Understanding the Role of the Trustee: A Spectrum of Choices
Many family trusts can be handled with family members in the role of a trustee, but alternatives to “Uncle Joe” serving as a trustee should often be explored, including using professional or institutional trustees. This article explores the role of the trustee, the merits of various arrangements and combinations of trustees, and their removal and replacement.
What Is a Trustee and What Does a Trustee Do?
A trustee is, fundamentally, the person or institution who is legally responsible for managing the assets that are in a trust1 and for making decisions on the use of trust assets for the trust beneficiaries. In this role the trustee must decide on distributions of the trust funds for the benefit of beneficiaries and determine how beneficiaries may use certain assets, such as a vacation home, owned by the trust.
The trustee must consider trust purposes such as the education of young beneficiaries and the support of ordinary folks, or perhaps even helping beneficiaries with special needs such as beneficiaries who are elderly, disabled, or down and out. The beneficiaries may be persons the trustee knows, sometimes all too well, like siblings, children, nieces, nephews, or their own parents. The trustee may have to run a business, commercial or investment real estate, and may have to make decisions concerning trust assets that the trustee has never had to deal with before such as valuable artwork, property in foreign countries, investments, and annuities.
A trustee is sometimes charged specifically with protecting assets for the beneficiaries, so that their creditors and so-called predators cannot get at the wealth that has been reserved for the beneficiaries. Complicating matters is the fact that the trustee has to look out not only for today’s beneficiaries, but also for those who follow.
The trustee, therefore, must not only be a person of at least common intelligence and maturity, but also someone who is sufficiently wise to understand the nature of the decisions and transactions that come with the territory. Trustees must be devoted to learning and keeping up with both the circumstances of the beneficiaries of the trust, such as their family situation, their employment, income, and health, as well as staying current on what the trust means and how to apply terms in light of legal requirements.
1: A trust is an agreement or declaration, usually in written form, providing for the use of assets to benefit certain beneficiaries. The parties to the agreement are the grantor(s) of the trust who create the terms, and the trustee(s) who will carry out the terms of the trust in accordance with law.
What Professional Assistance Should a Trustee Seek?
It is no surprise, based on the foregoing, that a trustee is going to need legal and accounting advice in order to make appropriate decisions, properly document transactions, account for funds coming in and funds going out of the trust, and properly file tax returns (more on that later). Trust counsel should advise on interpretation of the language as it often has a particular meaning in the state where it is being applied.
Trust Accounts are to be given annually to qualified beneficiaries, showing beginning and ending balances and what was received and paid out. Technically, trust Accounts should also show book values and some market values. Real estate is generally carried at book value. But these formalities are often overlooked in favor of reporting of basic financial activity. Providing tax returns and account statements is often deemed sufficient accounting, but local practice should be consulted.
Compensation of Trustees
All trustees should be reimbursed for their expenses and, unless a document requires otherwise, all trustees are entitled to some form of compensation for their efforts. Trustees are not usually rewarded for their results, but instead are paid “reasonable compensation.”
Reasonable pay may mean being paid by the hour as in the case of professionals and laypersons, where hourly rates of compensation make sense in the context of the tasks being handled, whereas institutions are more likely to provide their services for a flat annual fee as a percentage of the income produced by the trust and a percentage of the principal of the trust.
A percentage fee must still be a reasonable fee. For example, 1% to 5% might be reasonable as a fee to charge for the settlement and wrapping up the affairs of the trust, but an annual fee of 5% would probably be unreasonable in administering most trusts. There may be exceptions where the duties are significant or the risks and rewards are extraordinary. Hourly fees may range from as little as minimum wage for untrained family members doing grunt work, such as assisting with cleaning out a house prior to sale, all the way up to the highest hourly rates for attorneys and accountants.
In the experience of this author there are very few set patterns and the most important point is to make sure that the discussion regarding how the trustee will charge or what kind of compensation would be paid should be had up front whenever possible.
Liability of a Trustee
A trustee can be liable for their mistakes, depending on the terms of the trust. For example, neglecting to file income tax returns, missing opportunities to sell or to take other actions and precautions concerning assets held by the trust, failing to keep proper insurance on real estate, and so on. These mistakes or oversights can all result in liability for the trustee for the gross neglect of duties.
Operating in good faith is a baseline duty expected of all trustees. When the trustee acts to benefit himself or with the intent of hurting rather than helping a beneficiary (the ultimate in bad faith), watch out! In that case, the trustee cannot even be reimbursed for legal fees defending their actions, which ordinarily they would be able to expect from the trust in fending off beneficiary’s claims.
Very often the trust instrument itself will limit the trustee’s liability to the baseline standard so that, as long as the trustee is operating in good faith, the trustee will not be liable for losses or breach of duty. Sometimes the trust instrument will expand upon this minimum duty and call for liability if there is gross negligence (even though there was no lack of good faith).
If the trustee is a layperson, such as a family member or other nonprofessional, when it comes to investment losses, they will be held is the community’s standard for a prudent investor, i.e., one who is reasonably careful about how assets held in the trust should be handled.
It is fair to say that professionals who act as trustees, such as financial institutions, lawyers and accountants, are held to a somewhat higher standard than the layperson, even though the wording of the trust may not differentiate between whether the trustee is a person or a professional. Professional trustees may be found liable for even ordinary negligence (as opposed to gross negligence) and may have to repay the trust for a particularly bad result.
Safe Territory?
Trustees are typically going to be insulated from liability, no matter who they are, for their discretionary decisions concerning the benefit for beneficiaries, as long as they act in good faith and have made inquiries of the beneficiaries and conducted research and other diligence (including relying reasonably on professional advice) before making a decision. However, not all decisions allow for the luxury of time for research and diligence. Therefore, trustees will also be judged by how they acted under the circumstances.
Tax Filings
During the grantor’s lifetime, most trusts are not separate taxable entities. At this point, the trust income is taxed to the grantor and included on the personal income tax returns. During this time, the trust is known as a “grantor” trust for tax purposes. But, income taxation changes at death when the trust becomes irrevocable and obtains its own tax identification number, and files its own tax returns. Some trusts are irrevocable from the moment of their creation and, if they are not “grantor” trusts, they must file their own tax returns even while the grantor is living.
Removal and Replacement of Trustees
Most trusts name successor trustees to hold office after the current trustees, and further alternates after them. Most will also allow the grantors to remove and replace trustees. If this creates a conflict of interest that cannot be allowed to happen, then the power to remove and replace trustees is put in the hands of others – “interested” persons like family members or independent persons, like trust protectors (advisors who act like consultants and are often given the power to decide certain matters).
Trustees are sometimes permitted by the trust to appoint co-trustees while they serve, as well as their successors when they are stepping down. Some trusts limit the service of a co-trustee to the period when the appointing trustee is also serving (in other words, the co-trustee cannot become a successor trustee who could serve alone). Trusts may not have successor provisions, in which case a court may have to appoint the successor.
With the role of trustee comes lots of responsibilities. Read part 2 of Borchers Trust Law’s Spectrum series to see what goes into choosing a trustee and under what circumstances you would consider replacing them.
