How to be a trustee

How to be a trustee

By: Martin M. Shenkman, CPA, MBA, JD

IRS Circular 230 Legend: Any advice contained herein was not intended or written to be used and cannot be used, for the purpose of avoiding U.S. Federal, State, or Local tax penalties. Unless otherwise specifically indicated herein, you should assume that any statement in this communication relating to any U.S. Federal, State, or Local tax matter was not written to support the promotion, marketing, or recommendation by any parties of the transaction(s) or material(s) addressed in this communication. Anyone to whom this communication is not expressly addressed should seek advice based on their particular circumstances from their tax advisor.

Caveat: These are ROUGH meeting notes to help you follow the audio lectures on this web site. Do not rely on these notes for any decision making. Similarly, the audio file of this seminar merely presents general planning ideas for trustees, not specific advice or guidance.

    • Introduction - Martin M. Shenkman, Esq., Paramus, New Jersey.
    • Family dynamics, divorce rate, asset protection concerns, aging population, large wealth transfers, all indicate increasing frequency of use of trusts.
    • Trustee liability and litigation - Melvyn Bergstein, Esq. of Walder, Hayden & Brogan, P.A. of Roseland, New Jersey.
    • Often it is not possible to avoid estate litigation.
    • Estate litigation can be the ugliest of all litigation. It often arises out of familial relationships and the emotions it generates make such litigation both contentious, and intractable. Nit infrequently, the genesis of estate litigation starts when the siblings are coming out of the womb. Too often many of the parties to estate litigation have agendas long in advance of the death. The death of the parent or another benefactor triggers and set off a dynamic that is beyond reason. It can truly bring out the worst in the people involved.
    • Most disputes could be handled quickly.

    i. Gather information.

    ii. Review the law.

    iii. Evaluate the equities.

    iv. Arrive at a clinical resolution.

    • Unfortunately, the above result often doesn't happen.

    i. Emotions of participants.

    ii. One or both lawyers may be unprofessional or pursuing a self interest.

    iii. The relationship between the lawyer and their client may be something other than the clinical and logical relationship it should be.

    iv. Sibling or other rivalries.

    v. A myriad of issues can hinder a reasonable resolution of the estate problems.

        • Drafting issues in the documents can be significant.

        i. Too often the documents (wills, trusts) ignore the people component.

        ii. How have the people lived? Who has what types of assets? What are the expectations of the family members?

        iii. Attorneys should be obliged to be counselors, not just Scribner's. Many lawyers see their roles solely as technicians. They simply execute their clients' wishes uncritically. Other lawyers see themselves on the other end of spectrum and function almost like therapists.

        iv. As a litigator, one sees documents setting up trusts which have no human component. The real life problems, the people issues and depth of emotions, all can be foreseen.

        v. The will and trust should reflect the intent of the testator and grantor. But the "counseling" component should be part of the lawyer's role. Ultimately, the lawyer should draft what the client wants.

            • Do I Want to be the Trustee?

            i. This is the first issue to address.

            ii. Ask yourself before accepting the appointment as trustee whether you really want the role, and whether you can really carry it out.

            iii. The next question, before accepting is to review the trust document. Find out about the family. What are the family dynamics? Have these issues been considered? Example: If children of first spouse are trustees for the second wife's trust, every dollar they give her will be a dollar they don't get. This is almost begging for a problem. Regarding the second wife, if later has health issues or becomes incompetent, a court may have to intervene to determine how distributions should be made. But these are the issues that the trustee to be should evaluate.


            v. Have a family meeting to review issues and feelings in advance.

            vi. The concept that people with different points of view should be allowed to be heard. The fear that this will split up a family is often an excuse. In many cases airing the issues will avoid worse problems later.

