INTRODUCTION
Many people who create a trust put little thought into selecting a trustee. Most simply choose a friend or a relative they trust. However, many times that trusted friend or relative does not have the knowledge to properly administer the trust or does not understand what it actually takes to be a trustee. This article explains the laws governing a trustee and the tasks that a trustee must actually perform year in and year out in order to comply with those laws.
BACKGROUND
A trust is an arrangement in which a trustee manages property in a fiduciary capacity for one or more beneficiaries. A trustee is a fiduciary—a person or entity in a special relationship of trust, confidence, and responsibility with the beneficiaries of a trust. The trust itself holds legal ownership of the property, while the trustee is granted the authority to manage and control it on behalf of the trust and its beneficiaries.
All fiduciaries are held to strict standards, but because trustees manage property for the benefit of others, their fiduciary duties are more extensive than those of most other fiduciaries.
STRUCTURE OF FIDUCIARY LAWS
Many years ago, when trust laws were created, lawmakers decided that the laws governing the conduct of trustees should not create long lists of what a trustee should or should not do. Instead, they designed a system where beneficiaries could hold trustees accountable after the fact. This allows courts to evaluate whether a trustee’s actions were loyal, prudent, and in the best interests of the beneficiaries.
Courts may review a trustee’s decision-making process, looking at factors such as conflict of interest, cost minimization, record-keeping, and oversight of third-party advisors. Because of this, the role of a trustee carries significant responsibility and requires diligence.
MAJOR RESPONSIBILITIES OF A TRUSTEE
Interpret the Trust Document
Trust documents are typically lengthy and complex. A trustee must familiarize themselves with the document to fully understand their duties. This includes identifying the primary beneficiaries and remainder beneficiaries, understanding distribution language and powers of withdrawal, and being aware of any limiting provisions, such as spendthrift clauses. Before accepting the role of trustee, one must fully understand the trust document.
Determine Allowable Distributions
Trusts often outline different scenarios under which distributions are allowed or required. Determining these distributions is rarely straightforward. Trustees must assess the validity and necessity of distributions, gather multiple estimates, and document their decisions thoroughly.
Additionally, trustees must balance the needs of different beneficiaries. For example, some trusts stipulate that income is paid to one beneficiary for life, with the remaining assets going to another beneficiary upon their death. Trustees must be knowledgeable about state laws governing principal and income allocation, such as the Uniform Principal and Income Act.
Invest Trust Assets Prudently
Trustees are responsible for investing trust assets in a way that aligns with the trust’s objectives. Unless the trust document states otherwise, trustees have a duty to diversify investments and establish an appropriate asset allocation strategy. This responsibility begins immediately upon receiving trust assets.
A trustee must evaluate investment decisions, including whether to buy, sell, or hold various assets. If hiring a third-party investment manager, the trustee must actively oversee their decisions. Some trusts hold unique assets, such as timberland or mineral interests, requiring specialized investment expertise. Trustees must ensure proper oversight of all trust investments.
Provide Beneficiaries with Regular Accountings
State law and trust documents typically require trustees to provide beneficiaries with periodic accountings of trust activity. Accountings generally include details about initial assets, income and principal transactions, and assets on hand at the end of the reporting period.
The form and frequency of accountings vary by state, trust value, and the sophistication of the beneficiaries. However, most trustees should prepare an accounting at least annually to ensure transparency and compliance.
Inspect, Safeguard, and Protect Trust Assets
Trusts can hold various assets, including cash, real estate, businesses, or other valuable property. Trustees must inspect any property before accepting it into the trust, conduct regular inspections, ensure proper insurance coverage, and manage the assets effectively.
If a trust owns rental properties, for example, the trustee is responsible for maintaining them, ensuring they generate appropriate returns, and complying with applicable laws.
Comply with Federal and State Tax Laws
Trustees must understand federal and state tax laws, including whether the trust is classified as a simple, complex, or grantor trust. Since tax laws vary by state, a trust may be subject to income tax in multiple jurisdictions.
Trustees must maintain accurate records of trust income to file tax returns and provide beneficiaries with required tax documents. Additionally, they must be familiar with estate and gift tax laws, including cost basis adjustments, annual gift exclusions, and generation-skipping tax rules.
Regularly Communicate with Beneficiaries
Beyond providing formal accountings, trustees must maintain open communication with beneficiaries. This includes making financial statements available for inspection and ensuring beneficiaries receive relevant updates.
Trustees are also typically required to notify beneficiaries if they intend to resign. Clear communication fosters transparency and trust between the trustee and beneficiaries.
Participate in Legal Proceedings
Trustees must enforce and defend legal claims on behalf of the trust. This can involve hiring legal counsel, appearing in court, providing testimony, and attending legal proceedings.
For instance, if a trust owns contaminated property, the trustee must handle any related legal disputes. Trustees may also need court approval for certain actions, such as making unusual distributions or resigning from their role.
TRUSTEE LIABILITY
Trustees are held to high standards, and even small missteps can lead to legal liability. Courts can hold trustees personally liable if they fail to act loyally, prudently, or in the best interests of the beneficiaries.
Additionally, trustees may be responsible for the actions of third-party investment managers or agents they hire. This underscores the importance of careful oversight and adherence to fiduciary duties.
SERVING AS A TRUSTEE IS A LONG-TERM COMMITMENT
Trusts are often designed to last for decades, sometimes even perpetually. Trustees must understand that accepting the role is a long-term commitment. Over time, a trustee may experience fatigue, but their responsibilities and potential liability remain constant.
Before accepting a trustee role, one must fully grasp the long-term nature of the commitment and the level of diligence required.
CONCLUSION
Being a trustee is a demanding role that carries significant responsibilities and potential risks. Trustees must manage trust assets, comply with tax laws, maintain records, and adhere to the terms of the trust.
For those selecting a trustee, it is crucial to choose someone capable of fulfilling these responsibilities. Likewise, anyone considering becoming a trustee should fully understand the ongoing requirements before making a commitment. Failure to carry out these duties properly can result in legal and financial consequences.
Before appointing a trustee, sit down with potential candidates to discuss the trust document, their responsibilities, and their ability to manage the trust effectively.
This article is strictly for informational purposes and is not intended as legal, tax, or investment advice. For professional advice, consult an attorney or tax professional. Investment advisory services are offered through CWM, LLC, an SEC-registered investment advisor. Carson Partners, a division of CWM, LLC, is a nationwide partnership of advisors. The views stated in this article do not necessarily reflect those of CWM, LLC.
