It is common for a family member, a family friend, or a close family advisor, such as an accountant, to serve as trustee of a family trust. The individual may have substantial experience serving as a fiduciary, or may have no experience at all. When serving as trustee, it is important to have a solid understanding of the powers and responsibilities associated with the role.
A person may be asked to serve as trustee of either a revocable trust or an irrevocable trust. Usually, the settlor of a revocable trust serves as his or her own trustee while alive and well. In most cases, therefore, fiduciary issues arise where a person is serving as trustee of an irrevocable trust. Except where otherwise indicated, the discussion in this article refers both to situations in which a person is serving as trustee of an irrevocable trust and where she is serving as trustee of another person’s revocable trust.
Understand the Trust
At the outset, the trustee should read the trust instrument carefully. The trust instrument sets forth the powers that the trustee has, the beneficiaries’ rights to distributions, and the trustee’s administrative responsibilities. The law requires that a trustee administer the trust in accordance with the terms of the trust instrument. With very few exceptions, the terms of the trust instrument govern over the default rules that are provided in the Probate Code. A trustee should not assume that he or she already knows what the trustee’s powers and responsibilities are. The terms of the trust instrument govern the administration of the trust, and different trust instruments have different terms. Trustees generally have all of the powers over trust property that an individual has over his or her own assets, but trust instruments sometimes place restrictions on these powers. For example, some trust instruments place restrictions on the ability of a trustee to borrow or to pledge trust property as collateral for a loan. The trustee must be aware of such restrictions.
Duty Of Confidentiality
The terms of a trust are private, and the trustee owes a duty of confidentially to the beneficiaries with respect to the terms of the trust. Individual trustees often overlook their duty of confidentiality when opening accounts at banks or brokerage firms. The institution will often ask to see a copy of the trust instrument. Instead of giving the institution a copy of the trust instrument, the trustee should generally provide a trust certification. The trust certification will contain the information the institution needs: the name and date of the trust, the name of the settlor, the name and address of the trustee, the relevant powers that the trustee holds, the respective authority held by co-trustees, and the names of any persons who have the power to revoke the trust. Similarly, if a copy of the trust would typically be attached to a document that will be filed as a matter of public record, a trust certification should be attached instead. The trustee and her attorney should be careful when filing petitions, complaints and other documents that pertain to the trust with the court. Sealing of court files is generally reserved for extraordinary situations. In ordinary cases, instead of attaching a copy of the trust to the petition, the trustee or her attorney should perhaps contact the court clerk about the possibility of separately submitting a copy of the trust to the judge for in camera inspection.
Trust Exists for the Benefit of the Beneficiaries
The overriding principle in trustee/beneficiary relationships is that the trust exists for the benefit of the beneficiaries, not the trustee. All action the trustee takes in connection with the trust must be for the benefit of the beneficiaries. A trustee must never engage in any act that benefits herself rather than the beneficiaries. One exception to this rule is that the trustee may receive reasonable compensation for her services as trustee, as discussed below.
Duty of Loyalty
A corollary of the rule that the trustee must act only in the best interests of the beneficiaries is that neither the trustee nor any person related to the trustee should engage in any transaction with the trust or with any trust beneficiary. This rule is known as the “duty of loyalty.” Thus, the trustee should not, in her individual capacity, borrow money from the trust or a trust beneficiary, nor should the trustee lend money to the trust or a trust beneficiary. The trustee should not buy property from the trust or a trust beneficiary, nor sell property to the trust or a trust beneficiary. In addition, the trustee should not usurp any opportunity that would otherwise belong to the trust. If the trustee (or a relative of the trustee, or an enterprise in which the trustee has an interest) does any of these things, the beneficiaries might be able to void the transaction unless the transaction is authorized by the trust instrument, was approved by a court or was approved by the beneficiaries.
Keep Beneficiaries Informed
The trustee must keep the beneficiaries fully informed regarding the operations of the trust. This includes providing each beneficiary with a copy of the trust instrument and sending an annual accounting to each beneficiary.
The accounting should show
- the assets and liabilities of the trust at the beginning of the year,
- all income items received during the year,
- all expenses items paid during the year,
- all distributions made to beneficiaries during the year, and
- the assets and liabilities of the trust at the end of the year. The accounting should also disclose any other matters pertaining to the trust of which the beneficiaries should be aware.
