Clients often don’t put much thought into the importance of the selection of trustees and the standards for distributions used by the trustee. Truth be told, these are some of the most important decisions clients will make. The trustee is the CEO of the trust. They make the decisions regarding how to invest the assets and exercise whatever discretion is in the trust regarding distributions to beneficiaries.
First, who makes a good trustee? Clients often choose a trustee simply based on birth order. The oldest child often is the first one in line to be the parent’s successor trustee. Sometimes, that decision is best, but sometimes a better choice is available. Perhaps a younger child might have a better temperament to serve as trustee. Perhaps there is not a suitable child or other family member and an institutional trustee might be the best choice. Whomever is chosen as trustee, they should have the financial acumen to manage the trust assets, as well as the organization skills to manage the trust’s affairs. They need not be an expert in financial matters, but they should have the ability to manage experts whom they hire to give advice on investments, taxes, accounting, legal, and other matters.
Once a trustee has been selected, the next question is the discretion to give the trustee regarding distributions to beneficiaries. Great care should be taken in giving the trustee completely unfettered discretion. If total discretion is given to the trustee, they could refuse to make distributions to the beneficiary. This may not be what the client wishes to happen. Further, if the trustee is a remainder beneficiary of the trust, they may be making a gift if they exercise their unfettered discretion to make a distribution to the beneficiary.
If the trustee has complete discretion to make distributions to themselves, they will be treated as owning the assets of the trust for tax and creditor protection purposes. For example, in the case Estate of Nunn, a decedent’s will gave his widow the power to invade trust principal “for her own use and need as she may determine.” The court in that case determined that the widow-trustee had a “general power of appointment.” Such a power would cause the assets to be included in the estate of the trustee. Further, such a power could make the assets of the trust available to the creditors of the trustee.
The trustee may have a standard for distributions which is “ascertainable” without it being a general power of appointment. An example of an ascertainable standard is provided in Section 2041 of the Internal Revenue Code: health, education, maintenance and support. These buzz words are found in many trusts. If an ascertainable standard is used, the holder of the power, like a trustee, is deemed to not really have complete discretion because the beneficiary could go into court and force a distribution. In addition to “health, education, maintenance and support,” any other language, as long as it made the distributions enforceable by a court, would be ascertainable as well. However, other distribution standards, such as for “comfort” are not ascertainable.
Let’s look at a few common scenarios.
- The surviving spouse of a decedent’s credit shelter trust is the trustee of that trust. The surviving spouse must have an ascertainable standard as trustee in order to avoid the assets being included in their estate at the surviving spouse’s death.
- Joan wants to set up a trust for her daughter, Sally. Joan wants Sally to be the trustee of Sally’s own trust, but does not want it included in Sally’s taxable estate. Sally’s discretion as trustee must be limited to an ascertainable standard, such as health, education, maintenance and support.
- Bob wants to set up a trust for his son, Gary. Gary has a substance abuse problem and has difficulty managing his money. Gary also has creditor issues (which often accompany money management and substance abuse issues). Gary should not be trustee of the trust for his benefit because of these issues. In order to provide creditor protection, it would be best to have a completely discretionary distribution standard since Gary’s creditors could get at whatever Gary could demand. Bob could pick Gary’s sister, Meg, as the trustee. However, this might put a strain in the relationship between the siblings. Also, if Meg is the remainder beneficiary of the trust for Gary, this could cause problems, as well. It may be best to choose Bob’s best friend, George, who likes Gary but will not be intimidated by Gary in Bob’s role as the trustee. This will preserve the sibling relationship and provide the management and creditor protection desired.
The choice of a trustee and the distribution standard to be used are often the most important decisions a client will make. Great care should be taken in the selection of the trustee and in the selection of the distribution standard. There could be tax and creditor protection consequences to the selection of the wrong distribution standards or the wrong trustee.
The attorneys in our firm are experienced in all aspects of estate and income tax planning and charitable giving. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up-to-date with information regarding all types of estate planning strategies and tools. You can receive more information about a complimentary review of your clients’ estate plans by calling our office at (408) 356-9200 or (831) 476-2400.