                • A same problem presented to different lawyers is likely to get a very different recommendation and perspective from each.
                • Before accepting a trusteeship, understand the circumstances and read the document. Ask the grantor or testator questions about what is going on in the family, what their goals are, and other questions.
                • How Can You get in Trouble as a Trustee - Melvyn Bergstein, Esq.
                • Use common sense. If it seems "evil" it is likely to be bad and you might face dismissal, suit. See NJSA 3B.
                • If you receive an order from the court and you don't follow up it will be trouble. Courts tend to be very sensitive to the issues facing trusts and protecting beneficiaries' interests.
                • If you embezzle, waste, misapply funds, commingle funds, leave the jurisdiction, neglect your responsibilities, become of unsound mind, incapacitated to do business, etc. you can be removed.
                • You have to hold your end up. If you are a co-trustee or co-fiduciary and don't fulfill your responsibilities you can be removed as trustee.
                • Making a "false suggestion" in getting the letters of trusteeship, you will be removed. Example, you tell the surrogate your client has died and they haven't.
                • If the document contains a contingency that has expired you will be removed. This is a limitation on your power and right.
                • If you change your address and do not give the court notice you can be removed.
                • If you remove property out of the state without court approval you can be removed.
                • If you don't appear for a court citation or summons you can be removed. The court can unilaterally dismiss you in such a situation. If you cannot be found to be served with a court order you can be dismissed.
                • If the will or trust agreement has been declared invalid in another state you can be removed.
                • If you commit a felony or commingle funds you are removed or terminated as trustee.
                • Conflict of interest issue is important to be wary of.
                • Most estate litigation is funded out of the proceeds of the estate unless the executor is involved in wrongdoing himself. For example, if there was undue influence exercised by the executor to get appointed, the court may not permit payment of legal fees by the estate. This is a variable. Don't assume you will have all your costs covered, it is not assured.
                • If the trustee is involved in discretionary decision-making, the beneficiary not receiving funds may protest. The displacement of the anger onto the executor or trustee is enormous. It too often becomes a real battle ground. If a professional makes the decision as to distributions, the beneficiary reactions are often beyond reason. Is there a face saving middle ground?
                • It is essential that the fiduciary (trustee, executor, etc.) must believe that each beneficiary is being treated fairly. Bring the lawyers and beneficiaries in for a meeting and try to find a middle ground.
                • The issues are often human problems, not technical problems.
                • What is more important? Maintaining a family relationship or fighting over the "thing" (what is in issue or what is being litigated). Often the real problem is the relationship, not the thing being litigated.
                • If the litigation is frivolous you might possibly make the litigant pay the fees. This is difficult.
                • Courts are reluctant to dismiss trustees and executors. This is hard because this is who the donor or testator appointed. You need a high standard of clearly and convincingly to prove that the fiduciary has violated one of the statutory basis for removal. It is tough to terminate or dislodge the fiduciary.
                • Using an Institutional Fiduciary - Sharon Klein, Esq., Fiduciary Trust Company International.
                • The role of the trustee is to balance the competing interests of the current and remainder beneficiaries.
                • When you have a conflict and have to make a decision that benefits one beneficiary over another. You need to understand the conflicts and how they arise.
                • Conflicts often arise in 3 areas:

                i. Investment arena. How does the trustee invest the trust assets to balance competing interests.

                ii. Distribution field. How and when should a trustee make distributions and how can the trustee use the unitrust or power to adjust to balance competing interests.

                iii. How is tax burden to be shared? How and what tax elections should be made? How do you determine which client or beneficiary bears the brunt of this.

                    • Conflicts in the Trust Investment Arena - Sharon Klein, Esq., Fiduciary Trust Company International, New York, New York.

                    i. Prudent Investor Act governs the investment of trust assets.

                    ii. Must formulate overall strategy to meet trust objectives.

                    iii. Not individual security selection but rather an overall allocation based on facts and circumstances, size of trust, anticipated duration, and other factors listed in the statute.

                    iv. Trustees must invest for total return - income plus growth.

                    v. Must consider income, growth potential, and risk attributes of each asset.

                    vi. This creates conflict between income beneficiaries who are primarily interested in growth, especially if constrained by traditional definitions of accounting income.

                    vii. Base line objective of a trustee is to preserve purchasing power. Trust portfolio must be designed to keep pace with inflation. Mere preservation of principal is not sufficient unless purchasing power is preserved.

                    viii. No investment is inherently too risky, but risk must be managed.

                    ix. Must diversify unless determine that it is in best interests of beneficiaries not to.

                    x. Delegation of investment responsibility is permitted if skill and care is exercised in delegating and it is monitored.

                    xi. Prudent Investor Act sets forth a standard of conduct. Must document that this has been done.

                    xii. Different asset classes have different return expectations. The higher the return generally the higher the volatility. The role of the trustee in constructing the portfolio is to mix investment classes to get the best return within the appropriate risk parameters.

