Investment and Distribution Trustees: Why Would I Need Both?

When creating a trust, it is common to name yourself as the initial trustee who is responsible for all aspects of administering the trust. However, when considering who will take over when you can no longer act (either because of illness or death), it is sometimes helpful to divide the responsibilities between two or more successor trustees. For example, you may decide to have one trustee who manages the accounts and property held by the trust and another trustee who makes decisions about distributions to the trust’s beneficiaries. There are some important reasons why you may want your trust document to bifurcate the trustees’ duties in this way.

Benefit from specialized knowledge or aptitudes. Trustees have a variety of duties and responsibilities in administering a trust, and it is sometimes beneficial to divide them up between more than one trustee based upon the expertise or skills needed to perform a particular aspect of the trust’s administration. For example, if your sister-in-law is knowledgeable about investments and experienced in making financial decisions, but is not as skilled at handling potentially difficult interpersonal interactions, it may be beneficial to name her as your investment trustee, which is a trustee whose sole duty is to make discretionary decisions about the investment of funds held by the trust. 

Some trusts call for distributions to be made to beneficiaries at the trustee’s discretion rather than mandatory distributions of a certain amount or percentage at specific times. For trusts that provide for discretionary distributions, it may be helpful for another trusted person capable of making impartial decisions, skilled at communicating with others, and familiar with the beneficiaries of the trust and their needs to be named the distribution trustee, which is a trustee responsible for making decisions about whether and when to accumulate or distribute the income or principal of the trust. 

This division of responsibilities is particularly helpful if there are any difficult relationships or potential conflicts between beneficiaries or between one of the trustees and a beneficiary. For example, if your second wife is one of the trustees of the trust but the beneficiaries of the trust are your children from your first marriage, naming an unrelated third party as the distribution trustee may avoid hard feelings or the perception of unfairness related to distributions. Although it may be more expensive to have two or more trustees instead of a single trustee, the additional expense may be worthwhile to maintain family harmony and avoid damaging relationships. 

Gain additional asset protection. Most creditors may not reach a beneficiary’s interest in a trust if the trustee is not required to make distributions. Some creditors may be limited in how much they can reach if distributions are based on an ascertainable standard such as for the health, education, maintenance, and support (HEMS) of the beneficiary. Depending on state law, this may be true even if the beneficiary is also the sole trustee. 

However, the general rule is that the less control a beneficiary has over the trust’s accounts and property, the more protection is provided against creditors’ claims. Even if the beneficiary of the trust is also the investment trustee, greater asset protection may be available if a separate distribution trustee is appointed who is empowered to make distributions to the beneficiary in their sole discretion. In some jurisdictions, the trust could also provide that the beneficiary could resign as a trustee and appoint another independent trustee to take their place. This might further enhance the level of asset protection if the beneficiary is concerned that they may become more vulnerable to creditors’ claims in the future.

Note: This asset protection is typically not available for certain creditor claims, such as for child support or alimony or tax debts. The list of “exception creditors” varies by state and should be discussed with your estate planning attorney.

Minimize taxes. When a trustee has total discretion to make distributions from the trust to themselves or others, the value of the trust’s accounts and property may be included in the trustee’s estate for estate tax purposes, or the trustee may be taxed on the trust income under Internal Revenue Code (I.R.C.) § 678. Depending on the type of trust and the goals it is designed to achieve, an independent trustee could be appointed to minimize either estate or income taxes. 

Example: To avoid having the property held by the trust included in their estate for estate tax purposes, a trustee who is also a beneficiary may be permitted by the terms of the trust to select an independent distribution trustee, as long as that distribution trustee is actually independent—not a related party or a person subordinate to the beneficiary as defined by I.R.C. § 672(c). In this situation, the investment trustee who is also a beneficiary will not have direct control over the amount or timing of the distributions, but they may still retain significant control over who serves as the independent co-trustee. In addition to choosing the independent distribution trustee, the trust document may provide that the beneficiary can replace the independent trustee at any time and for any reason. 

Example: If your trust is a nongrantor trust—i.e., a trust that is a separate entity for tax purposes that pays taxes on trust income at the trust level—it is important for someone other than the grantor (the person who creates the trust) or any party who is related or subordinate to them to be the investment trustee. This is because the power to determine trust investments may be considered to be the power to control the beneficial enjoyment of the trust assets under I.R.C. § 674, which would mean the grantor, rather than the trust, must pay taxes on the trust income.  

Give Us a Call

If you would like to find out more about whether you should appoint separate investment and distribution trustees, give us a call to set up an appointment. Although having more than one trustee will make the trust more complex, and additional fees may be required for the services provided by the trustees, you may decide that the benefits far outweigh any additional costs. We can help you design your trust in a way that best achieves your goals by maintaining family harmony, protecting assets, and minimizing taxes.

man on computer looking at trust documents

How to Protect Yourself from Claims of Self-Dealing When Serving as a Trustee

What Is Self-Dealing in Trust Administration?

