By John M. Goralka
Sacramento, CA
Perhaps the most important decision that you can make is the selection of the person to oversee your financial affairs if you are unable to do so. This person is the successor trustee of your trust, the executor in your will and the designated attorney-in-fact in your power of attorney. We will refer to all of these people as the successor trustee in this article. This selection is particularly important when, as is usually the case, the successor trustee may hold broad discretionary powers. Legal title to assets is actually vested in the trustee’s name on behalf of the trust. The trustee manages the trust on behalf of the beneficiaries to carry out the grantor’s purposes for establishing the trust.
Trustee duties
The trustee’s duties may change based upon the properties held by the trust. For example, overseeing a closely held business or farm or even diversified investments may be more challenging for a trustee than overseeing a trust holding an investment in a mutual fund or an interest in a building with a triple net lease. That said, the trustee can hire investors and others to advise on investment activities.
At the outset, the successor trustee should read, understand and otherwise become familiar with the trust provisions and any related statements of the trust purpose. A grantor creating the trust may also leave the successor trustee a personal directions letter with specific guidance and a description of the trust’s purpose and goals and how those relate to specific beneficiaries.
The successor trustee may wish to interview trust beneficiaries at the beginning of his or her administration to better accommodate each beneficiary’s personal circumstances, goals and needs. The trustee should also consider whether the existing trust assets and investments are best suited to satisfy the trust requirements and needs, including those of the individual beneficiaries.
A trustee must agree to carry out the terms of the trust as stated. If the proposed trustee believes that he or she knows better than what the grantor wished and that understanding differs from the plain language of the trust, then that person should not act as the successor trustee. If the successor trustee agrees to act, then he or she must identify, protect and manage the trust assets, pay all expenses, maintain appropriate insurance, file all required tax returns and distribute trust principal and income as directed in the declaration of trust.
Note that a successor trustee may become personally liable for the trust’s unpaid debts if assets are distributed to beneficiaries prior to payment of other obligations. The successor must ensure that all taxes and trust debts and obligations are paid before distribution. If not, then the trustee may be liable for trust obligations in the absence of trust funds being on hand to pay. The trust may have a right to be indemnified from the beneficiaries for such expenses, but that is never a position that a trustee should put himself or herself in.
Trustee qualifications
Many clients initially select their child or the guardian of their minor child to be their successor trustee. Acting as a successor trustee may involve a long-term commitment. For example, if the trustee is overseeing assets for a minor child or children until they attain the age of 25 or 35, that is certainly a long-term commitment. Consider whether we want to have one sibling holding the purse strings for his or her brother’s or sister’s inheritance. Will withholding discretionary distributions because one sibling disagrees with his or her brother’s or sister’s life choices injure their family’s bond or friendship?
If there is a guardian with physical custody of a minor or child, are we concerned that the child’s trust estate is not being used to cover or contribute to other household expenses? Having a trustee overseeing the finances and reviewing expense requests for the beneficiary’s care and upbringing may be appropriate.
The successor trustee need not be a financial guru, as he or she can hire appropriate professionals to provide guidance. The successor trustee does have to be someone you trust to be both honest and trustworthy and to follow through on the trustee’s duties. If there is a family business, are there family members already working in the family business who could be the successor trustee?
There are many times that having the beneficiary serve as the successor trustee is appropriate. However, this can result in reduced asset protection for the beneficiary and possibly negative income and estate tax consequences if the beneficiary seeks to keep the assets out of his or her estate for estate tax purposes or to avoid tax on income earned.
The professional trustee
The first concern when a professional trustee is considered is typically the cost. Family members or relatives are generally considered to be able to keep family matters and finances private and save money. However, neither assumption is necessarily true.
As to cost, some trustees will bill for the services performed at an hourly rate that is much lower than typically charged by an attorney. Despite what you may see on television with celebrity estates such as the Michael Jackson estate, most lawyers do not act as professional trustees. This is for at least three reasons:
- The lawyer would make more money working on other matters
- There may be a conflict of interest precluding the lawyer from acting as a lawyer and trustee
- The lawyer might not find serving as a trustee as enjoyable due to the minutia of detail and disputes or negotiations on minor matters between beneficiaries and others
Many professional trustees will charge a percentage based upon the value of the estate per year, such as 1.0% or 1.2% of the value of trust assets, though perhaps a higher percentage for smaller trust estates and a smaller percentage for larger trust estates. However, the size or value of the trust estate is not always the best indicator of the amount of actual work required. If the trust provisions are simple and the asset composition does not require a lot of oversight or effort, then the percentage may be a high price despite the fact that it is only 1% or 1.2% of value.
Care should be taken when using bank trust departments because a bank will often move all liquid or semi-liquid assets into bank investment products. That may not have been the wishes of the grantors, who may have wanted the trust to continue with the existing financial professionals. The bank will typically charge for that transfer, so they are charging the trust for the privilege of the bank making more money during the trust administration. Many banks will not wish to handle real property or manage active business interests.
The use of a professional trustee can also mean a loss of control by family matters. If the trust administration is of short duration, then this issue may not be as great a concern. Detailed trust provisions and/or a personal directions letter from the grantors of the trust can minimize this concern.
Some families want the trust administration to be as easy as possible for all family members. Serving as a successor trustee can be a lot of thankless work performed for beneficiaries waiting only for the trustee to “pay them the money.”
A thankless job sometimes
I had a client years ago who was designated as the successor trustee for a large estate that included an airplane, apartment complexes and a wide variety of assets. She was designated as the trustee because, as a Secret Service agent, she was considered the most successful and responsible member of that family. The apartments were fully rented, but there was not a single written rental agreement. We did not know the amount of rent owed by each tenant. The apartments were not up to code, and many tenants had illegal gas stoves in use inside the apartments. When construction was started to prepare the apartment complexes for sale, toxic mold was discovered. Many tenants had to be moved at the expense of the trust.
This was a complicated trust administration, to say the least. Due to the size, we made many preliminary distributions of trust funds to beneficiaries as funds were available. Despite my advice, the trustee did not seek compensation until the very end of the trust administration. The beneficiaries by then were accustomed to, and perhaps depending upon, regular distributions of cash, which were now ending. The beneficiaries, including her mother, objected to her fee, which was later confirmed by court order. The point is that acting as a trustee is often a thankless, demanding job.
A professional trustee can be very helpful for beneficiaries receiving needs-based governmental benefits. There are many rules regulating what are permissible distributions, and a professional often has many tips, suggestions and alternatives that can empower the special-needs recipient to live a more independent life (for example, using prepaid debit cards of controlled amounts).
A family member may serve as an investment trustee to manage the trust investments, while the professional trustee can act as the administrative trustee to oversee distributions to the special-needs beneficiary and compliance with the governmental agency’s reporting and other requirements.
The foreign trustee
Foreign trusts (trusts with a situs or business location outside of the United States) are subject to very high income tax and other filing requirements. The “business address or situs” of the trust is where the trustee resides. Selecting a trustee living in Canada, Mexico or another location outside the United States can trigger a foreign trust classification and the higher reporting requirements. Professional advice should always be obtained, as the penalties for failure to properly report can be substantial.
One way to help minimize that risk is to include language in the trust guaranteeing that trust assets would always remain under the jurisdiction of a state court within the United States. You may wish to utilize a state such as Nevada, which does not have a state income tax for its residents. The successor trustee would need to live in that jurisdiction for that to be effective.
