Five Factors Trustees Should Consider When Evaluating Discretionary Distribution

by Jennifer Junker, Chief Fiduciary Officer

Death and money are two of the most difficult topics for families to discuss so many families avoid these topics altogether. This lack of communication often leads to the creation of estate plans, which may include trusts, with little to no communication among the family regarding how a trust functions or what a beneficiary may expect when an inheritance is held in trust.

Once the actual trust administration commences, beneficiaries typically lack control over the administration process, which can create feelings of frustration., especially when the duties and obligations of a trustee are not fully understood and/or the beneficiaries did not expect that their inheritance would end up in a trust.  

Gaining an understanding as to why a trustee may take certain actions or make requests enables you to set expectations and facilitate the process of trust administration for your clients who are trust beneficiaries.

Trust distributions are an essential part of the trustee role, and most trusts provide for at least some of the distributions to be discretionary. This means that the trustee must determine whether it is prudent to make a requested distribution considering the terms of the trust and its requirements.

Let’s discuss five key factors a trustee must consider when determining whether a distribution can be made.

1. Does the request benefit a permissible beneficiary and fall within the trust’s discretionary standards?

The first item a trustee considers is whether the requested distribution is for a permissible purpose when considering the discretionary standards chosen by the grantor. For example, if the trust only permits distributions for health or education purposes, a distribution for the purpose of a beach vacation is likely not to be permitted.

 The trustee must also consider who the distribution will benefit.  While a distribution to pay a dental bill would fall within a health and education standard, a distribution to pay a dental bill for the beneficiary’s girlfriend or boyfriend would not.

2. Is te requesting beneficiary the only current beneficiary of the trust?

Another factor when considering a discretionary distribution is the number of trust beneficiaries. There may be more than one beneficiary who can receive current distributions from the trust, and the beneficiaries who receive assets at the time the trust terminates may be different than the current beneficiaries. All beneficial interests must be considered by the Trustee when determining whether a distribution should be made.

Because a trust has finite resources, distributions that deplete the trust must be carefully considered as the trustee must treat all beneficiaries, current and remainder, impartially unless otherwise stated in the trust agreement. If unequal treatment is desired, the grantor could direct in the trust document that the trustee give primary consideration to a specific beneficiary when making discretionary distributions before considering the needs of other beneficiaries.

3. Who are the trust beneficiaries at the time it terminates?

Since the current and future needs of other beneficiaries are considered as part of the discretionary process, the trustee is likely to request that the beneficiary provide information about outside resources and income. While compiling this information can be arduous, if the trustee is to determine whether a distribution is necessary for a certain purpose, the trustee must understand whether there is an actual financial need for the distribution.

While this is not determinative as to whether a distribution should be made, it is a factor that should be considered in most cases. If the grantor would prefer something different, the trust could be drafted to direct that the trustee shall not take into consideration outside income or resources when making a discretionary distribution decision.      

4. What is the trust's market value and projected income, and how long is the trust intended to last?

Another element of the discretionary process is reviewing the current market value of the trust and its projected income, as well as the trust’s time horizon. Some trusts terminate and pay out to the current beneficiary upon the occurrence of specified events (age attainment, for example). Others may be intended to last for multiple generations. In order to gauge the effect of recurring distributions on the trust’s assets, the trustee may request that you run projections estimating the depletion rate of the trust. If the depletion rate shows that the trust is unlikely to last as long as was intended, a reduction of distributions will likely need to be considered.

5. Are there any adverse tax or legal consequences when making the distribution?

Finally, there can be legal or tax consequences to consider when determining whether to make a discretionary distribution.  For example, a trust may have been created that benefits both a child and grandchild. Because the trust is not exempt from generation-skipping transfer tax, any distribution to the grandchild could cause a substantial tax to be paid. However, distributions to the child do not incur the tax. Additionally, in the case of a special needs trust, while certain distributions may be permissible under the trust document, actual distributions for those purposes could cause problems with beneficiary eligibility for government programs and services.

Most people do not deal with trusts on a regular basis, and the legal documents and financial complexity surrounding administration can be daunting. By helping make sense of this complexity, your guidance will help your clients have a clearer understanding of how trusts work, ultimately resulting in a better experience throughout the administrative process. Partnering with a trust expert can further enhance your client relationships by bringing additional resources to the table. client relationships by bringing additional resources to the table.