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Estate Planning: Trusts

After years of working with fami-lies to establish trusts, and withindividual trust beneficiaries, it

has become clear to me that there is aneed for better understanding by thepersons creating trusts and, more impor-t a n t l y, by beneficiaries, about what atrust is, and how trusts work.

I r o n i c a l l y, the beneficiary, who is thevery person for whom a trust is estab-lished, is often quite confused aboutfundamental trust concepts.

In my view, the education of familymembers, especially beneficiaries, is asimportant as the creation of legal struc-tures and the proper investment of assetsto ensure the preservation and growth offamily wealth and enhance the benefi-ciary’s life.

F u r t h e r, legal and financial advisors,as well as trustees, should assist benefi-ciaries in the educational process.

This article summarises some funda-mental issues that advisors can andshould strive to teach their clients.

The process should begin when a trustis created and continue for its duration.This will help the beneficiary betterunderstand the trust and how the bene-ficiary can play an active role in itsadministration.

O b v i o u s l y, this list hardly begins toaddress the complex set of issues thateach trust entails. Hopefully though itcan guide advisors as they raise theirawareness and assist beneficiaries in theprocess.

1.Terms of the trust agreementA beneficiary should receive a copy of thetrust agreement, or at least relevant partsof it, from the trustee.

The trust agreement provides a set ofinstructions for the trustee and guidelinesfor the beneficiary.

The trustee should also provide asummary (oral or written) of the trustand be available to answer questions

about its terms. It is only by reference tothe specific provisions of the benefi-c i a r y’s own trust that the beneficiary willfully understand how they apply to himor her.

Key parties The trust agreement defines the keyparties to the trust relationship:• the “grantor” or “settlor”

contributes funds to the trust andgenerally sets its terms;

• the “trustee” is the individual, bank or trust company who isresponsible for holding the trustfunds and implementing its terms;

• the “beneficiary” is a person who is to receive current benefits(income and/or principal) from thetrust;

• the “remainderperson” is anyonewho is entitled to receive trust property when it terminates.The beneficiary should seek clarifica-

tion on what the trustee can or must dowith trust income and principal.

Often, the agreement states that thetrustee is to pay income to a particularb en e f i c i a r y. This is generally annually ormore frequently. It may also providethat principal is to be paid at certainages or from time to time in the trustee’sdiscretion.

A trustee who has discretion overpayment of trust income and/or princi-pal is subject to certain standards thatdetermine when payments can be made: • under a broad standard, the trustee

may pay principal for any reason, ornot at all;

• a more restrictive standard mightstate that principal may be paid forthe emergency needs of the beneficiary.The beneficiary and trustee should

discuss openly the types of payments thatcan be made.

By helping a beneficiary

understand the essential

vocabulary and concepts of

the trust relationship, an

advisor can increase the

chances that the beneficiary

will be able to truly benefit

from the trust

By Patricia M Angus

TEN FACTS EVERY TRUST BENEFICIARYSHOULD KNOW

Trustee’s powersThe trust agreement provides specificguidance on the trustee’s powers. Thispart contains important information thatwill give the beneficiary key ideas onwhat the trustee can and can’t do for himor her. For example, before the benefi-ciary calls the trustee to request a distri-bution, it would be useful to find outwhether a loan would be possible. Fortax or other reasons, it might be betterfor the beneficiary to take a loan ratherthan a distribution.

Beneficiary’s powersThe beneficiary should also find outwhat specific powers are reserved to theb e n e f i c i a r y. He or she may have a“power of appointment”, which givesthe ability to determine where trust prop-erty goes upon the beneficiary’s death.

2. Identity of the trustee, otherbeneficiaries, investment advisors,accountants and other advisors tothe trustThe beneficiary should know who theother parties to the trust relationship are,currently and in the future.

The trustee can be one or more indi-viduals or institutions.

There may be an investment advisorwho is responsible for managing trustassets.

The beneficiary may be one of severalpeople (family members or others) towhom income and principal may bepaid. The beneficiary should understandw h e t h e r, and to what extent, he or shehas the ability to request or demandremoval of the trustee. It is also helpfulto find out whether there is a trust“protector” or other trust advisor.

3. Purpose of the trustIdeally (but infrequently), the trustagreement contains a statement of theg r a n t o r ’s reasons for establishing thetrust. If the trust agreement is not clear,the beneficiary should seek clarificationof the purpose. Understanding themission will help the beneficiary keep theentire arrangement in perspective.

If the trust agreement is not clear, thebeneficiary should ask the trustee, lawyeror other advisors for some backgroundinformation. The beneficiary will notnecessarily be happy with the grantor’spurpose. However, knowing the reasonsmay help keep potential frustration andanger in the right direction, rather thanat the trustee, who is merely carrying outthe grantor’s wishes.

4. Trustee’s dutiesA trustee is a fiduciary and, as such,must act in the best interests of the bene-ficiaries and remainderpersons.

If a trustee takes advantage of its legalownership of the property it faces notonly the ire and wrath of disgruntledbeneficiaries, but can also face legalaction by them.

In addition, a trustee has a number ofspecific duties, including duties to:• exercise reasonable care, skill and

caution;• keep and render accounts of

administration; • take and keep control of trust

property; • keep the trust property separate;• make the trust property productive.

5. Beneficiary’s rights and responsibilitiesOne unique aspect of the trust structureis that the beneficiary is an integral, andindeed the most important, person in theoverall structure. Yet often the benefi-ciary is not involved in the process ofestablishing the trust or in its adminis-tration. This can lead to an unhealthyfeeling of dependence.

