Estate Planning: Trusts

TEN FACTS EVERY TRUST BENEFICIARY SHOULD KNOW By helping a beneficiary fter years of working with fami- about its terms. It is only by reference to lies to establish trusts, and with the specific provisions of the benefi- understand the essential Aindividual trust beneficiaries, it ci a r y ’s own trust that the beneficiary will vocabulary and concepts of has become clear to me that there is a fully understand how they apply to him need for better understanding by the or her. the trust relationship, an persons creating trusts and, more impor- advisor can increase the t a n t l y, by beneficiaries, about what a Key parties trust is, and how trusts work. The trust agreement defines the key chances that the beneficiary I r o n i c a l l y, the beneficiary, who is the parties to the trust relationship: will be able to truly benefit very person for whom a trust is estab- • the “grantor” or “settlor” lished, is often quite confused about contributes funds to the trust and from the trust fundamental trust concepts. generally sets its terms; By Patricia M Angus In my view, the education of family • the “trustee” is the individual, members, especially beneficiaries, is as bank or trust company who is important as the creation of legal struc- responsible for holding the trust tures and the proper investment of assets funds and implementing its to ensure the preservation and growth of terms; family wealth and enhance the benefi- • the “beneficiary” is a person ciary’s life. who is to receive current benefits F u r t h e r, legal and financial advisors, (income and/or principal) from the as well as trustees, should assist benefi- trust; ciaries in the educational process. • the “remainderperson” is anyone This article summarises some funda- who is entitled to receive trust mental issues that advisors can and property when it terminates. should strive to teach their clients. The beneficiary should seek clarifica- The process should begin when a trust tion on what the trustee can or must do is created and continue for its duration. with trust income and principal. This will help the beneficiary better Often, the agreement states that the understand the trust and how the bene- trustee is to pay income to a particular ficiary can play an active role in its be ne f i c i a r y . This is generally annually or administration. more frequently. It may also provide O b v i o u s l y, this list hardly begins to that principal is to be paid at certain address the complex set of issues that ages or from time to time in the trustee’s each trust entails. Hopefully though it discretion. can guide advisors as they raise their A trustee who has discretion over awareness and assist beneficiaries in the payment of trust income and/or princi- process. pal is subject to certain standards that determine when payments can be made: 1.Terms of the trust agreement • under a broad standard, the trustee A beneficiary should receive a copy of the may pay principal for any reason, or trust agreement, or at least relevant parts not at all; of it, from the trustee. • a more restrictive standard might The trust agreement provides a set of state that principal may be paid for instructions for the trustee and guidelines the emergency needs of the for the beneficiary. beneficiary. The trustee should also provide a The beneficiary and trustee should summary (oral or written) of the trust discuss openly the types of payments that and be available to answer questions can be made. Private Wealth Management 2003 48 Estate Planning: Trusts

Trustee’s powers If the trust agreement is not clear, the The trust agreement provides specific beneficiary should ask the trustee, lawyer guidance on the trustee’s powers. This or other advisors for some background part contains important information that information. The beneficiary will not will give the beneficiary key ideas on necessarily be happy with the grantor’s what the trustee can and can’t do for him purpose. However, knowing the reasons or her. For example, before the benefi- may help keep potential frustration and ciary calls the trustee to request a distri- anger in the right direction, rather than bution, it would be useful to find out at the trustee, who is merely carrying out whether a loan would be possible. For the grantor’s wishes. tax or other reasons, it might be better for the beneficiary to take a loan rather 4. Trustee’s duties than a distribution. A trustee is a fiduciary and, as such, must act in the best interests of the bene- Beneficiary’s powers ficiaries and remainderpersons. The beneficiary should also find out If a trustee takes advantage of its legal what specific powers are reserved to the ownership of the property it faces not b e n e f i c i a r y. He or she may have a only the ire and wrath of disgruntled “power of appointment”, which gives beneficiaries, but can also face legal the ability to determine where trust prop- action by them. erty goes upon the beneficiary’s death. In addition, a trustee has a number of specific duties, including duties to: 2. Identity of the trustee, other • exercise reasonable care, skill and beneficiaries, investment advisors, caution; accountants and other advisors to • keep and render accounts of the trust administration; The beneficiary should know who the • take and keep control of trust other parties to the trust relationship are, property; currently and in the future. • keep the trust property separate; The trustee can be one or more indi- • make the trust property productive. viduals or institutions. There may be an investment advisor 5. Beneficiary’s rights and who is responsible for managing trust responsibilities assets. One unique aspect of the trust structure The beneficiary may be one of several is that the beneficiary is an integral, and people (family members or others) to indeed the most important, person in the whom income and principal may be overall structure. Yet often the benefi- paid. The beneficiary should understand ciary is not involved in the process of w h e t h e r, and to what extent, he or she establishing the trust or in its adminis- has the ability to request or demand tration. This can lead to an unhealthy removal of the trustee. It is also helpful feeling of dependence. to find out whether there is a trust To maximise the benefits the benefi- “protector” or other trust advisor. ciary may receive from the trust and to ensure the wellbeing of the overall trust 3. Purpose of the trust arrangement, the beneficiary should be Ideally (but infrequently), the trust comfortable with his or her rights and agreement contains a statement of the responsibilities (Tables 1 and 2). g r a n t o r ’s reasons for establishing the trust. If the trust agreement is not clear, 6. Duration of the trust the beneficiary should seek clarification Most trusts are governed by a local of the purpose. Understanding the “perpetuities period”, which usually mission will help the beneficiary keep the states that no trust (other than a chari- entire arrangement in perspective. table trust) may last more than one life- Private Wealth Management 2003 49 Estate Planning: Trusts

To review the trust agreement and related documents

To expect the trustee to be accountable to each beneficiary and remainderperson of the trust

To have a trustee who is willing to maintain open communication

To attend regular (at least annual) meetings with the trustee to discuss trust matters and the be n e f i c i a r y ’ s personal financial circumstances and goals, and to provide input on the trustee’s performance in light of the trustee’s duties and responsibilities

To seek removal of a trustee in appropriate cases

Table 1: The beneficiary’s rights.

