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The Imperial Trustee: Whose Money Is It?

The good news is that, when they died, your parents thoughtfully left their estate to you and your siblings in a trust. Of course, they named a trustee to manage the trust. The bad news is that the trustee is pompous, arrogant, unresponsive and expensive. The trust's investment performance has been far from stellar. The trustee, who holds part of the family business' stock, seems unable to comprehend your business strategy.

After years of frustrating meetings with the guy/lady/institution, you finally yell, "WHOSE MONEY IS IT ANYWAY?!!!! Why won't you do what I ask you to do?"

Good questions. As a beneficiary, you think of the trust as your money (or at least your family's money). Trustees sometimes act like it's their money. And our legal system presumes that it's your parents' money, even though they are long dead! The lawyers make out like bandits presumptuously interpreting your parents' wishes based upon a lengthy document full of mumbo jumbo that your parents probably never read and certainly never understood.

One thing's for sure, there's little more lucrative than being an entrenched trustee. They have broad latitude to set their fees and select investments. In many trusts, they have broad discretion in deciding whether to make distributions. Their actions are virtually immune from challenge. Absent gross negligence, the law is heavily stilted in the trustee's favor. Suing a trustee is expensive. The beneficiaries pay their own legal costs and the trustee's defense costs most likely are paid by the trust. It's almost like suing yourself! And, I've seen statistics that indicate total surcharges, settlements and other losses by trust companies are .06% of their income . . .a truly miniscule amount!

Here's the problem from a business-world perspective. There is no competition. "Wait!" you say. "There are lots of banks, lawyers and friends willing to serve as trustee. I can pick from a vast assortment, so there must be competition." That is true, until you appoint one as trustee. Then, the beneficiaries are stuck. Compare it to selecting a phone company and then being prohibited from changing to another one for 50 years. What might happen to your service and cost?

There is a simple cure for new trusts. Incorporate a mechanism for the beneficiaries to remove and replace the trustee. Some trust instruments permit removal, but only "for cause." That probably does not go far enough. The subjectivity of that phrase suggests the need for lawyers and litigation to determine whether "cause" in fact exists.

Go for the gusto. Permit the beneficiaries to remove the trustee without cause . . . a kind of no-fault divorce. There is a trade?off here, but it's a matter of emphasis. You can:

Protect the wealth from the beneficiaries at all costs, but subject that wealth to the risks associated with an entrenched trustee;

Or

Encourage trustee accountability by giving the beneficiaries the right to "shop around," but with the risk that they will find a trustee who might bend the rules to make distributions or investments that you intended to prohibit.

There actually is a reasonable middle ground for you fence straddlers. Until 1995, the estate planning community was hesitant to give beneficiaries the power to fire and replace a trustee without cause because the IRS thought it could subject trust assets to estate tax when the beneficiaries die. However, the IRS backed away from that view. Now, you're OK in Uncle Sam's eyes as long as the replacement trustee cannot be related or subordinate to the beneficiaries who have the removal power.

The IRS' restriction on the identity of potential replacements is based upon a shaky interpretation of the law. However, limiting the replacement to those who are not related or subordinate can reduce the risk that the beneficiaries will find someone willing to go too far in bending the rules.

You could go a step further and define a class of potential replacements. A typical example is to require the replacement to be an institution of at least a certain size that is regularly involved in providing trust services.

Our society rejects kings and dictators, yet it remains surprisingly willing to anoint trustees for life (and institutional trustees forever). Based upon my experiences in trying to get entrenched trustees to take actions in the family's overall best interests, maybe people need to reflect a little on this dichotomy.

 

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