Understanding Your Client's Trusts

Jennifer Junker, Chief Fiduciary Officer, Arden Trust

As a financial advisor, you work intimately with your clients and provide them with expert investment advice and service. You may be asked to help clients with investments that are held in many different forms, including IRAs, individually titled accounts and in trust.

Trusts are a common estate planning tool as they are useful for many purposes. Your clients may have multiple trusts which all slightly differ from one another. However, all trusts have certain basic attributes which are important to understand. Clients should have a basic understanding of the common terms used in trust documents, such as:

• Beneficiary: One or more persons who benefit from the assets held in trust. Beneficiaries are considered to have a beneficial ownership in trust assets, while the Trustee holds legal title to all trust assets.
• Fiduciary Standard:  One of the highest standards of care imposed by law. Someone acting as a fiduciary, such as a Trustee, must act only in the best interests of the trust beneficiaries.
• Grantor/Settlor:  The person who creates and funds a trust.
• Income Beneficiary:  A current beneficiary who may receive either mandatory or discretionary income distributions and potentially principal distributions.
• Prudent Investor Rule:  The legal standard of care for investments made in the Trust.  This can be modified by the Trust document.
• Remainder Beneficiary: A beneficiary whose interest does not arise until after the income beneficiary’s interest terminates. 
• Trustee: An individual or an entity with trust powers that holds legal title to trust assets.

Your Clients’ Trust

A trust is a separate legal entity, whether revocable or irrevocable. Most trusts have a separate taxpayer identification number although revocable trusts usually use the grantor’s social security number. Assets can be owned by the Trust and are distributed and invested as the Trust’s terms and applicable law requires.  

The Trustee

The Trustee of a trust is responsible for the management of all trust assets and for the duties that go along with property ownership. For example, the Trustee is responsible for ensuring that tax payments are made, insurance premiums, if real property is owned, are made, and tangible assets are safeguarded. 

Whether to make a distribution of income or principal to a current beneficiary is often a discretionary exercise of authority by the Trustee who must follow the standards that the Trust instrument specifies.  A common example of a distribution standard is the “HEMS” standard, which is short for health, education, maintenance, and support. When making the decision as to whether to make a distribution under this standard, the Trustee must balance the interests of the income beneficiaries and remainder beneficiaries, as the Trustee has a fiduciary duty to all beneficiaries who often have competing interests.

Trust Investments

Similarly, Trust investments must be made prudently, considering the needs of both the income beneficiaries and the remainder beneficiaries. This is why Trustees generally invest assets to provide for both fixed income as well as an equity exposure, balancing the needs of the current beneficiaries for income distributions with the needs of the remaindermen to receive trust assets at the termination of the trust. Additionally, irrevocable trusts need to be considered independently of other assets when formulating investment policies for clients as the trust is a separate legal entity with beneficiaries who may not have interests in the clients’ other assets.

Trustee Duties

Trustee duties may be modified or varied depending on state law and the purpose of the Trust.  However, the fiduciary duty of a Trustee to the beneficiaries of a Trust is the foundation of a Trust relationship and cannot be eliminated with respect to the duties owed by the Trustee to the beneficiaries.

Recent law, however, does allow in some cases for the Trustee’s duties to be split, such that another individual or entity has the fiduciary responsibility to manage trust investments or discretionary distributions. These types of trusts are called “directed trusts” and generally are governed by specific state statutes which sets out the requirements for the Trustee’s fiduciary duty to be successfully segregated. In other cases, a Trustee may “delegate” the responsibility for investing trust assets to a separate investment advisor who will then be responsible for investing trust assets according to the terms of the Trust. In this case, the Trustee has continuing responsibility for the investments, although state law typically reduces the extent of that responsibility when investment advisors are chosen prudently, and the delegation is done appropriately.  

Elements of a Trust

Although the terms and purposes of trusts may vary widely, fundamentally all trusts will have a Trustee, beneficiaries, and trust assets. The Trustee will have the legal title to the assets and will manage the assets in the best interests of the beneficiary. The Trust document, supplemented by state and other applicable law, will specify how the Trustee must carry out duties to the beneficiaries of the Trust.

The uncertainty and disruption of the last few years have led numerous clients to consider or implement financial and estate plans. As your client’s trusted advisor, you’re in a position to help ensure the future success of these plans. Since trusts play a critical role in the planning of many clients, an understanding of how they work and what may be required when considering investment options is expertise you can bring to the table. Partnering with a trust expert can further enhance your client relationships.  

Arden Trust Company does not provide legal or tax advice. Please consult a legal or tax professional for advice specific to your circumstances.