In addition, the trustee should notify the beneficiaries before the trustee takes any significant action with regard to the trust, in order to give the beneficiaries an opportunity to register objections with the trustee before the action is taken. The trustee must also notify the beneficiaries when a new trustee takes office, when a revocable trust becomes irrevocable as a result of the settlor’s death, and when the trustee’s compensation changes.
If there is a particular dilemma associated with keeping a beneficiary informed about the trust’s activities, such as where a beneficiary suffers from substance abuse, the trustee should discuss her options with her attorney. For example, while it is prudent for a trustee to provide a copy of the accounting to all beneficiaries, the statute requires only that a copy be sent to beneficiaries who request it. In addition, some informational requirements can be, and may have been, waived by the settlor in the trust instrument.
In Bountiful Utah, the requirement that the trustee keep beneficiaries informed generally applies only to “qualified beneficiaries.” A qualified beneficiary is any beneficiary who is a current or permissible distribute of trust income or principal, or any beneficiary who would be a distributor if the trust terminated at the time in question.
In addition, if contributions to the trust are intended to qualify for the annual exclusion from the federal gift tax, it will be the responsibility of the trustee to send out the annual Crummy withdrawal notices to the beneficiaries.
Treat Beneficiaries Impartially
The trustee must treat the beneficiaries impartially, except to the extent the terms of the trust instruct the trustee to favor one beneficiary over another.
Segregate Trust Assets
The trustee must maintain separate accounts and separate books for the trust. The trustee must not commingle her personal funds with trust funds.
File Tax Returns
An irrevocable trust is a separate tax-paying entity. If the trust does not already have a taxpayer identification number, the trustee will need to obtain one.
It is the trustee’s responsibility to file federal and state fiduciary income tax returns each year, reporting the income earned on trust assets. Preparation of these returns requires a sophisticated understanding of the income tax principles relating to trusts. The trustee should have the returns prepared by an accountant who is familiar with such returns.
Responsibly Administer the Trust
In general, the trustee must administer the trust in a prudent manner. The trustee is responsible for protecting trust property, enforcing claims that the trust has against other persons, keeping appropriate records and incurring only reasonable costs. Where applicable, the duty to protect the trust property includes the duty to keep it adequately insured from loss.
Prudently Invest Trust Funds
A trustee may believe that she is a sophisticated investor, and she may in fact be such. Nonetheless, the trustee should familiarize herself with the “Prudent Investor Rule.” This rule has several important components. First, the trustee must hold a diversified portfolio of assets unless the trust instrument relieves the trustee of this responsibility or the trustee, after careful consideration, reasonably determines that because of special circumstances the purposes of the trust are better served without diversifying. Second, the trustee must have an investment strategy with risk and return objectives that are reasonably suited to the trust, and trust investments must take into consideration the purposes, terms, distribution requirements, and other circumstances of the trust.
Third, the trustee must weigh the following factors when making investment decisions:
- general economic conditions;
- the possible effect of inflation or deflation;
- the expected tax consequences of investment decisions;
- the role that each investment plays within the overall trust portfolio, which may include interests in closely held enterprises, tangible and intangible personal property, and real property;
- the expected total return from income and the appreciation of capital; other resources of the beneficiaries;
- needs for liquidity, regularity of income, and preservation or appreciation of capital; and
- an asset’s special value, if any, to the purposes of the trust.
The trustee should consult with a professional financial advisor when designing and implementing an investment strategy for the trust. The trustee should not assume that the investment experience she brings to her own personal investments is sufficient for her role as a fiduciary.
When more than one trustee is serving, the co-trustees must act by majority decision, unless the trust instrument provides otherwise. Thus, if two trustees are serving, they must act unanimously. If more than two trustees are serving, they can act only if a majority of them concur in the proposed action. Co-Trustees are generally able to delegate their authority to act to other co-trustees, unless the trust instrument places restrictions on the ability to delegate. A trustee has a duty to monitor the actions of her co-trustee.
Consequences of Breach
If a trustee fails to faithfully perform her responsibilities, she may be subject to any of a variety of sanctions, including monetary damages, removal as trustee, denial of her compensation, and the setting aside of certain transactions that she may have entered into improperly. In order to protect herself from monetary damages, the trustee may want to consider obtaining errors and omissions insurance. It is rare for an individual trustee to carry such insurance, but it is good to be aware of the option, since umbrella insurance policies do not usually cover liability arising out of a person’s role as a fiduciary.
In extreme cases, a fiduciary may be subject to criminal liability for breach of fiduciary duty if the breach results in substantial risk of loss to the beneficiaries.