So You’re A Trustee – Now What? What You Don’t Know, Could Really Hurt You

Introduction

Many of you, both families and individuals, have spent time and resources to establish revocable trusts. Such trusts allow you to manage their assets during life, after death and avoid probate. The attorney drafting these trusts usually spends a fair amount of time explaining how the trust operates, the roles of the grantors, beneficiaries and trustee. Often the information is soon forgotten and the trust placed somewhere "safe" never to be seen again.

After all, there is usually very little to do to maintain the trust while the grantor(s) is still alive and there may be many years between the signing of the trust and an event requiring some action be taken.

As a result, when an event does occur, the parties are caught like a "deer in the headlights" unable to figure out what to do and what direction to make. The party most affected will invariably be the successor trustee(s). He or she will be the one who most if not all of the responsibility for trust administration will fall. In many cases, the successor trustee will know almost nothing about what to do first, let alone have a developed plan of action. They also will have no idea about the extent of personal liability that they could have if they make a misstep.

The obligations of a trustee are defined by law and by the trust instrument, which may be created under the Last Will and Testament of someone who has died, or an agreement that takes effect during one's lifetime. A trustee is expected and required to apply the property faithfully and according to the grantor's objectives for the benefit of the beneficiaries and not for the personal benefit of the trustee.

A person appointed as trustee does not have to accept the appointment. He or she can decline to serve, usually by written instrument. After appointment and acceptance, a trustee may resign, generally only by a written instrument. A trustee may also be removed according to the terms of the trust or by court action.

General Duties of a Trustee

A trustee stands in a special relationship of fiduciary responsibility to the grantor of the trust and to the beneficiaries. A fiduciary is a person or other entity that manages property belonging to someone else without themselves having an ownership interest in the property. The starting point is the trust instrument and its specification of what the trustee is to do to accomplish the purposes for which the trust has been established. For example, in the case of a simple trust disposition, the instrument might state that the trustee is to hold and invest the assets to pay net income to beneficiary #1 for life and then to distribute the remainder to beneficiary #1 after the death of beneficiary #1.

Beyond that, certain duties are imposed on trustees by state law as follows:

(1) Duty to Administer Trust by its Terms. The trustee is obligated to administer the trust strictly by its terms, in good faith, in accordance with the purpose and terms of the trust and in the interests of the beneficiaries. The trustee must be guided in all acts by the trust instrument, including any amendments. Therefore, it is critical that the trustee read and understand the entire trust instrument. However, there are certain mandatory rules that prevail over any provision contained in a trust.

(2) Duty of Skill and Care. A trustee must administer the trust with reasonable care, skill, caution, prudence and diligence to accomplish the purposes, terms, distributional requirements and other circumstances of the trust.

(3) Duty to Give Notices. The trustee is required to give notice to beneficiaries, co-trustees and successor trustees in a variety of circumstances. For example, the trust is required by law to provide notice to beneficiaries when a trustee first takes over as trustee or wishes to resign; or when the trustee intends to delegate investment, and the trustee must be careful to give notices to the beneficiaries of their withdrawal rights in those situations.

(4) Duty to Furnish Information and to Communicate. A trustee has the duty to keep the beneficiaries reasonably informed regarding the trust and its administration. Except to the extent that the trust instrument specifically excuses the trustee from doing so, on at least an annual basis and at the termination of the trust, the trustee must provide to those beneficiaries who actually received a distribution during the annual period (except a beneficiary who received a specific bequest), a trust report that includes information about the assets, liabilities, receipts, and disbursements of the trust and the trust's investment performance. The preparation and completion of this report is not simple for someone who is not familiar with accounting principles in general, let alone trust accounting principles. To the unfamiliar, this report will appear challenging to say the least.

(5) Delegation of Duties. A trustee who is unfamiliar with accounting principles thus, will often seek professional assistance in preparing the trust accountings. The trustee can delegate many of the trustee's duties or powers to others (agents), such as attorneys, accountants and investment advisors, but is held to a high standard of care, skill and prudence in selecting such agents and in monitoring the agents' actions. Certain delegations require notice to be given to the beneficiaries (see Duties to Give Notice).

(6) Duty of Loyalty, Conflicts and Segregation of Trust Property. A trustee is obligated to administer the trust solely in the interests of the trust beneficiaries in accordance with the terms of the trust. In general, the trustee may not use trust assets in any manner that benefits the trustee personally, even if there is no loss to the trust. The trustee has a duty not to use trust property for his or her personal gain. The trustee may not engage in any act that puts his or her personal interests in conflict with those of any of the trust beneficiaries. In many cases the successor trustee will also be a beneficiary and will benefit personally from trust transactions. Most trusts will allow trustees who are also beneficiaries to self-deal. However, in that case, the trust should specifically allow for such transactions.

