When you create your living trust, you will be the initial trustee. This permits you to maintain control over your assets.
It is important to name at least one—and preferably two—successor trustees. One or both of these successors will step into your shoes in the event you cannot serve as trustee. Generally, for married couples, the spouse is named as the successor trustee. Adult children, parents, brothers, sisters or other trusted family members are also often named as successor trustees.
Some people prefer to name an institution, such as a bank or trust company, to serve as successor trustee if all of the persons named in the trust are unable to serve as trustee. However, you should check the institution's fee schedule. Corporate trustees charge fixed fees based on the value of the trust, and some will not accept a trust if it does not have a minimum value.
A trust is a contract between the grantor and trustee. The trustee agrees to be bound by the terms of the trust and act in accordance with the wishes of the grantor as set forth in the document. This is a tremendous responsibility. It is important that you talk to the successor trustees and get their permission to name them as trustees. If all of the successor trustees you name refuse or fail to serve, and the document doesn’t provide a process to nominate a successor, the court will have to appoint a successor trustee.
If you decide to name two or more individuals to serve as trustee together—to be co-trustees—generally all individuals must agree before any investments or distributions can be made. Some state laws require that only the agreement of a majority of the trustees is required. Some grantors give one trustee veto or tie-breaking power. This subject can be specifically addressed in the trust.
Sometimes a person you want to designate to serve as trustee may have a lot of knowledge about investments and property management, but may not be responsive to the needs of others—namely, the trust beneficiaries. In contrast, you may have in mind a person who is very understanding about the needs of the beneficiaries, but who has no investment management skills. You can name both of these people to serve as trustees and designate the primary role that each will play as trustee. The investment-wise individual may have the final word with regard to transactions involving the investment of trust property, and the other individual may be given the final word with regard to the nature, amount and timing of distributions to the beneficiaries.
Once you have identified who will serve as trustee and successor trustee, the trust agreement must set forth the duties and responsibilities of the trustees.
Duties of a Trustee
Each state has laws that impose certain duties on trustees. If the trustee does not fulfill these duties, he or she is said to have breached his or her duty and can be sued by the grantor, the beneficiaries, or both. If the trustee loses the lawsuit, he or she can be ordered to pay money to the grantor or beneficiaries to recover losses the trust suffered while he or she served as trustee. The trustee can also be ordered to pay the attorney's fees and court costs of the grantor and beneficiaries. Finally, he or she can also be removed as trustee.
Possessing and Controlling Trust Assets
A trustee must collect and take possession of trust property as quickly as possible after becoming a trustee. This does not mean that the trustee must take actual physical possession of trust assets. He or she must, however, take whatever steps are necessary to take control of the assets. For instance, the trustee does not have to take actual possession of the stock certificates held by a brokerage firm. Instead, the trustee must make certain that legal title to the stock is transferred into the name of the trust and that the trustee is authorized to deal with the stock.
Preserving Trust Assets
After the trustee has located and taken control of the trust assets, he or she must preserve and protect the trust assets. The trustee must make certain that the trust assets are not wasting away or in danger of losing value. For instance, if the trust assets include an interest in a family business, the trustee must make certain that the business is being managed appropriately and that there is no interruption in the business.
Investing Trust Assets
The trustee must invest and maintain the trust assets so that they produce income for the benefit of the beneficiaries. Traditionally, almost every state requires that a trustee adhere to the prudent investor rule with regard to investing trust assets. The prudent investor rule requires the trustee to invest, reinvest, supervise and manage trust property by exercising reasonable care, skill and caution.
Trustees are generally authorized to acquire and maintain every kind of property (real, personal and mixed ) and every kind of investment (including stocks, bonds, securities, real estate partnerships, and the like).
Under the prudent investor rule, a trustee should:
- diversify the trust assets among many types of investments, such as stocks and bonds;
- diversify the trust among various industries;
- consider current income as well as long-term increase in value of the asset, since the beneficiaries of income and those who will eventually receive trust principal may not be the same; and
- seek professional advice for initial investment and continuing review of investments.
Under the prudent investor rule, a trustee should not:
- invest in risky ventures;
- lend trust property to him- or herself, except at fair value and with the consent of the beneficiary (or all beneficiaries);
- buy assets from the trust except at appraised value;
- continue to hold investments that a prudent person would no longer hold;
- continue to hold investments transferred to the trust without independently investigating their quality; and
- delegate investment decisions to others. It is acceptable to seek advice from others, but ultimately, the trustee must make the actual investment decisions.
If you wish to restrict the investment power of the trustee, you may want to include a provision that contains specific investment guidelines for the trustee. These guidelines could limit investments to stock in Fortune 500 companies and bonds with a minimum credit rating. However, you must be careful and try to consider the future when you limit a trustee's investment powers. The trustee needs some degree of flexibility to take into account changing economic circumstances and investment situations.
Example: David established a trust in the early 1980s when certificates of deposit were earning as much as 15%. David limited the trustee's investment power to certificates of deposit and any other financial instrument backed by the U.S. government with comparable interest rates. Because interest rates on CDs are now yielding less than 2%, they would no longer be a good investment.
