The grantor or settler creates a trust, but the trustee administers it. The objective of every trust and, thus, the duty of every trustee is to benefit the beneficiaries according to the terms of the trust. Although the trust has many advantages in estate planning, including greater control over the disposition of the settlor's assets and the reduction of estate taxes, it cannot be successful unless the trustee is successful. However, even if the trust does well, the trustee does not benefit from it, but if the trust does poorly, then the beneficiaries suffer even as the trustee continues to be compensated for his services.
A trustee requires business judgment, honesty, integrity, legal capacity to contract, should live close to the client or heirs, investment skill, and administrative and legal skills, since the trustee must send reports and account for the trust periodically. The type of assets held by the trust is also an important consideration. If the trust has a business, then obviously a trustee should be selected that has knowledge about managing that type of business.
Although the laws governing trusts varies widely among the states, the operation of trusts is fairly uniform because of their common objective and method of operations. Additionally, most states have adopted, in whole or in part, the Uniform Trust Code (UTC) exemplifies the laws governing trusts even in the few states that have not adopted the code. Even if the governing state has not wholly adopted the UTC, the settlor can specify in the trust document that the UTC should govern the trust.
The trustee has several duties:
- to collect and inventory trust property
- to manage and invest trust assets
- reduce taxes and probate costs
- provide for minor children
- invest assets that are not easily partitioned for the benefit of the beneficiaries, such as real estate
- protect the assets from divorced spouses or from other creditors of beneficiaries
- for a discretionary trust, the trustee must ensure that the beneficiaries can handle the money that they are receiving; otherwise, distributions should be delayed until they are more mature and financially savvy
- to abide by the terms of the trust and the law of the state in which the trust is located, and
- to give periodic reports to the beneficiaries and to the court, if necessary
The trustee must administer the trust in good faith, which is defined by UTC §801 as administering the trust in accordance with the trust terms and purposes, and the interests of the beneficiaries, and in accordance with the law. To adjudge whether there was good faith, the courts look to the trustee's state of mind, that what the trustee was doing was in the best interest of the beneficiaries.
The trustee must also administer the trust as a prudent person would administer his own property, exercising reasonable care, skill, and caution. (UTC §804)
Trustees can be either people — usually family or friends – or corporations, such as trust companies or trust departments of banks. While the executor of an estate may serve 1 or 2 years, the trustee may serve for generations. For various reasons, many wealthy families choose both a corporate trustee and a personal trustee, usually a member of the family. To ensure that the beneficiaries will receive the best service, the trust document should always provide for the replacement of the trustee, especially corporate trustees. Many trust documents provide that the adult income beneficiaries and the guardians of minor beneficiaries can vote to replace the trustee.
The tax treatment of the trust will depend on the type of trustee: grantor, adverse party, or non-adverse party. An adverse party, defined in IRC §672, is anyone with a substantial beneficial interest that would be adversely affected by the exercise or non-exercise of the powers in which she possesses over the trust, such as having a general power of appointment over the trust property. A non-adverse party is simply one who is not an adverse party and is not closely related to the grantor. Relationships include any businesses in which the grantor or family members have a significant ownership interest. Using a non-adverse trustee will yield the greatest tax benefits and credit protections for the trust. When the grantor serves as trustee, then the trust has no tax advantages, since the trust property is his property and taxed accordingly.
If a family member serves as trustee, especially if they are paid a fee for their services, then ensure that it will be acceptable to the other beneficiaries, that it will not generate resentment? If selecting more than one trustee, then the trust document should specify how disagreements will be handled. Note, however, that the trustee cannot also be the only beneficiary of the trust, since under the doctrine of merger, a trust ceases to exist when the legal title to the property held by the trustee is identical to the beneficiary's interest in the trust, in which case, the beneficiary has a fee simple title to the trust assets.
Another potential problem with trusts is that the trust may be considered a passive trust, where the beneficiary has most of the control and benefit of the trust assets, while the trustee does little or nothing, resulting in a merger of the equitable title with the legal title. In other words, the beneficiary has total title to the property, rendering the trust a fiction.
Corporations offer many benefits as trustees, especially as cotrustees to family members, but they require a minimum value of trust assets, usually at least $500,000, to make it worth their while. Corporate trustees will want to review the terms of the trust to ensure that they have the powers to carry out their fiduciary duties. Often, they will seek amendments to the trust document or seek additional powers for the trustee.
A trustee should be competent, trustworthy, and intelligent. Additionally, if the estate has a business, then a trustee should be selected that knows that particular type of business, and should also have knowledge about accounting and tax planning. Other general requirements are that the trustee should be willing to serve for the term of the trust, or as long as possible; charge low fees; have knowledge of beneficiaries and their circumstances; and it would also be helpful if the trustee has already managed a trust. Trustee should also be financially savvy, including being able to handle credit and debt, and manage investments. The trustee should also be impartial with respect to the beneficiaries and have no conflicts of interest in serving as trustee.
