When you, or your client, agree to become the trustee of a trust, you will immediately take on several risks, not only to yourself, but also to the beneficiaries and the trust itself. Even trustees with experience in world of trust administration can be faced with stormy seas that are not easy to navigate.
Being aware of and prepared for these scenarios can make the role of trustee a smoother experience for everyone involved.
Blended-families and multiple marriages
A common example of such risks is the existence of blended families or a Settlor who had multiple marriages. This fact pattern often presents the trustee with complicated distribution decisions, which place the trustee in a “damned if I do, damned if I don’t” conundrum.
Should the trustee make a distribution to the settlor’s surviving second spouse? What if such a distribution angers the adult children from the settlor’s first marriage? Will such a distribution lead to lawsuits being filed by the adult children from the first marriage? After all, the surviving spouse wasn’t their parent … On the other hand, if the trustee does not make a distribution to the surviving spouse, will the surviving spouse file suit?
Even if the trustee is making the correct distributions in accordance with the terms of the trust and any such lawsuits might prove to be without merit, the trustee individually and the trust itself can still be left with a healthy tab of attorney fees and court costs to pay out of pocket or from trust funds. Such a scenario was likely not envisioned by the trustee or the settlor of the trust, but unfortunately is an all-too-common occurrence.
Another common risk faced by trustees occurs when the trustee happens to also be a beneficiary of the trust. Perhaps the eldest child of five siblings is named the trustee, because that eldest child is a lawyer. Maybe the other four children don’t like the oldest sibling because he is a “know it all” and talks down to them. Thus, when that trustee makes distributions to himself, even if such distributions are legitimate, the other beneficiaries may become suspicious.
Alternatively, the trustee may have to defend the trust in a lawsuit brought by outside third parties, which could lead to other beneficiaries to believe he is making distributions that are too many or too large than might be necessary to fund the defense.
These common scenarios make it a “no brainer” for the trustee to purchase trust insurance to protect not only the trustee individually, but to protect the funds in the trust from being severely diluted.
Prior accounting mistakes
What if your best friend, who has been seriously ill for some time, asks you to be the trustee of her trust because she doesn’t “trust” anyone else to do the job? You might say, “Sure, no problem,” but then discover that while the trust is well-funded, the prior trustee made some errors.
Perhaps they treated trust principal and trust income the same and never used the separate accounting and tax treatment methods that must be employed for both principal, and income, respectively. Indeed, this is a complex area, but litigation and severe tax consequences will be forthcoming if the principal and interest generated by the trust are not dealt with separately and appropriately.
There is also the issue of unwritten trusts. Imagine if your grandfather and your uncle had a long-standing oral agreement, dating back decades, as to how your grandfather’s wealth was to be managed and distributed. However, your uncle unexpectedly passed away and now you’ve become the trustee.
In this case, the intent and parameters of the trust may be unclear and difficult to navigate for you, the new trustee. It’s very possible that, depending upon the facts and the law in your jurisdiction, you may have a “constructive,” “resulting,” or “equitable” trust on your hands and you may not know what to do.
Finally, what happens when you take over as trustee of an existing trust, maybe to help out a friend or family member, and you discover that tax returns have not been filed for several years or perhaps there is a long-running tax dispute or litigation with the IRS?
In such a situation, which happens more often than you would believe, obviously it’s important to file the missing tax returns as soon as possible to avoid or reduce interest, penalties, and potential liability. Moreover, the retention of experienced tax litigation counsel may be necessary to fulfill your fiduciary duty to the trust and its Beneficiaries.
These are but a few of the pitfalls that can swallow a trustee whole without leaving a trace. Trust administration quite often can be a minefield of malpractice for the unsuspecting trustee. However, trustees who educate themselves and take the proper precautions not only protect themselves, but also provide a valuable service for the grantor and beneficiaries.
William C. Waller Jr., Esq., practiced law for more than 40 years in the Denver area and retired as a partner in the Denver office of Ryley, Carlock & Applewhite. He tried countless cases involving contested wills, trust and estate administration, and income and estate taxes. Dennis Channer, CPA, CFP, AEP, a managing principal at Denver-based Cornerstone Investment Advisors, has over 40 years of experience in financial planning and trust management. In 2020, Dennis and Bill co-founded The Private Trust Consortium, a membership organization dedicated exclusively to providing trustees with education and tools to successfully manage trusts. To learn more about becoming a member and the services of The Private Trust Consortium, click here.