To maximise the benefits the benefi-ciary may receive from the trust and toensure the wellbeing of the overall trustarrangement, the beneficiary should becomfortable with his or her rights andresponsibilities (Tables 1 and 2).

6. Duration of the trustMost trusts are governed by a local“perpetuities period”, which usuallystates that no trust (other than a chari-table trust) may last more than one life-

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Estate Planning: Trusts

time (starting at the time the trust iscreated) plus an additional 21 years. Thiscenturies-old restriction is now beingloosened in many jurisdictions. All newtrusts in Delaware, South Dakota,Alaska and many other states (and coun-tries) may now last in perpetuity.

7. General overview of trustaccountingA beneficiary does not need to becomean accountant to gain a basic under-standing of trust accounting. The basicconcept – that a trust is established withcontributed assets, known as trust “prin-cipal”, and any amount that is generatedby that principal (such as interest or rent)is considered to be “income” – is quitesimple.

More specific definitions of incomeand principal are provided by the lawgoverning the trust. Indeed, the defini-tion of “income” can be quite compli-cated.

The beneficiary should be aware thatt rust accounting principles are not alway sthe same as tax rules. In this way, a bene-ficiary may be subject to tax on incomethat he or she did not actually receive butis attributed to the beneficiary.

8. General overview of trust lawEach trust is governed by the laws of aparticular state (or country). These locallaws and court interpretations provideguidance to the trustee and beneficiaryabout trust administration. In general,the terms of the trust agreement will

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Estate Planning: Trusts

To participate actively in trust affairs

To understand the trust’s mission or overriding purpose

To understand the general nature and composition of the trust assets

To understand his or her rights and responsibilities under the trust agreement and how these

relate to the rights and responsibilities of other beneficiaries and remainderpersons

To gain a basic understanding of trust law

To obtain a general understanding of investment fundamentals, including modern portfolio

theory and how it fits with the “Prudent Investor Rule”

To understand the trustee’s roles and responsibilities

To develop a general capacity to understand trust accounting

To know how and in what amount trustees and other professionals are compensated, and

obtain a general understanding of the budgets for the trust and investment entities in which

the trust will be invested

Table 2: The beneficiary’s responsibilities.

To review the trust agreement and related documents

To expect the trustee to be accountable to each beneficiary and remainderperson of the trust

To have a trustee who is willing to maintain open communication

To attend regular (at least annual) meetings with the trustee to discuss trust matters and the

b e n e f i c i a r y ’s personal financial circumstances and goals, and to provide input on the trustee’s

performance in light of the trustee’s duties and responsibilities

To seek removal of a trustee in appropriate cases

Table 1: The beneficiary’s rights.

apply to the extent that they are nototherwise prohibited by law. A grantormay choose the laws of a particular stateor country, so long as there is a sufficientconnection with that state to obtaincertain benefits. For example, an increas-ing number of trusts are being establishedin Delaware because there is no statefiduciary income tax, asset protection isenhanced and a trust can last forever.

9. General overview of investmentfundamentalsThe trustee (or in an increasing numberof cases, its delegate) will be responsiblefor investing trust assets.

The beneficiary should, at a mini-mum, understand the basic availableinvestment options, including cash, stock,bonds, mutual funds, real estate, art and“alternative” investments such as hedgefunds.

The trustee is responsible for decidingwhether to retain the original assets andfor ensuring that the investments matchthe trust’s goals.

The beneficiary should seek to under-stand the basics of “modern portfoliotheory”, which states that the mostimportant factor in determining a port-f o l i o ’s performance is the allocation ofassets over time – not stock picking ormarket timing.

The beneficiary should be able toengage in a discussion of each asset class,the historical return for each class and itsfunction in the portfolio.

The asset allocation can and should beadjusted as the needs of the beneficiary –and the financial climate – change overtime.

10. The “Prudent Investor Rule”Traditional rules have limited the trustee’sability to invest trust assets under a fairlyrestrictive standard that emphasise main-taining principal even if growth ishindered.

Under the new “Prudent InvestorRule” adopted by many states, a trusteemust develop an overall strategy for thetrust portfolio in the light of the presentand future needs of beneficiaries while

taking into account risk and return.Diversification among asset classes isconsidered essential. The “total return”of the trust is paramount.

Each asset or class is looked at in thecontext of the entire portfolio. Tr u s t e e smust balance income and growth. Theymay also delegate their investmentresponsibility so long as the delegation isprudent.

This law is being complemented byanother new law to ensure that invest-ments chosen for total return (including“growth” stocks) do not adversely affectincome beneficiaries. New rules nowallow trustees to adjust between incomeand principal and in some cases tochoose a specific percentage (“unitrustamount”) of the trust to be considered“income” for distribution.

“Advisors should strive

to teach their clients

fundamental issues to help

beneficiaries better understand

what a trust is, how it works

and how they can play an active role

in its administration”SummaryMany of the ideas in this article (espe-cially beneficiary roles and responsibili-ties) have been explored in greater detailby James E Hughes Jr, who shares myviews.

I hope that this article will add to theresources that advisors and beneficiariescan draw upon to reduce misunder-standings that can lead to conflict and toensure that trusts are truly beneficial inthe lives of their beneficiaries.

By helping a beneficiary understandthe essential vocabulary and concepts ofthe trust relationship, an advisor can helpincrease the chances that the beneficiarywill be equipped to work better with hisor her advisors and truly benefit from thetrust. ◆ Private Wealth Management 2003

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THE AUTHORPatricia M Angus

is Counsel to Day, Berry &Howard (including Hughes

and Whitaker), New York, USA

E - m a i l :p a t a n g u s @ e a r t h l i n k . n e t

Estate Planning: Trusts