By
The Law Offices of Jerold E. Rothkoff
Setting up and administering a trust is a five-step process:
1. Creation
2. Tax Recognition
3. Funding
4. Administration
5. Distributions
The steps in creating a trust are:
2. Identifying an appropriate trustee. A Trustee is the person who holds, invests, manages, and distributes the money for the “Beneficiary” (“Beneficiary” = the person for whom the trust is established).
3. Drafting the trust to meet any specifics for the trust that the law requires, to avoid the trust assets being counted as a resource to the trust beneficiary.
4. If a court must establish the trust, petitioning the court for an appropriate order “establishing” the trust.
Trust funds are invested under a federal employees identification number (a tax ID number). The trust is or could be a taxpaying entity. In practice, however, any income the trust earns will be distributed to the beneficiary, who would pay the taxes on the income earned. The trust would file a federal income tax return, but usually would not have to pay any income taxes.Once the trust has been created, a tax ID number is obtained from the Internal Revenue Service. The easiest way to get one is by going online to the IRS’ Web site (www.irs.gov) and filling out an application.
Needless to say, if there is no money, there is nothing to manage or distribute. After the trust has been created, the trust is funded. All this means for most trustees is that they go to the bank or brokerage company with a copy of the trust agreement and the federal tax ID number and open up an account in the name of the trust. Instead of a social security number, the tax ID number is used.
The trustee is a fiduciary. A fiduciary is someone who acts solely for the benefit of trust beneficiaries. Unless the trust agreement says otherwise, local law limits the kinds of investments that a trustee may make. It is wise for a trustee to discuss trust investments with an investment adviser to help the trustee determine what investments of the trust assets should be made that further the intent of the trust.
A fiduciary is as any person who:
· Exercises any discretionary control or authority over the management of the trust or the disposition of its assets;
· Offers investment advice regarding plan assets and derives compensation for it, either direct or indirect; or
· Has any discretionary authority or responsibility regarding trust administration.
The fiduciaries involved in a trust are therefore at least these persons: the trustee, the trust administrator, and the investment adviser.
I divide the duties of a fiduciary into two functions: back-end duties and front-end services. The fiduciary’s back-end services can themselves be split into two functions: trust administration and investment management. Both relate to the establishment, monitoring, and daily management of a trust fund. (Front-end services pertain to distributions for the beneficiary’s special needs, the trustee’s role that will be considered in the next section.)
A fiduciary’s responsibilities as administrator of the trust are as follows:
· Open the trust account in accordance with a written trust agreement;
· Operate the trust in accordance with the trust document and other operating procedures;
· Operate the trust solely in the best interests of the trust beneficiary; and
· Ensure that the trust remains in compliance with all legal and regulatory requirements.
For large trusts, most trustees work with a recordkeeper, service provider, or consultant to ensure that these administrative duties are properly handled. It is also the fiduciary’s responsibility to select the service provider and to monitor the service provider’s performance to ensure that the trust is being administered correctly. For small “family” trusts, the trustee may do most or all of this work.
The responsibilities for a fiduciary acting in an investment management capacity include the following:
· Establish policy outlining how investment decisions are to be made and monitored;
· Ensure diversification of assets in accordance with risk and reward objectives;
· Monitor trust investment options to ensure that established objectives are met;
· Utilize prudent experts to make investment decisions;
· Control and account for all investment expenses;
· Monitor money manager and service provider activities; and
· Avoid conflicts of interest.
The trustee should monitor investments closely. Look for a financial services firm that not only can relieve the burdens of recordkeeping, compliance, and administration, but one that can assist with investment advisory services too. Choose an investment adviser who understands the conservative approach that must be taken toward the trust funds. Document the file as to the investment advice given to the trustee.
The Foundation for Fiduciary Studies has made available for free download a handbook on prudent investment practices. The primary purpose of the Fiduciary Handbook - Prudent Investment Practices is to outline uniform fiduciary standards of care and practices that are intended to define a prudent investment process. The handbook covers 27 practices culled from federal and state legislation, regulatory opinion letters, and relevant case law. The handbook states: “Fiduciary liability is not determined by investment performance, but rather on whether prudent investment practices were followed. It’s not whether you win or lose, it’s how you play the game.”[2]
Establish a regular schedule for accounting to the beneficiary or the beneficiary’s representative of investments and distributions from the trust sub-account.
Trustees must have a thorough understanding of their own fiduciary responsibility—and potential liability. It is not a privilege or an honor to be a trustee, it is a job.
Front-end services are those that the beneficiary and the beneficiary’s representative see when they interact with the trust. Although much of this is social service-type work, it nonetheless requires an exercise by the trustee of its fiduciary obligation on behalf of the beneficiary. Distributions to the beneficiary that are disqualifying may render the trustee liable to the beneficiary for a loss or diminution of public benefits.
The trustee will be entering into a potentially long-term relationship with the beneficiary. From time-to-time, this is likely to be contentious, because a beneficiary and his or her representative often do not understand the constraints under which trusts operate.
Some trust beneficiaries receive public benefits such as Medicaid or Supplemental Security Income. For these beneficiaries, care should be taken to make sure that distributions from the
trust do not result in a reduction or elimination of these public benefits. In most instances, distributions for the beneficiary’s “special needs” are OK.
What are special needs? These may be defined with some specificity in the trust document itself, or, for instance, would include:
· Out-of-pocket medical and dental expenses
· Eyeglasses
· Annual independent check-ups
· Transportation (including vehicle purchase) and maintenance of vehicles
· Insurance (including payment of premiums)
· Rehabilitation
· Essential dietary needs
· Materials for a hobby or recreation activity, computer or electronic equipment
· Trips or vacations
· Entertainment like going to a movie, a ballgame, concert, etc.
· Goods and services that add pleasure and quality to life: videos, furniture, television, stereo, or entertainment center
· Personal care attendant, escort, or nursing home resident advocate
The trustee should never give cash directly to the beneficiary.
Occasionally, the trustee will be requested by the beneficiary or his representative for permission to use trust funds to make gifts on behalf of the beneficiary. These gifts are not special needs solely for the benefit of the beneficiary, and such requests should be refused.
When a trust is created for the benefit of a person who is disabled or has special needs, the trustee should initiate an investigation into the nature of the beneficiary’s disability. This should include a review of an existing care plan, if available, and perhaps the development of an individualized care plan. The care plan will be used by the trustee as a guide when making distributions to or on behalf of the beneficiary.
The trustee should consider hiring a geriatric care manager to assist the trustee in ensuring that distributions will meet the beneficiary’s goals and objectives, that such distributions are made solely for the benefit of the beneficiary, and that such distributions are made for special needs only (that is, distributions that will not disqualify the beneficiary from any public benefits program that the beneficiary is receiving benefits from such as Medicaid). Care manager involvement also can help identify needs that are not currently identified or that have arisen because of changes in the beneficiary’s circumstances.
[1] Note: This document is meant for the clients of The Law Offices of Jerold E. Rothkoff. Before acting on any information presented here, you are strongly urged to consult with an attorney who is competent in this area of the law.
[2] Foundation for Fiduciary Studies, http://www.ffstudies.org/checklist.pdf (May 2003).