According to the IRS, there are more trust income tax returns being filed than corporate returns. This statistic points to the massive growth in trusts over the last two decades. Perhaps one of the greatest struggles for clients is finding the right trustee and providing a framework for the appointment of successors. With an estimated $41-$136 trillion passing in the next 50 years, the concerns surrounding trustee selection will only grow.
Selecting the right trustee
We find that the most common struggle for clients is the choice of who will provide long term management of the family assets. In many cases, the choice of who will handle the children is easier than choosing the manager of the family assets. There are a number of criteria that we typically recommend for the client to use in choosing a trustee. These include:
- Protect the Family. In many cases, a traditional trustee will view his or her primary role as protecting the trust assets. Instead, we believe the primary role of a trustee is to protect and preserve the family, even if that means depletion of family assets over time. The goal should not be to preserve assets for remote remainderman, but to assure a family is properly provided for.
- Discretionary Judgment. A direct result of the first criteria is that the client must trust the judgment of the trustee. Typically, we recommend that the trustees be given broad discretionary authority in making decisions on distributions (to the extent permitted by law). Such a broad discretionary authority typically involves value-based judgment decisions, and a client has to be comfortable that the trustee is up to the task.
To minimize this need for discretionary judgment, some advisors have told their clients to use an ascertainable standard, for example providing for the health, education, maintenance and support of the beneficiary in his or her accustomed manner of living. However, we do not believe that ascertainable standards are typically in the best interest of the client or his or her family. First, the language is so ambiguous that value judgments are still necessary on the part of the trustees (For instance, what is the accustomed manner of living?) Second, how do you know when the standard is exceeded? The ambiguity of the standard asks for conflict. Last, what if a genuine need exists outside of the ascertainable standard?
- Financial Ability. Although the trustees do not have to have professional financial skills, it is wise to use someone who has shown financial responsibility in the past and who has shown the ability to make correct decisions on financial issues. A trustee needs to be able to differentiate good investment proposals from sham transactions.
- Conflicts. The trustees who are chosen (both originally appointed and successors) should be appointed with an eye on the potential conflicts of interest which may exist or could be perceived by the beneficiaries.
- Guardians. We recommend that the trustees not be the guardians of any minor beneficiaries. This removes an inherent conflict of interest of the guardian/trustee being accused by a dissatisfied heir of mismanagement of assets by making distributions that indirectly benefited the trustee/guardian.
- History. Particularly where the trustees will hold funds for the benefit of minors, we recommend that the client think through how they have seen this potential trustee deal with his or her own children, because that treatment will probably parallel how the trustee will treat the client’s children.
Finding a trustee
Even with the above criteria, many clients have a time trying to determine whom to choose as trustee. When looking for a trustee, we tell clients to start with family, then review friends, then look at professional advisors and finally look at institutional trustees. The trustees may also be given the authority to hire a third party or trust department to handle certain administrative functions.
In many cases, we have recommended that co-trustees be used so that persons with some, but not all, the above characteristics can be blended with a trustee who has other characteristics. For example, it often makes sense to use a family member as co-trustee to mentor the children in financial responsibility, while also having an institutional co-trustee to manage the trust.
Institutional trustees are often of concern to clients because of rumored horror stories they have heard from friends. To minimize this we provide that either co-trustees or adult beneficiaries can remove an institutional trustee at any time without cause and appoint a replacement institutional trustee. Particularly when the primary beneficiaries may be minor children, it may be important to provide that the non-institutional co-trustee and/or guardians of the minor children have the ability to replace an institutional trustee with another institutional trustee.
The IRS has acknowledged that both the grantor and beneficiaries can be given the right to remove and substitute trustees without adverse tax consequences. Revenue Ruling 95-58, 1995-2 CB 91 provides that such a power is not considered a power of appointment which would pull the assets into the grantor’s or beneficiary’s estate. The substitute trustee cannot be related or subordinate to the party having such a power.
In many cases, it makes sense to permit the grantor or a spouse who is beneficiary of the trust to remove any trustee (for instance, a child becomes a problem). Moreover, after the death of the grantor and the grantor’s spouse, giving a majority of the adult beneficiaries the ability to remove and substitute a trustee can avoid a legal fight if the trustee does not perform properly. However, to protect against arbitrary action, it may be appropriate to require approval from the remaining trustees and/or a super-majority (66% to 80%) of the adult beneficiaries. Finally, it may be important to permit family trustees to appoint, remove and substitute an institutional co-trustee. This co-trustee can provide investment and administrative services if the family trustees do not want to perform these functions. In some cases, it may make sense to have the institutional component perform the functions without being a co-trustee, reducing the fees to the institution.
Particularly where the trust is expected to have a long-term existence (for example, a dynasty trust), the trust agreement needs to document how successor trustees are chosen. Potential future co-trustees may not even be born when the trust is created.
Choosing a trustee to manage family assets can never be done cavalierly. Hopefully, this column can provide you and your clients some useful perspectives in making the selections.
John J. Scroggin, J.D., LL.M., a graduate of the University of Florida law school, practices tax and estate planning at his own firm, John J. Scroggin & Associates, in Roswell, Ga. He can be reached by phone at 770-640-1101 or by email at firstname.lastname@example.org.