TRUSTEES ARE HELD TO THE HIGHEST FIDUCIARY DUTIES UNDER THE LAW. WHETHER YOU ARE ACTING AS AN INDIVIDUAL TRUSTEE OR A TRUSTEE UNDER A PRIVATE TRUST COMPANY, UNDERSTANDING THE RISKS AND RESPONSIBILITIES IS CRITICAL TO SERVING AS A TRUSTEE.
Acting as a trustee, in an individual capacity, carries with it risks and responsibilities that need to be understood by anyone stepping into that capacity. Trustees can be held personally liable for failure to adequately serve the needs of the trust and its beneficiaries. Pursuing a fiduciary role through a Private Trust Company (PTC) insulates individuals from their personal risk to some extent but transfers those risk to the PTC. Managing the liability is not always easy, but achievable, if the trustee follows certain policies and procedures, approaching the management of all trusts and execution of it activities in a professional and responsible manner. There are several areas where the trustee can take action to minimize its liability.
OBTAIN INSURANCE (E&O AND D&O)
While this is easier for corporate (PTC) trustees, all trustees should endeavor to obtain insurance for their errors and omissions. If there is a corporate entity, directors and officer’s insurance should be obtained as well.
UNDERSTAND ALL TRUST DOCUMENTS
Understanding the trust documents, and ensuring that the trustee has the ability to administer the assets, directly or through the use of outside vendors, is an important part of risk mitigation. As a best practice, it is worth having a trust administrative memo (“TAC” memo) prepared, by the trustee himself, by trust counsel or by the operating team of a PTC, to ensure that the trustees understand the nature of trust assets, the issues in the trust, and the administrative activities necessary under both state and federal law and within the trust document itself. The memorandum should also address any gaps (such as the lack of strong retention language in the trust or lack of authorization to delegate investment authority, or limitation on investments – often in older documents). If the role of trustee reaches unacceptable levels of risk in the management, sufficient to warrant a refusal of the appointment as Trustee, the trustee should raise this with the grantor and understand what issues are involved in refusing to act (often there is no clear succession).
The trust administrative memorandum (“TAC” memo) is divided into three parts; a table summarizing salient information, a descriptive section summarizing the trust provisions as well as setting out observations by the administrative team, and closing with another table listing outstanding routine tasks that need to be addressed as part of the trust “onboarding” process. In the case of a PTC, the Committee needs to be able to review the TAC memorandum and to ask questions, relying on the administrative team to prepare these memoranda and to raise issues of interest or concern to the Committee. The trust review process will be integral to the preparation of these memoranda and ensuring that the PTC is able to accept most, if not all, trusts for administration. The trust review process also permits the PTC to sign off in advance on future fee appointments, allowing the administrative team to work with the family throughout the creation and funding of a trust, to ensure that it will be compliant with PTC policies and procedures. This pre-acceptance review process is considered a best practice in the field of professional trust administration and is recommended as a consideration by Private Trust Companies and individual trustees alike.
HOLD QUARTERLY COMMUNICATIONS WITH BENEFICIARIES
As a best practice, we recommend that trustees have regular and frequent communication with the trust beneficiaries. In the case of a PTC, quarterly meetings or communications with beneficiaries and an annual in-person review are integral to the function of the enterprise. The quarterly review process will ensure that there is constant communication between the trustees and the beneficiaries and allow the trustees (or PTC) to minimize confusion or missed expectations with respect to trust management, diversification of investments and operation.
Quarterly beneficiary communications might consist of a trust administration and investment letter, and/or a PowerPoint summary, and a call and may be conducted by the trustee or the administrative team of the PTC, or appropriate subcommittee, involved. Annual reviews are typically more in-depth, should be in person, and should include a broader group (attorney, CPA, Investment Committee of PTC) and include outside investment managers. A typical review will consist of a review of the following areas or topics:
Overview or Summary of Trust Operations – This will include income earned, distributions, investment performance and so forth. Depending on your choice of custodial platforms, the generation of these reports should be mostly routine with some manual work needed to polish and collate information.
Investment Review – In addition to the performance reporting of trust assets, the trustee (or PTC) will need to provide a broad market overview as well as a discussion of the tactical and strategic asset allocation of the trust, review of the investment policy guidelines and distribution provisions, with a summary of what this means to the beneficiary and the trust longer term. Outside managers may join for all or part of this review, depending on logistics (in the case of multiple managers, we would have one member of the administrative team handle this, perhaps in conjunction with the Investment Committee.) The investment review should also be consistent with the Investment Committee and PTC’s approach to investing and philosophy around trust management.
Principal and Income Review – There should be a review at each quarterly meeting, with an in-depth review annually, of the principal and income accounts of the trust, what this means for beneficiary cash flows and taxes.
Outstanding Issues or Questions – This may reflect longer-term projects or objectives of the trust and status updates on each area. For example, a decision to continue distributions to allow a beneficiary to raise income in their personal account in order to provide for a spouse might have a target goal of wealth to be moved over and progress reports on this objective.
Next Steps and Outlook – Each review will conclude with a summary of changes to objectives, outlook for future of trust investments or distributions, etc.
