By Alexander J. Gross, CFP®, CPA/PFS®, AEP®
Family members and friends are frequently asked to serve as a trustee of a trust because of their close relationship with the settlor (the trust’s creator) and their families, as well as familiarity with the settlor’s wishes. While it is an honor to be asked to serve in this role, it can also be a significant burden. Trustees have a great responsibility to carry out the terms of the trust, and one should fully understand the importance and risks involved before agreeing to take on this role.
A trustee stands in a “fiduciary” role with respect to both current and future beneficiaries of the trust. A fiduciary will be held to a very high standard, meaning that even more attention must be paid to the trust’s investments and disbursements than perhaps a trustee’s personal accounts. Failure to do so could lead to beneficiaries suing for breach of fiduciary duty.
The Trust’s Terms
The trust needs to be read carefully both now and when any questions arise. The trust is the instruction manual set forth by the settlor and the trustee must follow its directions. State law also impacts how a trustee must operate. Decisions about whether, when, and how to distribute income and principal must be made carefully based on all facts and circumstances. Protecting the trust’s assets for the benefit of its beneficiaries is paramount.
The investments a trustee directs or approves must be prudent, meaning that trust assets cannot be placed in speculative or risky investments. In addition, any investments must take into account the interests of both current and future beneficiaries. For instance, a current beneficiary entitled to income from the trust would benefit more by investing the trust funds to generate as much income as possible. However, this may be detrimental to the interest of future beneficiaries who would benefit more from trust funds invested for long term growth. In addition to balancing the current interests of the various beneficiaries, future financial needs must be considered. Does a trust beneficiary anticipate starting a new business or going to school? Will they be depending on the trust assets for retirement in 20 years? All of these questions need to be considered in determining an investment plan for the trust.
When evaluating whether or not to approve a distribution request from a beneficiary, trustees must consider several factors. Thought must be given to the current and future needs of the beneficiary. Does the beneficiary receive other sources of income they could use instead of trust funds? Would a distribution put funds at risk with creditors or divorce proceedings? Could distributions further enable a beneficiary struggling with substance abuse? Trustees also must consider the fiduciary responsibility they have to other beneficiaries of the trust. Often the most important role of a trustee is the ability to say “no” and set limits on the use of the trust assets.
Depending on whether the trust is revocable or irrevocable and whether or not it is considered a “grantor” trust for tax purposes, the trustee will have to file an annual tax return and may have to pay taxes. In many cases, the trust will act as a pass through, with the income being taxed to the beneficiary. Keeping meticulous records and seeking tax preparation by a CPA is advised.
A trustee is responsible for keeping track of all income to, distributions from, and expenditures by the trust. Generally, the trustee must give an account of this information to the beneficiaries on an annual basis; however, the terms of the trust and state laws can vary and should be verified. Some trusts require principal and income to be tracked and reported separately.
While the inherent responsibilities of a trustee cannot be delegated, most of the functions described above can. Financial and investment advisors can be hired to manage the cash flows and investments in a trust. Accountants can handle tax compliance and attorneys can help interpret trust language. The trust’s custodian can keep records of principal and income if required by the trust.
Trustees are entitled to reasonable fees for their services. Family members who become trustees often choose to decline payment, although that can depend on the work involved in a particular case, the relationship of the family member, and whether or not the family member trustee has been chosen due to his or her professional expertise. Determining what is reasonable can be difficult. Banks, trust companies, and law firms typically charge a percentage of the funds under management. Others may charge for their time. In general, what is reasonable depends upon the work involved, the amount of funds in the trust, other expenses paid out by the trust, the professional experience of the trustee, and the overall expenses for administering the trust. In any case, it makes sense to consult with a professional who is experienced with trust work and who can offer guidance on determining appropriate trustee fees after considering all circumstances.
Much like agreeing to serve as a guardian for minor children in a person’s will, agreeing to serve as a trustee can be a tremendous gift to give. It is important to remember that being a trustee can be a long-term commitment, and the responsibilities can be time consuming. Before agreeing to become a trustee, it is prudent to speak with the settlor of the trust (if possible) and understand their intent and the trust’s purpose. It is also advisable to seek professional advice from a financial advisor and make sure the risks and responsibilities are well understood. A potential trustee should consider what functions of the role can be done independently and what services would need to be hired out. It is also important to consider who the current and future trust beneficiaries are and if the trustee/beneficiary relationship would be a healthy one.
Print version: Your Duties and Responsibilities as a Trustee
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