(7) Duty of Impartiality. In the event a trust has two or more beneficiaries, a trustee has a duty to treat the beneficiaries impartially. The trustee must show impartiality in balancing the interests of lifetime beneficiaries with those of remainder beneficiaries.

(8) Duty to Invest. A trustee has the duty to invest trust assets in a manner which is appropriate for the particular trust. Generally, this means the trustee must diversify investments and determine an appropriate asset allocation program. A trustee who is not a professional investor would be well advised to delegate investment functions to a professional investment advisor.

(9) Duty of Confidentiality. The trustee should keep the affairs of the trust, confidential, unless otherwise required by law. For example, the trustee should not disclose the terms of the trust, the identity and interests of the beneficiaries or the nature of the trust assets.

(10) Duty to Collect, Enforce and Defend Claims. The trustee should take reasonable steps to enforce claims of the trust an defend claims against the trust.

Investing Trust Assets

State law provides standards and guidelines as to the type of investments which are appropriate for trust assets.

Distributing Trust Assets

One of the fundamental duties of a trustee is to make appropriate distributions to designated beneficiaries. The following are types of distributions commonly confronting trustees:

(1) Required Distributions during the Existence of the Trust. Required distributions to a beneficiary during the existence of the trust are generally obvious to both the trustee and beneficiary, but if the wording of the trust instrument is unclear, or is ambiguous, the trustee may need to seek the advice of counsel. Allocation of receipts between the income and principal is a complex matter, and requires considerable knowledge of California law and/ or possible federal tax law.

(2) Discretionary Distributions during the Existence of the Trust. It is not unusual for a trust instrument to give the trustee certain discretion in making distributions to the beneficiaries. One typical approach is to provide the trustee with authority to make distributions to the beneficiary to provide for the beneficiary's "health, education, support and maintenance." Such provisions will require substantial judgment by the trustee in determining the needs of the beneficiary. The trustee may find it necessary to secure data from the beneficiary.

(3) Termination Distributions. The final distribution which the trustee is required to make is the allocation of assets among the appropriate recipients upon the termination of the trust.

Records and Accountings

A trustee must keep clear trust records and provide accountings to beneficiaries. A trustee who is unable to account for the trust estate properly may face substantial risk in the event of a dispute with the grantor or beneficiaries. This may result in removal as trustee and/or a loss of compensation and/or personal financial liability. Moreover, trust beneficiaries have a right to inspect trust records. The following are types of records to be maintained by trustees:

(1) General Records of the Trust. The financial assets of a trust require the keeping of written records such as bank statements, cancelled checks, receipts, brokerage statements and security trade confirmations. Other asset classes, such as real estate, will also have a routine set of records. All trust records are important for legal and tax purposes and need to be retained in an orderly fashion.

(2) Records of Trustee Actions. Trustees often are authorized by the trust instrument to make discretionary decisions. The decisions should be supported by memorandum or correspondence. Records of trustee action can run the full spectrum from highly formal (a vote of co-trustees on the sale of a business) to informal (the letter by which a beneficiary requested a payment which the trustee made).

(3) Trust Accountings. The beneficiaries of a trust have a legal right to receive sufficient information about the trust to protect their interests in the trust. Furthermore, accountings for prior periods are also essential when there is a change of trustee, to ensure that the successor trustee begins his or her responsibilities with full knowledge and a clean slate. At a minimum, accountings should be prepared on an annual basis and should show initial assets, income and principal transactions and assets on hand at the end of the year.

Compliance with Tax Laws

The tax law of trusts is confusing and complex even for relatively simple trusts. The terms simple vs. complex trusts, distributable net income (DNI), income in respect of a decedent (IRD), trust accounting income and the deduction for distributions to beneficiaries have specific meanings which are at best difficult to understand or apply. Thus, it is important for the trustee to understand the nature of the income taxation of trusts, or to retain qualified tax counsel who will provide assistance in this regard.

A Trustee's Compensation

A trustee who performs the required duties, is generally entitled to financial compensation for his or her services.

Conclusion

A trustee who does not perform his/her duties may find their personal assets in danger from lawsuits by disgruntled beneficiaries. Trustees could lose their homes, investments, savings, if they make a mistake in managing trust assets, making distributions, and many other possible pitfalls. Thus, a trustee can become personally liable for a breach of duty as trustee when the breach results in a loss of the trust.

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