                        • How do you construct a portfolio that complies with the prudent investor act.

                        i. Each portfolio has a yield component and a capital appreciation component, and the aggregate of the two is the total return.

                        ii. Must keep pace with inflation so must evaluate returns versus inflation.

                        iii. A trust which is 65% fixed income and 35% equities provides the minimum exposure to equities necessary to keep pace with inflation. This might imply that every trust should have some exposure to equities.

                        iv. Consider taxes and fees in making the asset allocation.

                            • Power to Adjust and Unitrust.

                            i. Depending on State

                            1. Power to adjust.

                            2. Unitrust election.

                            3. Choice between power to adjust and unitrust regimes.

                            ii. New Jersey - power to adjust between 3-5%. Prior to that there was a 4% safe harbor. The change was made to conform to IRS regulations that a 3-5% adjustment between income and principle is deemed reasonable.

                            iii. Delaware - power to adjust and flexible unitrust regime between 3-5%.

                            iv. Varies by state.

                            v. Unitrust has fixed percentage

                                • Principal and Income Act and Prudent Investor Act.
                                • How do you determine what to do?

                                i. New Jersey gives you a band from 3-5% to adjust.

                                ii. How do you determine what to do?

                                iii. Start the analysis.

                                1. If you had a balanced portfolio with a 7.6% rate of return.

                                2. What if could get a 10.3% rate of return in a growth portfolio.

                                3. But look at components of return and note that most of the return at that level is in the growth portion.

                                4. If yield declines because portfolio is invested for growth, might be able to give current beneficiary (income beneficiary) the same return by making an adjustment from principle to income.

                                    • How do you allocate tax burden?

                                    i. Allocation of capital gains is a significant factor. Who bears the tax burden is a significant decision. With a unitrust regime you are locked in to whatever capital gains tax treatment the trustee elects in the first year of the trust.

                                    ii. In contrast with a power to adjust you can adjust to deal with this.

                                    iii. Consider how trust is invested. If the bond portfolio is tax exempt then the income is not taxable to the income beneficiary. If the bond portfolio is in taxable instruments the current beneficiary may have to bear this tax.

                                    iv. Huge impact over duration of trust from what might be small tweaks in this.

                                        • When you appoint a family member or friend as trustee, most individual trustees don't appreciate responsibilities and liabilities of being a trustee. Most individuals serve as trustee as a favor. There is a minefield of pitfalls.

                                        i. Stock concentration can be a problem.

                                        ii. Even if the trust instrument absolves her of responsibility from retaining a concentrated block of stock, case law has still held the trustee responsible (liable) even when the trust had permitted it.

                                        iii. Must document:

                                        1. Why the concentrated position is being held.

                                        2. Demonstrate that you are monitoring the stock.

                                        3. Language in the trust.

                                            • Consider the Astor case and Atkins case. Many issues plague use of individual trustees.
                                            • To minimize liability as a trustee the cases and law teaches us:

                                            i. Carefully examine the individual facts and circumstances of the trust, beneficiaries, etc.

                                            ii. Do not blindly rely on protection in the trust instrument.

                                            iii. Must maintain communication with beneficiaries.

                                            iv. Must carefully maintain records.

                                                • Investment Policy Statement ("IPS") - Greg Plechner, Greenbaum and Orecchio, Inc., Old Tappan, New Jersey.
                                                • From a fiduciary perspective a portfolio should be created that accomplishes the objectives which a trustee has.
                                                • What is the process to create an IPS?
                                                • Make certain that there is understanding of what the investment manager's role is and what methodologies will be used to accomplish those goals and this should be embodied in an IPS.
                                                • Old approach of paying out income and preserving principal has given way to total return in a more modern view.
                                                • As wealth increases clients often become risk adverse. Is this appropriate for a trustee? Cannot ignore the risk of inflation.
                                                • What is an IPS?

                                                i. Written document.

                                                ii. Prepared by the investment advisor or portfolio manager.

                                                iii. Describes goals and objectives for investment.

                                                iv. Client for a trust is the trustee.

                                                v. Purpose is to create transparency as to how assets of trust will be managed.

