When setting up a trust, one of the biggest decisions is who to appoint as successor trustee. Many look to their spouse, a family member, close friend or business colleague to fill this crucial role. But as a recent Supreme Court case demonstrated, doing so isn’t always ideal. Learn why a corporate trustee may be a more prudent choice.
One of the most important powers you have when creating a trust is choosing who will step in as successor trustee in the event the initial trustee is no longer able or willing to manage the trust. That decision has become even more significant as a result of a recent ruling by the Supreme Court.
Randy Bullock was the non-professional trustee of a trust set up by his father for the benefit of Randy and his four siblings. The terms of the trust allowed the trustee to borrow money against the asset of the trust, which was an insurance policy. On three occasions, Randy borrowed against the policy to purchase real estate and shares in a business.
While all of the loans Randy took were repaid with interest, his siblings nonetheless sued Randy to recover his profits made on the investments. They alleged that although their brother “does not appear to have had a malicious motive in borrowing funds from the trust,” he “was clearly involved in self-dealing.”
The state court agreed and ordered Randy to repay the trust for “the benefits he received from his breaches” along with costs and attorneys’ fees. When Randy could not do so, he filed a bankruptcy case.
The bankruptcy court held that the debt was nondischargeable based on “defalcation” – in other words, the mishandling of funds by a fiduciary. The District Court affirmed that decision, as did the Court of Appeals. Randy took the case to the Supreme Court, asking it to consider whether the misappropriation of funds applied “in the absence of any specific finding of ill intent or evidence of an ultimate loss of trust principal.”
The Court agreed to hear the intent issue in Bullock v. BankChampaign, N.A. After consideration, it agreed with Randy and vacated the lower court’s decision, stating that defalcation required either a knowing breach of fiduciary duty or “gross recklessness” with regard to the conduct.
The Supreme Court unanimously ruled in favor of individual debtor-trustees who may have done harm without meaning to do so over injured beneficiaries. In doing so, it offered protection for individual fiduciaries, suggesting that, like Randy Bullock, most will be non-professional trustees of small family trusts. This is an important development: In providing a “heightened” standard for the definition of defalcation, the Court’s decision underscores the crucial importance of naming a successor trustee who can handle your trust affairs in the manner you intended.
Depending on the instructions you provide in your trust document, the successor trustee you name may have significant ongoing responsibility for distributing trust assets for the health, maintenance, education and support of your spouse, children and other family members. The more careful you are about choosing the right successor trustee, the more likely it is that your plan will accomplish the goals you want to achieve for your loved ones and other beneficiaries.
The reasons to appoint a close family member or friend as your successor trustee can seem compelling: that person is likely to understand your family dynamic and knows your long-term goals. What’s more, keeping the operations of the trust within the family may help to minimize expenses.
While it is true that an individual trustee can offer a very personalized trustee experience, appointing one is not without disadvantages. To understand why, consider the following three commonly made mistakes of individual trustees and tips on how to avoid them.
- Inadequate Recordkeeping
Most states require trustees to provide regular accounting to both the trust’s income beneficiaries and its remaindermen (the heirs who will receive the trust’s principal when the trust is finally dissolved). This requires the trustee to keep meticulous records of all income and distributions. Failure to do so can result in a lawsuit years later by your heirs.
In the case of individual life insurance trusts (ILITs), proper recordkeeping also typically requires sending out Crummey notices each year, informing beneficiaries that a gift was made to the trust to fund premiums and that the beneficiaries can withdraw the gifted amount during a specified window of time, say 30 days.
Because the Internal Revenue Service considers these gifts tax-free only if they can be withdrawn, Crummey notices are an important tool to help trustees avoid gift tax consequences for the contributing party. Failure to issue these notices can have significant consequences depending on the amounts of the contributions, the donor’s taxable estate and other factors, so it’s important for a trustee to maintain proof that the notices were sent.
Consider this: It’s very easy for individual trustees to overlook Crummey notices and/or reporting, especially in situations where the grantor pays the insurance premiums directly. One way to help ensure these and other important responsibilities will be met each year is to hire a tax accountant and/or estate planning attorney. Working alongside your individual trustee, this trained professional can help ensure that these and other important responsibilities are met each year.