A trustee usually has quite a bit of discretion in their management of a trust’s accounts, money, and property (known as assets). At the same time, as a fiduciary, a trustee also owes the trust’s beneficiaries a duty of loyalty, which prohibits the trustee from self-dealing. In the simplest terms, self-dealing happens when a trustee uses the trust’s assets for their own benefit instead of for the beneficiaries’ benefit. Despite this simple definition, self-dealing can be much harder to identify in practice and is often done in ignorance, particularly when there are complicating factors such as the trustee also being a trust beneficiary.

Some common examples of self-dealing are a trustee

  • making gifts to themselves from the trust’s assets;
  • borrowing money from the trust;
  • investing the trust’s assets in their own business;
  • investing in high-risk investments for their own benefit;
  • selling property to or buying property from the trust;
  • mixing the trust’s assets with their personal assets;
  • paying themselves more than a reasonable amount of compensation;
  • receiving kickbacks from a third party compensated from the trust’s assets; and
  • when also a beneficiary, making a distribution to themselves but not to any other beneficiary or making a larger distribution to themselves than to any other beneficiary.

Examples of Innocent Self-Dealing

Let us look at some real-life scenarios that demonstrate how a trustee may engage in self-dealing without even realizing it or while thinking that they are benefiting the beneficiaries.

Example 1. Tom is the eldest son of Dad and Mom. Over the years, Tom has proven himself to be hard-working and reliable and has assumed most of the responsibility for running the family business that supports Dad, Mom, Tom, and Tom’s three siblings. Not surprisingly, Dad and Mom select Tom as the trustee of their trust, with Tom and Tom’s brother and two sisters as beneficiaries. Prior to Dad’s death, Dad instructs Tom that the trust’s assets are available for Tom to use so long as, in the end, all the beneficiaries (Tom and his three siblings) receive equal shares from the trust. After Dad’s death, Tom spends many hours doing trust administration tasks and does not take one cent of compensation from the trust even though, under the trust agreement and state law, he is entitled to reasonable compensation for his time. Tom and his brother decide to buy a yacht together. Unfortunately, neither one of them has enough money in his personal bank account to buy the yacht. Tom makes a loan of trust money to himself and his brother to buy the yacht but does not make a similar loan to either of his sisters. Is this self-dealing? What if Tom makes the loans to himself and his brother under arm’s-length terms, charging a reasonable rate of interest and requiring security for the loan? Under these additional facts, is this self-dealing?

Example 2. Tom from Example 1 wants to expand the family business. Tom, his brother, and one of his sisters own equal one-third shares of the company as partners. Tom’s other sister has no ownership interest in the company but is a paid employee. Tom uses trust money to fund his business expansion plans. Is this self-dealing?

Example 3. Sue, a successful physician, and her two brothers are the beneficiaries of a family trust. Sue is the trustee. The trust owns a lake house that Sue’s parents purchased when she and her brothers were young, and many happy family memories were made at that vacation home. Unfortunately, the trust cannot afford to pay the mortgage and property taxes and keep up the required maintenance on the lakefront home, and neither of Sue’s brothers can afford even a one-third share of the amount needed for mortgage, taxes, and maintenance. Sue knows that the home must be sold, but she cannot bear to part with the property that represents so many happy childhood memories. Sue decides that she will buy the vacation home from the trust at fair market value. Is this self-dealing? What if, prior to Sue’s buying the home, the market crashes and the property loses a fourth of its value, but Sue purchases the home at the higher value? Under these additional facts, is this self-dealing?

How Do I Avoid a Claim of Self-Dealing?

As these examples demonstrate, there is not always a clear-cut answer to whether a trustee is engaging in self-dealing. An inexperienced trustee may not even realize that they are breaching their fiduciary duties. However, there are a few safe harbor rules that a trustee can follow to ensure that they will not be accused of self-dealing and find themselves involved in an unwanted lawsuit.

First, a trustee can engage in an action that might otherwise be categorized as self-dealing if the trust instrument authorizes it. So in Example 1 above, if Dad had wanted to allow Tom to use the trust’s assets in any way Tom saw fit as long as in the end all beneficiaries received equal shares, Dad should have made sure that such an instruction was included in the written trust instrument instead of being a separate oral instruction.

Second, a trustee can seek the approval of the trust beneficiaries for any action or inaction. If, after all facts are fully disclosed, the beneficiaries consent to the trustee’s proposed course of action or later ratify it, a trustee will not be guilty of self-dealing. So in Examples 2 and 3, if Tom and Sue had approached their siblings and explained what they planned to do, and their siblings had given them the go-ahead (preferably in writing), Tom and Sue would not be engaging in self-dealing.

Finally, a trustee can seek court approval of their actions. Nevertheless, any trustee looking to protect themselves from claims of self-dealing would be wise to avoid any transaction in which they stand to benefit unless the trust instrument specifically authorizes such action or they are transparent about the transaction and the beneficiaries consent to it.

If you are or will be a trustee of a trust in the future and have questions about the best way to fulfill your trustee duties, contact us. We would be happy to sit down with you and assist you with your role.