                                                    • IPS Contents.

                                                    i. Prepare financial plan, analyze cash flows, review insurance coverage, and create long term projections addressing client goals.

                                                    ii. End result of the process is a target rate of return necessary to accomplish goals.

                                                    iii. This is how you go from financial planning to investment management.

                                                    iv. Define the asset allocation model to achieve that target rate of return.

                                                    v. Establish management procedures to achieve this objective.

                                                    vi. Show communication of returns, and other matters pertaining to tax, performance and other management objectives.

                                                    vii. Time horizon - how long will this IPS be valid.

                                                    viii. Agreed upon components may include various matters.

                                                    ix. Which accounts will be managed. What is included and what is not.

                                                    x. Constraints and restrictions on account.

                                                    xi. Background data.

                                                    xii. Variance limits.

                                                    xiii. Signature of all parties to IPS.

                                                        • Review of Sample IPS.

                                                        i. Time horizon, plus extension.

                                                        ii. Accounts to be managed. Market value of account.

                                                        iii. Cash flow. What deposits are anticipated to come into the account. This information is used in re-balancing of portfolio. Risk is managed by re-balancing of portfolio. In rough terms, sell the winners and buy the losers in order to maintain balance.

                                                        iv. Withdrawals that are anticipated (cash out flows). Default cash position of say 1%.

                                                        v. Who is actually managing and directing investment philosophy and policy, e.g. the trust agreement.

                                                        vi. Fees. Expenses.

                                                        vii. Purchasing power rate of return.

                                                        1. Rate of risk must increase to get better rate of return. But if you can eliminate uncompensated risk you can achieve the same return with less risk and exposure. Diversification can often accomplish this.

                                                        2. Diversification use to be within an asset class, but modern portfolio theory stresses diversification across different asset classes.

                                                        3. Net return.

                                                        viii. Restrictions on portfolio design.

                                                        ix. Additional cash holdings to fund distributions.

                                                        x. Define and express range of methodologies available to come up with a target rate of return.

                                                        1. One is a risk free rate of return and layering different target rates of return on top of this based on different factors. What methodology is being used. Example, if you say bonds will get a 5% rate of return, what methodology is used to come up with this assumption.

                                                        2. Portfolio design is part of the IPS.

                                                        xi. Distinction between asset class investment (passive) and active management (ability of individual to outguess or outperform the capital market rate of return).

                                                        xii. Timing. When it will be implemented.

                                                        xiii. Re-balancing of the portfolio. This is a re-alignment of the target allocations from current back to the target allocations. Example: once per quarter? More frequently?

                                                        xiv. Understanding that a deviation from the target design could change risk and return parameters.

                                                            • Portfolio asset mix.

                                                            i. Some advisers use target portfolios, some use customized. Consider taxable versus tax free, risk tolerance, age and other factors.

                                                            ii. Quantify risk, e.g., standard deviation. This can guide and explain the different scenarios of downside risk, etc.

                                                            iii. In one of 20 years what is the worst downside you might experience with the particular investment mix.

                                                            iv. 100 year storm scenario - what is the worst case in 1, 2, 3 and 5 year scenarios.

                                                            v. All this can become part of the investment policy statement.

                                                                • IPS creates a mutual understanding between the owner (trustee) and manager (investment advisor, wealth manager, etc.).
                                                                • Trustees should have an investment policy statement to communicate ultimate goals.
                                                                • Insurance, Insurance Trusts, Insurance Reviews - Steven A. Fishman, Norwood Financial Group, LLC, Paramus, New Jersey.
                                                                • Report, background, of TOLI - "trust owned life insurance".
                                                                • TOLI is a popular estate, financial, asset protection, tax and other planning tool.
                                                                • Life insurance can be used to create cash where it did not previously exist and where and most importantly, when, needed.
                                                                • $15 Trillion dollars of trust owned life insurance in force in 1999.
                                                                • 40% reduction in premiums are common from review of policies that have been outstanding policies.
                                                                • There are a myriad of new policies and underwriting. Life insurance is often cheaper now than five years ago because of increasing longevity. Insurance companies understand health issues better than in the past and are more willing to underwrite policies for people with health issues that in past years would have been declined.
                                                                • Product design has become more sophisticated: no lapse universal life, etc. and etc.
                                                                • What do you need for a life insurance review:

                                                                i. Policy.