Any restriction on the type of investments a trustee can make must be included in the trust document and must be very specific. If you do not leave clear instructions, the trustee can unknowingly undermine your intentions.
After the grantor passes away, state law may require the trustee to inform the trust beneficiaries of the existence of the trust. Because the trust is a private document between the grantor and the trustee (who is usually also the grantor), the beneficiaries will often not be aware of the trust's existence until after the grantor dies or becomes incapacitated.
The trustee has a responsibility to report to the beneficiaries and keep them informed of all of the trust transactions. This includes reporting all assets received, sold, or exchanged by the trust, any income earned, any expenses incurred by the trust, and any distributions made to beneficiaries. The date, the amount, and a short explanation of each transaction should be included in the reports. These reports can be done on a monthly, quarterly or annual basis. You may include a specific instruction in the trust as to how frequently these reports must be given or you may give the trustee the discretion to determine the frequency of such reports. You may also give the beneficiaries the right to waive this requirement.
The trust assets must be clearly identified. Titles to items such as bank accounts and stocks should have the name of the trustee, labeled "as trustee,'' on them.
After the grantor(s) passes away or becomes incapacitated, it is important for the successor trustee to keep the trust assets separate from his own. Failure to do this is called commingling and is one of the primary reasons lawsuits are brought against trustees. After the grantor passes away, or becomes incapacitated, the successor trustee must continue to keep the trust assets separate from his or her own assets.
Trustees should never borrow assets from the trust, sell assets to the trust, or purchase or lease assets from the trust for their own purposes, unless it is at fair market value with full disclosure to the beneficiaries and with their written consent.
The trustee must make distributions to the trust beneficiaries as provided in the trust document. The trustee is not allowed to substitute his or her judgment for the terms of the trust. If the trust permits the trustee to use his or her discretion in making distributions to the beneficiaries, the trustee must be reasonable in his or her decisions. For instance, it would be inappropriate for a trustee to favor one beneficiary over another when making distributions simply because the trustee does not like the beneficiary or does not agree with how the beneficiary behaves.
Payment of Expenses, Claims and Taxes
The trustee must pay the expenses of administering the trust. This includes investment or brokerage fees if the trustee uses an investment or financial advisor to assist the trustee in evaluating trust investments and selling trust assets. If a creditor of the grantor presents a claim to the trustee for payment, the trustee must investigate the claim to determine its validity. If the claim is valid, the trustee is under an obligation to pay the claim. The trustee must also pay any taxes, whether income or gift, attributable to the trust assets or distributions from the trust.
Each state has specific laws giving trustees powers to administer the trust. As creator of the trust, you can broaden the scope of those powers or you may restrict the powers. For example, you may wish to prohibit the trustee from selling the vacation home you inherited from your parents.
The powers often given to trustees under state law include the power to:
- invest and sell trust assets;
- collect trust income and rents;
- invest in stocks and real estate;
- open bank accounts;
- join in litigation to protect the trust assets;
- hire professionals, such as accountants and attorneys, to assist the trustee in fulfilling his or her duties;
- operate a business that is part of the trust assets;
- borrow money on behalf of the trust or renew any existing mortgage or other indebtedness;
- collect life insurance proceeds from policies made payable to the trust; and
- make appropriate elections to receive distributions from retirement plans.
You can grant a trustee special powers, such as the power to distribute funds to a beneficiary before the time designated in the trust agreement, if the trustee believes that the beneficiary is in need of the funds.
Often, it is advisable to include a provision in the trust agreement allowing a trustee to terminate the trust and distribute the remaining trust assets to the income beneficiaries if the trust has become economically too small to continue. Additionally, trustees should be empowered to merge the trust with another trust that has the same beneficiaries and the same terms. This often occurs when a husband and wife have living trusts that each provide upon their death that their children will be beneficiaries of the trusts. It would be less expensive and administratively more efficient to combine the husband's and wife's trusts into one trust for the children.
Removing a Trustee
Sometimes it is important to be able to remove a trustee without having to involve a court. Generally, the trust document gives the grantor the right to remove the trustee and name an alternate trustee. You may wish to include a provision in the trust giving your beneficiaries or a third party the power to remove a trustee if the trustee is stealing from the trust, is not fulfilling his or her duties under the law, or is not following the terms of the trust agreement.
A trustee may also voluntarily choose to resign.
The trust should contain a clear definition of incapacity and the resulting effect on who will serve as trustee. A definition of incapacity in the trust will generally avoid the need of a formal court determination of a trustee's incapacity. When a trustee is determined to be incapacitated, a successor trustee will automatically step in the trustee's shoes and continue the administration of the trust. If a definition of incapacity is not included in the trust, some of the benefits of probate avoidance are lost. A court declaration of incapacity of a trustee can be costly and time-consuming, and the terms of the living trust may become part of the court's public record, shattering the privacy aspect of the trust.