To participate actively in trust affairs

To understand the trust’s mission or overriding purpose

To understand the general nature and composition of the trust assets

To understand his or her rights and responsibilities under the trust agreement and how these relate to the rights and responsibilities of other beneficiaries and remainderpersons

To gain a basic understanding of trust law

To obtain a general understanding of investment fundamentals, including modern portfolio theory and how it fits with the “Prudent Investor Rule”

To understand the trustee’s roles and responsibilities

To develop a general capacity to understand trust accounting

To know how and in what amount trustees and other professionals are compensated, and obtain a general understanding of the budgets for the trust and investment entities in which the trust will be invested

Table 2: The beneficiary’s responsibilities.

time (starting at the time the trust is More specific definitions of income created) plus an additional 21 years. This and principal are provided by the law centuries-old restriction is now being governing the trust. Indeed, the defini- loosened in many jurisdictions. All new tion of “income” can be quite compli- trusts in Delaware, South Dakota, cated. Alaska and many other states (and coun- The beneficiary should be aware that tries) may now last in perpetuity. tr ust accounting principles are not always the same as tax rules. In this way, a bene- 7. General overview of trust ficiary may be subject to tax on income accounting that he or she did not actually receive but A beneficiary does not need to become is attributed to the beneficiary. an accountant to gain a basic under- standing of trust accounting. The basic 8. General overview of trust law concept – that a trust is established with Each trust is governed by the laws of a contributed assets, known as trust “prin- particular state (or country). These local cipal”, and any amount that is generated laws and court interpretations provide by that principal (such as interest or rent) guidance to the trustee and beneficiary is considered to be “income” – is quite about trust administration. In general, simple. the terms of the trust agreement will Private Wealth Management 2003 50 Estate Planning: Trusts

apply to the extent that they are not taking into account risk and return. THE AUTHOR otherwise prohibited by law. A grantor Diversification among asset classes is Patricia M Angus may choose the laws of a particular state considered essential. The “total return” is Counsel to Day, Berry & or country, so long as there is a sufficient of the trust is paramount. Howard (including Hughes connection with that state to obtain Each asset or class is looked at in the and Whitaker), certain benefits. For example, an increas- context of the entire portfolio. Tr u s t e e s New York, USA ing number of trusts are being established must balance income and growth. They E- m a i l : in Delaware because there is no state may also delegate their investment pa t a n g u s @ e a r t h l i n k . n e t fiduciary income tax, asset protection is responsibility so long as the delegation is enhanced and a trust can last forever. prudent. This law is being complemented by 9. General overview of investment another new law to ensure that invest- fundamentals ments chosen for total return (including The trustee (or in an increasing number “growth” stocks) do not adversely affect of cases, its delegate) will be responsible income beneficiaries. New rules now for investing trust assets. allow trustees to adjust between income The beneficiary should, at a mini- and principal and in some cases to mum, understand the basic available choose a specific percentage (“unitrust investment options, including cash, stock, amount”) of the trust to be considered bonds, mutual funds, real estate, art and “income” for distribution. “alternative” investments such as hedge funds. Advisors should strive The trustee is responsible for deciding “ whether to retain the original assets and to teach their clients for ensuring that the investments match the trust’s goals. fundamental issues to help The beneficiary should seek to under- beneficiaries better understand stand the basics of “modern portfolio theory”, which states that the most what a trust is, how it works important factor in determining a port- f o l i o ’s performance is the allocation of and how they can play an active role assets over time – not stock picking or in its administration market timing. The beneficiary should be able to ” engage in a discussion of each asset class, Summary the historical return for each class and its Many of the ideas in this article (espe- function in the portfolio. cially beneficiary roles and responsibili- The asset allocation can and should be ties) have been explored in greater detail adjusted as the needs of the beneficiary – by James E Hughes Jr, who shares my and the financial climate – change over views. time. I hope that this article will add to the resources that advisors and beneficiaries 10. The “Prudent Investor Rule” can draw upon to reduce misunder- Traditional rules have limited the trustee’s standings that can lead to conflict and to ability to invest trust assets under a fairly ensure that trusts are truly beneficial in restrictive standard that emphasise main- the lives of their beneficiaries. taining principal even if growth is By helping a beneficiary understand hindered. the essential vocabulary and concepts of Under the new “Prudent Investor the trust relationship, an advisor can help Rule” adopted by many states, a trustee increase the chances that the beneficiary must develop an overall strategy for the will be equipped to work better with his trust portfolio in the light of the present or her advisors and truly benefit from the and future needs of beneficiaries while trust. ◆ Private Wealth Management 2003 51