                                                                ii. Correspondence.

                                                                iii. Premium notices (some show dividends).

                                                                iv. In force illustration.

                                                                1. Should receive at the end of every policy anniversary.

                                                                2. Planned premium should be reflected. That is the amount of money the insured was getting billed.

                                                                3. Cash value.

                                                                a. Year prior.

                                                                b. Is it declining?

                                                                4. Cost of actual insurance.

                                                                a. If cost exceeds payment the differential may come out of cash value.

                                                                5. Forecast, if you pay planned premiums when the policy will expire.

                                                                    • Options.

                                                                    i. Continue policy.

                                                                    ii. Cash in policy.

                                                                    iii. Sell policy with a life settlement.

                                                                        • Policy audit.

                                                                        i. Not a proposal to buy life insurance.

                                                                        ii. Obtain an in-force ledger for the actual policy.

                                                                        iii. Payment projections.

                                                                        iv. Evaluate cash value.

                                                                        1. What is payment on cash value?

                                                                        2. If cash value goes up what happens to death benefit? Does it increase or stay the same?

                                                                        3. When does death benefit expire?

                                                                        4. How long is coverage guaranteed.

                                                                            • What if a premium is missed?

                                                                            i. To have a policy reinstated requires new underwriting.

                                                                                • Beneficiary claims.

                                                                                i. Beneficiaries have sued trustees on the basis that they did not shop insurance policies and premiums so that less coverage was obtained than could have been for the premiums paid.

                                                                                    • 1035 Exchange of one policy for another.
                                                                                    • Evaluate whether changing the policy or coverage will benefit the beneficiaries. What are the current goals?
                                                                                    • Evaluate benefits of sale of policy and compare that value to the cash value of the policy. Does the insured want the policy sold? Is that relevant to the beneficiaries or trustee?
                                                                                    • Income Tax Considerations of Trust Planning - An Overview - Donald Scheier, E.A., Withum Smith + Brown, Morristown, New Jersey.
                                                                                    • Death of trustee.

                                                                                    i. Accounting prepared.

                                                                                    ii. Formal accounting approved by court versus an informal accounting.

                                                                                        • What is situs of trust?

                                                                                        i. Which state income tax should be paid.

                                                                                        ii. If filed incorrectly, what if statute of limitation has run? May only be able to file for refunds for past 3 years.

                                                                                            • You cannot prepare a tax return without reviewing the trust document.

                                                                                            i. Don't simply rely on last year's income tax return. SALY (same as last year,) is not sufficient.

                                                                                            ii. You need to review the trust document to determine what you have to file for income tax purposes.

                                                                                                • Review applicable tax and related laws to ascertain what should be done.
                                                                                                • How do you determine what to charge?
                                                                                                • Summary sheet for a trust should be prepared.

                                                                                                i. Name of the trust. Sometimes the manner in which a tax return is filed may differ with name on SS-4 (EIN), or how it is known. Whatever the ID number was filed under should be what is on the income tax return.

                                                                                                ii. Name and addresses of trustees. This is important for situs issue, see below.

                                                                                                iii. Situs.

                                                                                                1. Where was the instrument written? Must state clearly.

                                                                                                2. What is the tax situs. This is not a simple question. The fact that a trust was written in New Jersey doesn't make it taxed in New Jersey. It is a New Jersey resident trust if set up by someone in New Jersey.

                                                                                                a. Key cases: Potter and Pennoyer. If you have a New Jersey grantor and name a New York trustee and a New Jersey person is the beneficiary, this is not a New Jersey taxable trust.

                                                                                                b. Original cases did not make the residency of the beneficiaries a factor, but it is the domicile of the trustee that is determinative currently.

                                                                                                c. The above assumes no source income in New Jersey.

                                                                                                i. Income earned from a business or from real or tangible property located in New Jersey.

                                                                                                d. See instructions on NJ-1041.

                                                                                                3. New York Trust.

                                                                                                a. Section 605.

                                                                                                b. If no New York source income and no trustees in New York, even if set up by New York resident and a New York resident trust it is not a New York taxable trust.

                                                                                                4. If done wrong consider filing amended income tax returns with the state but the statute of limitations may affect the ability to get it.

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