The individual or institution you name as trustee of your trust fund is one of the most important steps involved in the process of setting one up. Even the best-structured trust can encounter significant difficulties if you don't put careful time and consideration into who should be responsible for protecting the capital you set aside in your trust as a legacy.
You should consider three things when attempting to select a trustee, and it all starts with a firm understanding of what a trust fund can and can't do.
What Is a Trust Fund?
A trust fund is typically a living trust, one that's formed while the grantor or creator of the trust is still alive. It's a legal entity that's set up to hold ownership of assets on behalf of the trust's beneficiaries, with a third-party trustee at the helm. The trustee manages the trust's assets and determines how distributions are made to beneficiaries unless the trust formation documents already set these terms.
A living trust can be either revocable or irrevocable:
- Revocable trusts allow the grantor—the individual who sets up and funds the trust—to act as trustee and manage the trust assets. The grantor can even dissolve or revoke the trust if they decide it no longer suits their purposes. They can change or eliminate beneficiaries.
- Irrevocable trusts require that the grantor step aside after forming the trust and appoint a trustee to manage the assets. These trusts cannot easily be "undone," at least not without a court order.
The appointment of a trustee is critical to the formation of an irrevocable trust, and the nomination can't later be changed, at least not without a court order, good cause, and the unanimous cooperation and consent of all beneficiaries.
A testamentary trust is one that's formed according to the terms of a deceased person's will after their death. By definition, this type of trust is irrevocable because the grantor is no longer alive to make changes to it.
Is Your Choice Qualified and Willing?
Grantors often establish a trust fund then name a close friend to the role of trustee without knowing whether the individual has the necessary experience and or even asking if they're willing to take on the job. The individual must be up to taking on the potential legal liability of overseeing the assets placed in the trust.
Just because you like or trust someone doesn't mean they should be your trustee, and just because someone is brilliant in business doesn't mean they'll be willing to accept the role.
Consider someone who has experience investing in real estate if your trust consists of a lot of property investments, or appointing an experienced banker if you plan on contributing a minority stake in a local bank into the trust. In other words, try to match your trustee to the assets you're funding into the trust.
Will It Hurt Family Relationships?
Imagine you have four sons. The oldest is successful, intelligent, and financially independent. You've been pretty successful yourself and expect to leave an estate worth at least $1 million. You want all the money put into a trust fund that pays 4% dividends per year. This would give each of your four sons $250,000 in principal, generating $10,000 in cash distributions annually.
You name your eldest son as trustee and give him discretionary power over trust distributions. He can make them when he thinks it's appropriate but they're not required.
The relationship could become strained, possibly even to the point of hatred, if your oldest son decides to deny funds to one of his siblings in their hour of need. They're grown men, but they're going to have to ask him for cash that was intended for their benefit, giving him significant power over their lives.
One solution would be to set the terms for distributions yourself at the time you form the trust so as not to give one son ultimate power over his siblings...or consider naming someone else as trustee instead.
Issues of Continuity
Many individuals and families opt for an institutional trustee, such as a bank's trust department, to avoid problems. They gain not only the professional oversight and services that can be brought by a financial institution, but some assurance as well that the trust won't be thrown into turmoil if an individual named as trustee should die or become incapacitated.
The bank can put another representative in place quickly if their appointed representative dies, leaves employment, or otherwise becomes unable to serve. There shouldn't be any lengthy court hearings or potential snags.
The downside is that an institutional trustee invariably costs more. The individual appointed by the institution to hands-on manage the trust might change from time to time for any reason, creating a lack of continuity and some discomfort or awkwardness for the beneficiaries.
In the Event of Malfeasance
As an added bonus, using an institutional trustee can help protect your assets from malfeasance. Imagine that you name a friend as your trustee and that individual develops a gambling problem years down the road after your death—or even if your preferred eldest son goes wayward.
Your beneficiaries would have the option of suing the trustee to recover the funds if they were stolen in cases such as this, but these lawsuits aren't always easy to win. Beneficiaries must establish to a court's satisfaction that the actions taken by the trustee were unreasonable, irresponsible, and a violation of fiduciary duty.
A bank has internal audit procedures and safeguards in place that would help prevent such a theft from occurring.
One way to get the best of both worlds is to appoint your friend or relative and a bank to act as co-trustees. They'll have to work in concert together on all major decisions. You'll know that someone you know and trust is looking out for your intentions, but you'll have the safeguards and watchful eye of a major financial institution to keep them honest as well.
Another option is to name an institution as successor trustee to take over when and if your primary trustee should die before the trust is closed. The institution would wait in the wings until needed.