Manage Taxation of Trusts – The Trustee (or PTC) needs to review, at least annually, the state and federal tax returns of the trust in conjunction with the distributions and investment objectives of the trust. PTC’s often provide tailored support to family members in the management of tax liability and ensuring a tax-aware approach is applied to all trust management and trust investments.
Develop an Investment Approach Appropriate to Trust Management – The Trustee (or PTC) needs to identify its approach to investment management and recognize where personal biases might be at odds with the investment needs of a trust. For example, the Prudent Investor Act is predicated on a belief that there is no ability to efficiently capture market alpha, or an outperformance of a benchmark, through active management. As such, the Act favors index-based approaches to trust management where low fees and strong adherence in the portfolios to their applicable benchmarks ensure that the trust will keep pace with its asset allocation. This belief places the focus on strategic asset allocation with tactical tilts in the portfolio balance to reflect market conditions, and is executed through exchange-traded funds (ETFs), option overlays and capital protected strategies. Where there is a belief in market alpha, the Trustee (or PTC) would need to articulate why this belief is held and why this manager is able to obtain the excess return expected. Moreover, the Trustee (or PTC) is responsible for ongoing review and oversight of the investment manager, would need to articulate a timeframe for such performance and be willing and able to fire that manager over time.
The Trustee (or PTC) needs to also recognize the long-term nature of many of the trusts it will be managing. Strategic asset allocations allow for long-term focus of portfolios. However, with the dislocations in the market and prolonged volatility of the last five years, many pundits are questioning whether the idea of “modern portfolio theory” makes sense. The Trustee (or PTC) will need to understand the differences between efficient investor mindset and a behavior finance approach and to understand how sector or other “bets” in a portfolio might not be appropriate to a trust portfolio.
A Trustee must employ a standard of care: The prudent investor act requires a standard of conduct, not outcome or performance. A Trustee’s performance is judged on the overall investment process and not on the appropriateness of individual holdings, income yield or whether they are “risky” investments inn and of themselves.
Create Formal Written Investment Statements – Each trust needs to have a formal written investment policy statement (“IPS”). These IPS statements address a number of topics, depending on the trust, but usually include the time horizon of the trust and its impact on the way investments are made, the distribution or income required by the trust terms, and attendant impact on investments, the risk tolerance of the trust and trust beneficiaries, the manner in which any large concentrated positions are incorporated into asset allocation, and sets forth the investment philosophy. The investment policy guidelines will contain performance benchmarks for the trust as a whole as well as each asset class, restrictions on asset allocation to force rebalancing of trust portfolios and timing or manner of rebalancing. Investment policy statements may also reflect trust-specific techniques to be followed, for example, if the grantor has retained the power of substitution (in a grantor trust), how this might affect trust management. The Prudent Investor Act imposes a duty on the trustee to pursue and overall investment strategy, having risk and return objectives reasonably suited to the entire portfolio, which will enable present and future distributions to/for the beneficiaries as required under the instrument. In constructing a portfolio investment strategy, Trustees must consider risk tolerance of the trust and the relevant circumstances of the beneficiary. Trustees are also required to diversity assets unless it is reasonably determined by the Trustee that it is in the best interest of the beneficiary not to diversity.
Create Formal Written Distribution Policies – Each trust should have formal written distribution policies. These distribution policies will include a recitation of what the trust documents provide with respect to distributions, the trustees interpretation of these documents and any philosophical approach or belief that will be used when reviewing special distribution requests. Timing and manner of distributions, clear expectations of the beneficiary with respect to the receipt of distributions, etc. will all be part of a distribution policy. Distribution policies are important as well for the investment management of trust assets as they provide guidelines to the investment managers as to when cash is needed from the portfolio and the amount of liquidity to be kept on hand.
Develop Strong (detailed, comprehensive but workable) Fiduciary Policies and Procedures – In the case of a PTC, the PTC Board will approve the policies and procedures to address operational issues in all areas of trust management. These policies and procedures will be developed by the administrative team and will reflect what the PTC will deliver in the operation of the trusts. By having clear, repeatable processes in place, the PTC can ensure (a) that its administrative processes are consistently applied and (b) that beneficiaries understand a process that must occur before action can be taken (e.g., any special distributions of trust assets require submission of a memorandum and a review of the situation by X members of the Distribution Committee with Y time horizon for making such distribution.”) By providing this type of clarity, the PTC can manage beneficiary expectations as to how quickly they can access cash in a portfolio, increasing the emphasis on their personal liquidity to provide emergency funds.
Ensure Meticulous Record Keeping Across All Areas – In particular, the Trustee (or PTC) will need to have strong records for:
- Accounting – The Trustee (or PTC) will need to have strong accounting mechanisms in place to ensure that each trust has robust principal and income reports and that the necessary information on transactions are captured for tax compliance purposes at the trust levels. At the corporate level, the PTC needs to have accounting systems in place to ensure that its costs are accurately reflected in trust administration and fees for services are appropriately reflected on the books and records of the company.
- Tax Compliance – The Trustee (or PTC) will need to ensure that all trusts are compliant with requisite state and federal income tax reporting. As such, the Trustee (or PTC) often hires a third party vendor to provide this service.
