Thoughts on multi-generational planning - Part 2: Choosing the right fiduciaries

Who owns the assets in a trust? Most families who create a trust assume that “the family” or perhaps “the beneficiaries” own the assets, but in fact the trustee is the legal owner under common law. A trust can be an extremely effective planning tool, offering tax savings, asset protection benefits, and professional management of complex assets. But choosing the wrong trustee – putting the wrong person or group in charge of the assets - can put all those benefits at risk.

First, what does a trustee do? A trustee is responsible for investing trust property, administering the trust, and making distributions, all in accordance with the terms of the trust. A good trustee understands the scope and responsibilities of the role and takes those responsibilities seriously. A good trustee
• understands the grantor’s intent in creating the trust,
• knows the beneficiaries and monitors their needs, their other assets and sources of income,
• if not an investment expert, has the knowledge and experience to monitor investment professionals (and/or, in the case of business-owning trusts, business managers) effectively
• has the administrative capability (whether in-house or outsourced) to manage trust accounting, reporting and compliance.

Trustee candidates come in many forms – from individual family members to corporate trust companies formed by major international money-center banks, to private trust companies formed by families to serve as trustees of their trusts.
• Individuals often provide more personalized service than corporate trustees. A knowledgeable family friend or advisor often can bring a better understanding of the grantor’s intent and the beneficiaries’ needs, but may lack comprehensive investment knowledge or have limited access to investment and administrative resources. Individual trustees may charge lower fees than corporate trustees, but families should keep in mind that an individual trustee will need to engage investment and administrative service providers, and so the total cost for an individual trustee may be similar to (or even greater than) the cost for a corporate trustee.
• Corporate trustees typically offer a full package of services; many have served wealthy families for multiple generations and have developed strong teams. However, corporate reshuffling, promotions and career transitions often mean that team members may change frequently. Families should be aware that some corporate trustees will not serve as trustee of a trust holding interests in an operating business or other non-liquid assets.
• Private trust companies offer a family the opportunity to create their own custom-designed corporate trustee, which may be of significant value when trust assets include a substantial operating business or other unusual and nonliquid assets, but families should be forewarned that a PTC requires a substantial and ongoing investment in legal, accounting and administrative structures and systems and so should not be undertaken without substantial due diligence and planning.

Separate trustees can be appointed to handle certain specified trustee responsibilities, thereby enabling the grantor to custom-design the fiduciary team (at least on paper). Conceivably, a trust might have a directed trustee in Delaware, an independent trustee to handle distributions, a family trustee to share investment decision-making, provide oversight and ensure that the beneficiaries’ interests and needs are met, an investment trustee to oversee management of the trust’s portfolio, and a special trustee to manage particular assets (such as an interest in a startup venture). When dividing fiduciary responsibilities among a group of the trustees, the potential to achieve a custom-tailored structure needs to be weighed against the risk of creating an overlap between trustee roles, or worse, a gap.

Families often invest large amounts of time choosing a trustee, without giving much thought to successor trustees. Often, the issue of successors arises many years after the trust’s creation. How can a family ensure that the successor will be qualified and capable? And what provisions can be included to protect against an incompetent, ineffective or downright dishonest trustee? Probably the least effective option is to name successor trustees in the document, because the successor may not be alive or capable of serving effectively when the time comes. Almost as ineffective is to give the trustee the right to name his, her or its successor, a practice which can perpetuate poor trustees. Giving the beneficiaries of the trust the power to name the trustee can work in the case of capable, adult beneficiaries, but will not be so effective if the beneficiary(ies) are young (or otherwise legally incompetent), disinterested or otherwise incapable of exercising the power effectively.

A better option for solving the problem of trustee succession may be to name a protector for the trust. A protector may be granted a number of powers under the trust, but the most common is the power to remove and replace the trustee. With this power, the protector serves as monitor and overseer of the trustee, providing an important check-and-balance to the trustee’s power. The protector is typically a knowledgeable individual who knows the family well and brings applicable professional expertise to the role. For larger trusts, or trusts holding complex assets such as interests in one or more closely-held businesses, appointing a committee or an entity to the role of protector can be especially powerful; while an individual protector might become incapacitated or otherwise inattentive, a committee or entity, properly constituted, should be able to exercise its responsibilities seamlessly for the duration of the trust. The committee or entity serving as protector would have its own set of rules and procedures specifying its composition, responsibilities, decision-making procedures, and succession provisions.

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Next week’s post: Thoughts on multi-generational planning – avoiding unnecessary complexity