You may have had conversations with family members about whether you would be willing to serve as a trustee of a trust for the children of a family member, particularly in the event that both parents should die while the children are still young. You may even be serving already as trustee of such a trust. Individuals often are asked to serve as trustees in many other situations as well. Few decline the request even though many do not fully understand the job description of a trustee until after they are on the job.
A trust represents a legal relationship where a trustee owns, invests and uses assets for the benefit of a beneficiary according to the directions of the individual who creates the trust (the “grantor”), and the requirements of applicable state law. The general duties of a trustee are to take control of and protect the trust property and to administer the trust as a prudent person would (a) as directed by the grantor and the law, (b) solely in the interests of the beneficiaries, and (c) impartially among multiple beneficiaries. Within that framework, the responsibilities of a trustee include making distribution and investment decisions, filing tax returns, and providing accountings to beneficiaries. The trustee must follow the directions of the grantor, which are typically written in a trust agreement or a will, and the requirements of applicable state law and state and federal tax laws.
Highlighted in this article are some key responsibilities of trustees, as well as potential liabilities. Individuals who agree to serve as a trustee should understand that competent and responsible service as a trustee is no small task but is entirely achievable with attention to detail and willingness to seek professional advice as needed.
Use and distribution of trust assets
Determining when and for what purposes to use or distribute trust assets to or for the benefit of a beneficiary is a primary responsibility of a trustee. A typical trust will direct the trustee to distribute the assets of the trust to the beneficiary or directly to a provider to pay the expenses of the beneficiary’s general support, medical care and education, as the trustee determines is advisable. Some trusts may require certain distributions to the beneficiary. Those requirements are fairly easy to meet because the trustee doesn’t need to make an evaluation as to whether the distribution should be made. For example, a trust document may require the trustee to distribute all the trust’s income to the beneficiary each year.
However, most distributions are determined at the discretion of the trustee. A trustee will not have specific directions from the grantor on how to use the trust in every circumstance that occurs in a beneficiary’s life, so a trustee has to consider many factors in determining whether or not to distribute the trust assets.
Some factors to consider are the needs of the beneficiary (e.g., living expenses, tuition or other educational expenses, or reoccurring medical expenses), the extent of the assets and income of the trust, the other resources of the beneficiary, and the aptitude of the beneficiary to responsibly use cash distributions.
For example, if a beneficiary relies heavily on the trust for living, educational or medical expenses, how quickly will the trust assets be completely expended? How long does the beneficiary need them to last? What expenses should take priority over others? For example, did the grantor intend that the trust be used, even entirely, for the education of the beneficiary as a first priority? What would the grantor want? What other financial resources are available to the beneficiary, and is the trustee required to take them into account in making or not making distributions? Did the grantor intend for the trustee to preserve assets for the remainder beneficiaries, those who will receive the remaining assets of the trust upon the death of the beneficiary?
Collecting information about a beneficiary’s financial resources and determining whether the beneficiary needs additional resources from the trust can be difficult, particularly when assets are to be preserved for remainder beneficiaries. The more a trustee knows about the life circumstances of the beneficiary and the intentions of the grantor — meaning what the grantor would do in various circumstances — the more informed the trustee’s decisions will be. And more informed decisions generally expose the trustee to less liability.
Investments
A second primary responsibility is to properly invest the trust assets. There is flexibility in choosing investments for a trust, but state law provides guidance and, therefore, some liability protection for trustees.
Many states, including Missouri, have adopted some form of the Uniform Prudent Investor Act which generally provides that a trustee must invest and manage trust assets as a prudent investor would by considering the purposes, terms, distribution requirements, and other circumstances of the trust. Violation of the state law standards exposes a trustee to personal liability.
Investment and management decisions regarding individual assets are evaluated not in isolation but in the context of the entire trust portfolio and an overall investment strategy that maintains risk and return objectives reasonably suited to the trust. Holding to this standard reduces trustee liability for poor performance from any one investment as long as the overall investment strategy that included in the investment complies with the standards set by the law.
Finally, a trustee may delegate the responsibility for making investment decisions — to a professional advisor, for example — and be relieved of liability associated with investments as long as the delegation is “prudent” under the circumstances and the trustee exercises reasonable care and caution in selecting an agent, defining the scope of the delegation, and monitoring the agent’s performance. Most individual trustees are well advised to at least consult with an investment advisor regarding the trust’s investments.
Accountings
Generally state laws require trustees to provide information to the beneficiaries about the existence, the assets, and the administration of the trust. State law may allow grantors to waive some of the reporting requirements in the governing trust document, but generally trustees must maintain clear accounts of the assets of the trust and all receipts, disbursements and distributions from both the income and principal of the trust and provide that information to current beneficiaries on a regular periodic basis and possibly to remainder beneficiaries who request it.
Taxes
Trusts of these types are considered taxpayers and have to file tax returns just like individuals do, but specific tax forms are used by trusts and special tax rules apply. Income of trusts can be taxed to the beneficiaries rather than the trust, thereby affecting the tax returns of the beneficiaries, and the federal ordinary income tax rate brackets for trusts are not nearly as favorable as those for individuals, so a trustee should request the assistance of a tax advisor who is familiar with tax planning for trusts and filing the required federal and state returns.
Liability
A trustee can have personal liability for losses associated with investment and distribution decisions. A grantor can protect individual trustees by limiting their liability in the governing trust document to the extent allowed by state law. For example, Missouri law allows a grantor to waive trustee liability for any acts short of acts committed in bad faith or with reckless indifference to the purposes of the trust or the interests of the beneficiaries. That is a provision to look for in a governing trust document before accepting the trusteeship. State laws also limit the time period during which an action can be brought against a trustee for distribution, investment or other decisions made by the trustee that are disclosed in accountings to the beneficiaries.
Conclusion
Serving as a trustee requires not only time and patience but also, in many cases, the ability to work with professional tax, legal and investment advisors from time to time to fulfill the duties of the position and minimize liability. However, the service of an individual as a trustee can promote administration of the trust more consistent with the grantor’s intent because of the personal relationship between the trustee and the beneficiary, which is most often why family members initiate those “trustee” conversations with each other.
For guidance on how to use this information in your estate planning, please contact a member of our Private Client practice area.
Jackie Dimmitt represents individuals and families in the areas of estate planning and charitable giving.