- Custody and Reporting – The Trustee (or PTC) will work with a selected outside custodian to facilitate the creation and maintenance of reporting mechanisms for all trusts. Regardless of whether a PTC chooses to staff with an educated team of employees, the custodial and reporting functions are usually licensed from a third party vendor. Of importance is the ability of the custodian to perform principal and income accounting for the trusts, to track tax and other considerations for the trust, to provide accurate oversight of investment activity (collection of dividends and interest) and to provide accurate performance reporting for the trusts in a number of forms, ideally independent of the investment managers.
- Beneficiary Meetings and Communications – As noted above, the Trustee (or PTC) will need to hold quarterly and annual beneficiary meetings. Part of the record keeping requirement will be to maintain copies of all meeting materials as well as communications with the beneficiaries.
- Audit – In the case of a PTC, the PTC will have an Audit Committee to oversee the audit processes and to sign off on the audit work to the Board for approval. The PTC must hire outside parties to provide objective audit work, both of PTC corporate work as well as PTC trust administration (“did the PTC follow the appropriate policies or procedures with respect to approval of attorney bills for the XYZ trust, etc.”)
- Develop a Robust Program of Beneficiary Education – While the quarterly meetings with beneficiaries will provide a great platform for communication, a Trustee needs to err on the side of over-communicating with the beneficiaries. Each beneficiary needs to be evaluated in terms of “what they need in order to understand the topics discussed in quarterly meetings” and then be able to address these educational gaps through either tailored programs delivered individually or in smaller groups. For every trust, the Trustee needs to be able to build consensus and collaboration with the beneficiaries to ensure they understand management decisions and can understand the tradeoffs being articulated, even if they do not like them. Moreover, a wise Trustee needs to create a strong paper trail in terms of communication, education and outreach, to show that the beneficiaries were aware of the trustee’s actions and understood these decisions. If a situation turns sour, this pattern of education and communication will protect the Trustee in over the long term.
Trustee Best Practices
Many of the best practices of a trustee are set forth above in the “Risks and Risk Mitigation” section. A few additional things to note include:
Do understand the implications of the Prudent Investor Act and the Principal and Income Act on trust management.
Do understand your rights and responsibilities as a trustee.
Do create a philosophy for the PTC to follow in the creation and operation of the enterprise.
Don’t let family ties, views, or prejudices obscure your legal obligations as a trustee.
Do focus on collaboration and consensus. Ensuring that all parties act in sync, that there is sufficient financial planning and education of beneficiaries to ensure that they understand their trusts will be important to any long term success.
Do have clear, repeatable metrics for making investment decisions, implementing trust structure and distribution decisions.
Do understand trust documents and distribution provisions.
Do recognize and use the flexibility offered to trustees under the Principal and Income Act to ensure that the best result for the beneficiary is obtained, while balancing the fiduciary obligations of the trust.
Whether you have chosen to appoint an individual trustee or create a family Private Trust Company, selecting a dependable trustee to oversee a family’s estate plan is one of the most important decisions to be made to ensure your wealth is managed and distributed according to your wishes. And, although creating an estate plan can be a complex process, it can ensure that your family will be provided for after your death and is a core element of a long-term wealth management strategy. You’ll want to make sure your trustees have a full understanding of the issues, responsibilities, and time involved in the process and have the resources and objectivity required to be effective. All aspects of estate planning involve significant legal considerations and many tradeoffs in terms of control or tax savings. It is imperative to work with a qualified estate planning attorney and advisor to obtain expert advice in crafting your long-term strategy and designing trusts or other entities that will shape your overall family legacy.
Wealthaven’s independent views and deep expertise across business, investments, trust administration, estate and tax planning can be an invaluable resource for trustees with significant and/or complex assets. By supplying technical knowledge and an objective voice, we can support your PTC and trustees to help ensure that tasks are handled properly and professionally to help avoid the costly legal disputes that can occur when large sums are involved.
Wealthaven can serve as a co- or sole Executor but usually acts in a consultant capacity to the family member or friend chosen as executor or trustee. This allows for continuity if there is a need to replace existing lawyers and accountants due to conflict issues or if other problems arise. Further, as part of our pre-mortem planning, Wealthaven works in partnership with your trusted advisors, proactively reviewing investment, insurance or estate planning issues, thus increasing the likelihood that assets will be preserved for future generations.
Wealthaven principals can be named to act as a trustee (sole or co-trustee) with your family members or can serve as a trust protector. We also work closely with families in the creation and operation of private trust companies as well as creating infrastructure to support the use of directed or administrative trust structures in conjunction with corporate (commercial) trustees, such as a bank or brokerage firm.
The information herein is for educational and discussion purposes only. It is not intended to constitute tax, legal or financial advice. Further, the examples provided may not be appropriate to all situations and should be tailored or amended for the particular needs or issues at hand. Before acting on any advice or recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek legal, tax or other professional advice. These views are current as of the time of publication and are subject to change without notice. No part of this document may be reproduced in any manner without the written permission of Wealthaven, LLC. Information dated as of September 2016.
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