- Not Remaining Objective
The person you appoint as successor trustee becomes a fiduciary. In other words, this person must be able to set his or her own interests aside. Fiduciary responsibility is significant and supersedes any interest the trustee may have in the trust assets as a beneficiary.
Not surprisingly, the duties of a successor trustee may come in conflict with the self-interests of a family member if that trustee is also a beneficiary. Emotional ties can further complicate those fiduciary responsibilities; for example, the trustee might be forced to decide whether to use some of the trust’s money to fund a sibling’s business venture or to sell the family home should a surviving parent enter a nursing home.
Consider this: To avoid this potential pitfall, name a professional as a co-trustee. Without having to navigate family dynamics, a corporate trustee is in a much better position to remain neutral and do what may be difficult for an individual trustee to do. This helps ensure that your heirs benefit both from the professional experience and objectivity of a corporate trustee and the personal involvement of someone who knows you.
- Failure to Understand Their Fiduciary Role
Most individual trustees have little or no experience acting in a fiduciary capacity or knowledge of what being a fiduciary entails. Not surprisingly, there has been a dramatic increase in the number of lawsuits involving estates and trusts in recent years.
Trustees are required to manage the trust assets in accordance with the best interests of the beneficiaries – not the person who established the trust. In many cases, beneficiaries want to maximize the amount of wealth that they will receive when the trust assets are distributed. This requires trustees to actively manage trust assets with that goal in mind.
Many trustees believe that their special relationships to your beneficiaries will keep them safe from lawsuit. Not necessarily. The person you name as your successor trustee will likely need to answer not just to the income beneficiaries of the trust but also to any heirs who may be entitled to the trust’s principal when it is finally dissolved (remaindermen).
Trustees are subject to rules and regulations, including the Uniform Prudent Investor Act, which are designed to help protect beneficiaries from the consequences associated with receiving poor advice. This means that trustees who invest and manage trust assets can be held liable for investment losses. Similarly, they can be held accountable for missed opportunities and the profits that could have resulted from more prudent investing.
In the case of an ILIT, trustees are required to determine whether a policy is performing in line with the projections reflected in the original life insurance illustration. It also means, when appropriate, identifying alternative policies that may be more in line with the terms of the trust and the desires of the beneficiaries. Nonetheless, individual trustees often neglect to review the health of the policy each year. This may expose the trust to any number of events that potentially could cause the policy to lapse, leaving the trust’s beneficiaries without access to the death benefit.
Consider this: When selecting a successor trustee, be sure that the trustee’s responsibilities are clearly outlined in the trust document and that he or she is well versed in the duties and obligations that come along with being a fiduciary. Doing so can give you peace of mind that your trust will be handled in the most honest and beneficial way.
If you are thinking about setting up an irrevocable trust or making gifts into a trust, there may be clear benefits to naming a professional trustee as the successor trustee. In doing so, you’ll gain the advantage of:
- Access to Experience and Expertise
A corporate trustee is likely to be more experienced in dealing with trusts and investment management. Unlike an individual trustee, a corporate trustee has professionals who specialize in areas of trust management. This level of understanding and expertise will ensure that your trust continues to be managed effectively – and according to your wishes.
- Longevity and Permanence
Often trusts are created to continue for generations. It is more likely that a professional trustee will be in existence for as long as the trust. Because of this, a professional trustee can offer a greater consistency and continuity of service than an individual trustee may be able to provide.
- Understanding of Fiduciary Duty
While sometimes an individual trustee may favor one class of beneficiaries over another or be subject to pressure from one class, a corporate trustee is bound by the terms of the trust document. Therefore, it is more likely that a corporate trustee will administer the trust more conservatively. ” What’s more, a corporate trustee is subject to many levels of oversight from internal auditors, outside auditors and government regulators – all for the protection of the trust beneficiaries.
Selecting the proper successor trustee is crucial to assuring both financial security and peace of mind. You want someone who will provide careful management of your trust assets, exercise the appropriate level of diligence when executing your wishes, and demonstrate the ability to put the interests of your heirs first. Above all, you want a trustee who will build and maintain a relationship with you and your family over the many years required to administer most trusts.