We hear a lot these days about “holistic” wealth management — service that goes beyond traditional investment advice — and how advisers should handle the disparate needs of their clients as part of a seamless whole. One of these needs is trust and estate planning. In all cases, it’s an attorney who drafts the trust document, but that doesn’t mean wealth advisers don’t have a role to play.
Consider this scenario: When a client sets up a charitable trust or a trust for his children and/or grandchildren, one of the biggest decisions he will wrestle with is who to appoint as trustee. Should it be an individual, such as a spouse, friend, business colleague or relative, or a corporate trustee? It’s a tough choice, and the client may turn to his wealth adviser for guidance. In either case, selecting the right trustee is essential to keeping a trust functioning smoothly and as it was intended.
“If a client is trying to make that decision, I talk to him or her about how I’ve seen the corporate trustee versus individual trustee play out with my other clients,” Sean Stannard-Stockton, a CFA charterholder and wealth adviser at Ensemble Capital Management, told the Enterprising Investor. “My role is to talk to them about some of the advantages and pitfalls of each option and then make sure they’re working with a good lawyer to put it all in place.”
A trustee has a number of duties, and the role is becoming increasingly challenging (see“Being a Fiduciary in the Age of Uncertainty” in Trusts & Estates magazine). Not surprisingly, individuals often trip up.
Thomas O. Katz, a partner at law firm Katz Baskies in Boca Raton, Florida, said there are several areas in which individual trustees tend to make mistakes. Here are some of the red flags:
Unlike corporate trustees, that abide by a published fee schedule, it is up to the individual to negotiate a reasonable fee. And while some trustees may feel uncomfortable talking about money at the outset, it’s important that the fee conversation be held early on.
The risk of not discussing fees up front is that years later, if the trustee decides it is time to get paid, the end result may be litigation. “What sometimes happens is that a trustee will serve for a number of years at no fee, and then things will start to deteriorate somewhat,” Katz said. “The trustee then says, ‘Now I’m going to charge a fee as this is taking too much of my time,’ and the beneficiaries come along and say, ‘What is this fee all about?’”
Katz noted that in one case his office handled, a child of the grantor of the trust acted as trustee of a trust for all children of the grantor for 20 years and never charged a fee. “The trust by its terms was to terminate, and a final accounting was filed,” he said. “The trustee sought a fee, which was contested by the remaining children. Not only did the trustee fail to obtain the fee, but the remaining children stopped speaking to their sibling.”
What is a reasonable fee? Katz said he often uses what a corporate fiduciary would charge as a starting point. But if an individual is farming out services that a corporate trustee would perform — such as investment advice or tax and accounting work — then that person should reduce his or her fee to account for that. “Also, the size of the trust matters,” he said. “A fee of 15 basis points ($1,500 per $1 million)* may be appropriate for a large trust, while 1% might be more appropriate for a smaller trust.”
Risk and Liability
It will come as no surprise that trust litigation is a thriving area of the law. Back in 2001, the authors of a paper titled “Suing and Defending Fiduciaries” from the American Bar Association Annual Meeting, noted that there had been “a dramatic increase in the number of lawsuits involving estates and trusts.” Given the number of financial frauds that have taken place over the past decade, the number has likely increased even further.
Katz said individual trustees tend to have a “good understanding” that they have to invest the trust assets, “a decent understanding” that they should have a third party prepare the tax returns for the trust, “little understanding” of what their reporting obligations are to beneficiaries, and “almost no understanding” of the risk component.
“There is one instance when they understand the risk — when there is a beneficiary that they believe from the outset is a rotten kid, then they go in with their eyes open, but other than that people don’t understand what the issues are,” he added.
Katz noted that sometimes the why of what trustees do can be as important as what they do. To this end, it is crucial to document all decisions. “If a trustee concludes that he or she should make a discretionary distribution, it is important to document what was asked, what was given, and why. Corporate fiduciaries tend to be very good at this,” said Katz.
Communication, Books, and Records
Most states require regular accounting to the beneficiaries — both income beneficiaries and what are known as the remaindermen (the family members who will receive the principal when the trust ends). This requires fastidious record keeping.
Failing to provide proper accounting means that beneficiaries can come back years after the fact and challenge investments and distributions. “Believe it or not, in Florida a beneficiary can come back up to 40 years after the trust has even ended,” Katz said. “On the other hand, if an accounting is provided (and sometimes just having the monthly statements sent to beneficiaries can suffice), the beneficiary has a more limited time to complain. In Florida, for example, that would be six months.”
Investing and Distributions
The most common mistake Katz has encountered is that individual trustees often fail to understand they owe a duty to remaindermen as well as to income beneficiaries. This has implications for how the trust is invested. Here is an example: When wife number two needs more money, investing in higher yielding securities may generate more income. But does it fairly and reasonably weigh the long-term needs of the children from the previous marriage who are the remaindermen? Katz said there needs to be some consideration for current income needs and capital appreciation.
Investments and Income Taxes
Fiduciary investments and fiduciary income taxes are specialized fields and just because someone is well-versed in personal investing or income taxes doesn’t mean they will get it right in the trust context.
“On a personal level I’m free to take whatever personal risk I want — but when you’re investing as a fiduciary you have a duty to diversify, for example, that as an individual you may not have,” Katz said.
The duty to diversify is not absolute in all instances, however. For example, trusts are often established for the sole purpose of owning life insurance or interests in a specific business or real estate. The trust agreement may provide explicit directions as to the investments, which is a reminder to always check the trust documents.
For more on the investment issues relevant to trustees, you may want take a look at the Research Foundation of CFA Institute’s Primer for Investment Trustees. And keep an eye out in March for the Primer for Investment Trustees e-learning session, a free online resource.
*Correction: An early version of this piece mistakenly stated that a fee of 15 basis points on $1 million would be $15,000.