Part I — When someone agrees to become the trustee of a trust, he or she will need to be aware of and plan for several risks, not only for themselves, but also for the beneficiaries and the trust itself. Even experienced trustees can be faced with stormy seas that are not easy to navigate.
Thankfully, The Private Trust Consortium (PTC) provides the tools and resources its member trustees need to survive and thrive in their fiduciary roles. This includes Trustee Liability Insurance especially designed for our members which protects both the trustees and the beneficiaries and trusts they serve. In Part I I want to briefly highlight the 10 most common risks encountered by most trustees. In future articles I will bore down for a more in-depth analysis of each risk.
Risk #1 – “Blended Families”: The existence of “blended families” – that is, families in which a Settlor has had multiple marriages and in most cases children from one or more of these marriages. This fact pattern presents the Trustee with a number of obvious – and not so obvious – conflicts of interest and complicated decisions regarding the investment and distribution of the assets in the trust. In these cases, the Trustee often finds himself or herself in a “damned if I do, damned if I don’t” conundrum.
Risk #2 – “Distributions to Current Income Beneficiaries vs Distributions to Remainder Beneficiaries”: In many trusts some beneficiaries are entitled to the distribution of current income. These beneficiaries are commonly referred to as “current income beneficiaries”. Other beneficiaries are not entitled to receive any distributions until the current income beneficiaries have died. These beneficiaries are called “remainder beneficiaries”. This situation offers many challenges for the trustee. For example, the current income beneficiaries usually want to have the trust’s assets invested in ways that maximize current income while the remainder beneficiaries would prefer having the trust’s assets in a way that will grow the value of the principal. The trustee has to balance these competing interests. The trustee also has to be aware of the rules regarding which beneficiaries are entitled to periodic reports. These rules can vary depending on the situs of the trust.
Risk #3 – “Proper Accounting”: Trustees, ironically, must “keep 2 sets of books for each trust”. One set of books keeps track of the tax consequences of each transaction. This set of books gives the trustee and his or her accountant all of the information they need to properly calculate taxes for the trust and the beneficiaries. The second set of books keeps track of the value of the Principal and Income for each trust in accordance with the Uniform Principal and Income Act or other applicable law. This “Income” may not be equal to the value of the income which is used to calculate taxes. This is an important distinction and the failure to have a proper fiduciary accounting system in place can have big implications for the beneficiaries.
Risk #4 – “Failure to Communicate with Beneficiaries”: Many, if not most, disputes regarding the administration of any trust can usually be traced back to the failure of the trustee to adequately communicate with the beneficiaries. If the trustee has a good relationship with the beneficiaries, and the beneficiaries feel like they understand why the trustee has done what they did, there is usually no reason why the beneficiaries would have a falling out with the trustee.
Risk #5 – “Failure to Keep Adequate Records”: A trustee must have a system for, among other things, memorializing in a contemporaneous, written record all communications with each beneficiary and advisor, the basis for all important decisions regarding the administration of the trust and the description of all receipts, disbursements and distributions of trust assets.
Risk #6 – “Failure to Prepare and Distribute Periodic Reports”: Each trust and the laws of each jurisdiction governing the administration of each trust sets forth detailed requirements regarding the preparation and distribution of periodic reports. These rules, among other things, describe the timing of these reports, the content of these reports and the people who are entitled to receive these reports. The trustee must make sure he or she understands these rules and has a system in place to comply with them.
Risk #7 – “Failure to Maintain Adequate Insurance”: The trustee is personally responsible for making sure the assets in the trust are properly maintained and protected. Among other things, this includes the responsibility of making sure that adequate insurance is in place to protect these assets in the event of a loss or casualty event such as a fire or hurricane.
Risk #8 – Reliance on Indemnification Provisions in the Trust”: Many trusts contain provisions which protect the trustee in the event a claim is made against the trustee by a beneficiary or someone else. These provisions are called “Indemnification Provisions”. These provisions transfer the risk of loss from the trustee to the trust so they can create a conflict with the beneficiaries of the trust, and in many jurisdictions, there may be limitations placed on the trustee’s reliance on these provisions by statutes and caselaw.
Risk #9 – “The Trustee is also a Beneficiary”: This is not an uncommon situation. For example, it occurs when one child is named to be the trustee of a trust that is established for the benefit of all the children. Although the trustee in this case is entitled to all the benefits bestowed on the beneficiaries by the trust, including the right to be reasonably compensated for his or her services, the trustee cannot make decisions which will benefit the trustee to the detriment of the other beneficiaries.
Risk #10 – “Failure to Retain Qualified Advisors”: A Trustee is personally responsible for making sure that the trust is properly administered, the assets are properly invested and protected and taxes are properly calculated and paid in a timely manner. This means the Trustee must retain qualified legal, accounting and financial expertise to assist them unless they are qualified to provide these services.
Hopefully, this brief summary provides an overview of some of the most common risks encountered by trustees during the administration of a trust and serves as an introduction to the articles which will follow.