. Rather, he or she must be exercise prudence in hiring a professional who can do so. In other words, a trustee may assign these investment and management functions to a professional delegate. In such a case, it is the trustee’s duty to exercise care, skill, and caution in hiring and picking a professional such as an investment advisor, accountant, lawyer, property managers, etc.
If the trust owns an investment portfolio, for instance, the trustee is responsible to arrange for safeguarding investments of the trust by securing an accredited financial institution or properly licensed and experienced financial advisor. Generally, we advise trustees to retain a professional to invest the funds of the trust and the trustee’s role would be to monitor the transactions on the account, and review investment portfolio on a monthly basis.
Additionally, a trustee has a duty to preserve property of the trust, with an example being a Trustee making sure that Trust property has insurance to cover losses due to potential risk such as theft, fire, or torts. If you are a trustee of a trust with real estate property, then you must make sure that necessary repairs are made, that the property is continuously in compliance with zoning laws, and that all maintenance fees and real estate taxes are paid timely. If a trustee holds funds in the bank accounts, it should be diversified among banks so that each account is covered by the FDIC insurance. This duty of prudence encompasses administering a trust with such skill and care as a person would be reasonably expected to manage a property. A person who manages real estate trust property must either have the knowledge and resources to do it well or must hire a professional who is knowledgeable enough to complete the tasks necessary instead.
It is a best practice for a trustee to create plan on how real estate or other assets will be invested, including whether real estate will be sold, held for appreciation or rented. It is important to exercise due diligence, demonstrate that professionals were consulted and to develop a plan and once a plan is developed, it should be followed. As long as trustees can show due diligence, they can avoid personal liability for loss of investment.
For more on the Prudent Investor Act please read our next Article.
Duty of Impartiality
Trusts oftentimes have different classes of beneficiaries: income beneficiaries who are entitled to current distribution of income and remainder beneficiaries who will get the remainder of the trust principal after income beneficiary’s rights end. There are also beneficiaries who have the right of use of the property potentially during their lifetime, and those who will be able to enjoy the use or proceeds from said property in a future date. A trustee may act in a way as to make sure that both of these beneficiary classes’ interests are considered. Thus, trustees must conform to the duty of impartiality, by being impartial to the income and remainder beneficiaries of a trust. As an example, let’s consider a Trust where A and B are the income beneficiaries (meaning they enjoy the income coming into the trust assets during set period of time), and C and D are remainder beneficiaries (meaning they will receive the trust funds when such set period ends and the trust terminates). Generally, A and B would want risky investments for higher profits during the life of the trust; they want more money generated over a shorter period of time. C and D, on the other hand, want the trustee to consider safe investments so there is money left for them when the Trust terminates. As a trustee, one must always keep balance as to make sure that the interests of one of the beneficiary classes does not infringe on the interests of the other.
However, even under the duty of impartiality, the trustee must always consider the intent of the Grantor. If, for instance, the Grantor intended for the income beneficiaries to benefit most from the trust, then the trustee’s outlook should be skewed towards the income beneficiaries. It’s very important for the Trustee to review the Trust Agreement with an advisor to ascertain the main goals of the Trust, whether it is to give life estate to reside in a property, to invest into the most income productive investments to provide for maintenance of income beneficiaries, or to preserve capital for future generations.
Duty of Loyalty
The Duty of Loyalty is a paramount fiduciary duty of a trustee: there are strict rules against trustee’s self-dealing with the trust. This means a trustee cannot have any personal interest in any trust related transaction.
Under trust law, a trustee may be entitled to a commission for the services rendered. The commission can be determined by a state statute or by virtue of an agreement between a trustee and a Grantor or other interested parties.
Besides commission payments to trustees, a trustee may not get any other benefit from the trust. While some of the services can be performed by a professional Trustee on behalf of the Trust, such as an accounting, tax or legal services, professional services such as a financial advisor or a broker services cannot be performed by a Trustee for additional enumeration. A trustee also cannot transact with the trust by being a party to a transaction with a trust and a trustee cannot borrow from the trust funds or lend to the trust, and cannot sell to or buy from a trust.
In short, a trustee should never behave in any other professional capacity, besides being the Trustee, without explicit approval of all interested parties of the Trust. If there is a personal interest in a transaction that is not approved by the settlor or approved by a court, a trustee would be automatically bound by the No Further Inquiry Rule and be in violation of a breach of the duty of loyalty. Let’s consider again the example of a Trustee who is also financial advisor; if, as a financial advisor, the trustee makes any profit, the no further inquiry rule would force him to disgorge of the profit and hand it back to the beneficiaries. However, again, self-dealing is permitted in limited circumstances: if the trust authorizes such a transaction; if the court authorizes such a transaction; or if all beneficiaries consent.