The trustee must also be available to administer the trust competently, especially if the trust has great value. There are 2 desirable traits of availability: permanency and proximity. Careful consideration should be given to how long the trustee is expected to live or to remain in good health, since it is difficult to remove a trustee if they start losing their ability to serve. Additionally, the trustee should be local to most of the beneficiaries, since it will be easier to serve them. The benefit of corporations serving as trustees is their permanency and, possibly, their geographic extent. Corporate trustees are more likely to be impartial; by contrast, it may be hard for a family member to be objective and impartial, since family members have higher or lower opinions of others in their clan.
Fiduciary Obligation of the Trustee
Because it is impossible to specify every requirement in the trust document and because the compensation of the trustee is not dependent on the performance of the trust, it is necessary to impose a fiduciary obligation on the trustee and it is up to the beneficiaries to enforce both the terms of the trust and the trustee's fiduciary obligation.
The beneficiary-trustee relationship is much like a principal-agent relationship. However, the beneficiaries cannot control the trustee as well as the principal can control its agent. Therefore, courts are stricter in applying the fiduciary principles to trustees.
The trustee owes a duty of loyalty to the beneficiaries, which is to say that the trust is only administered for their benefit — and for no one else's.
Hence, the trustee has a duty against self-dealing which is construed broadly as including any transaction that benefits the trustee or his family or friends or anyone else who is not a trust beneficiary (UTC §802). Self-dealing is considered a breach of the duty of loyalty per se. the beneficiaries can hold the trustee liable for any loss or undue the transaction, or compel the trustee to transfer any profit to the trust.
There have been exceptions to self-dealing that can be waived either by the settlor or by all the beneficiaries if they are provided a full disclosure of the proposed transaction. The court can also allow a transaction. UTC §802(i) allows the court to appoint a special fiduciary to render a decision about a proposed transaction. However, even when self-dealing is authorized the transaction must still be reasonable and fair.
If the trustee transfers property that the beneficiaries want to retain, then the beneficiaries may undo the transaction, unless the property was sold to a subsequent bona fide purchaser who had no notice of the breach of trust.
Furthermore, the costs of administration should be reasonable in relation to the trust property, the trust's purposes, and the trustee's skill. UTC §805
The law does allow some self-dealing for institutional trustees, such as banks and trust companies. For instance, a bank, acting as trustee, can also serve as the custodian for the trust funds. A corporate trustee can also combine separate trust accounts into a common trust fund or mutual fund for management, and the trustees are authorized to charge for reasonable compensation.
With more than 1 beneficiary, the trustee has a duty to be impartial with respect to their interests in the trust (UTC §803). Note that this doesn't mean equal treatment since the terms of the trust will probably not give all beneficiaries equal gifts. Impartiality only requires that any different treatment of beneficiaries be dependent on the trust document, their interests in the trust, or — if the trustee has discretion to distribute benefits according to the needs of the beneficiary — the beneficiaries needs. When the trust document gives the trustee discretion to distribute income or principal based on the needs of the beneficiary, then good faith requires that the trustee inquire into the needs of each beneficiary so that the discretion can be exercised according to the terms of the trust.
Duties at Inception of Trusteeship
The Uniform Prudent Investor Act §4 lists the duties that the trustee should attend to when the trusteeship is assumed. The duties of an inter vivos trust is generally not as urgent when the trust is created by the settlor and when the trust first acquires property, but a trustee that succeeds the settlor or another trustee, or when a trustee assumes the trusteeship of a testamentary trust, then it would behoove the trustee — if the investment duties have not been delegated to professionals — to quickly review the assets of the trust and how they are invested and determine if the investments provide the best conformance to the trust's objectives and whether the investments provide the return/risk ratio under current market conditions. If not, then the trustee should reallocate the assets in the portfolio to maximize the return/risk ratio.
The trustee should also ascertain that the investments and the administration of the trust are in compliance with both the settlor's intent and with the applicable law.
UTC §809 requires the trustee to collect and protect trust property without unnecessary delay. The trustee has a duty to care for the trust property as a prudent person would care for his own property. There is a duty to secure possession and to maintain the property. If the trust is a testamentary trust, then the trustee has a duty to monitor the executor's actions to ensure that the trust receives what it is entitled to without unnecessary delays. The trustee should insure real property, keep it in good repair, and take any other steps an ordinary owner would take to protect and care for the property.
UTC §810 requires the trustee to earmark trust property so that the property is designated as trust property, to distinguish it from the trustee's own property. Otherwise, for instance, the trustee could claim that profitable investments were his investments while losing investments were made for the trust.
Although the trustee has a duty not to commingle the trust assets with his assets, UTC §810 allows commingling with other trust funds to achieve economies of scale in investing and improving the efficiency of trust administration, especially for small trusts, and especially if the trustee is a bank or trust corporation.
Under common law, the trustee was held strictly liable for commingling, but the modern trend requires the beneficiaries to prove that they suffered because of the commingling.
Likewise, under common law, the trustee was strictly liable for any damage to trust property even if the damage was not caused by a breach of trust. However, the modern trend is to hold the trustee liable only for damages caused by a breach of trust.