Trusts: A Few Basic Principles
People often hear about trusts, but don’t really know how they work. Below, we explain some basic principles.
The classic express trust set up
A trust is a relationship based upon an agreement. There are basically three main positions in a trust set up: the “grantor”, who is the person who creates the trust and puts an asset into the trust; the “trustee”, who is the person who holds title to the asset and actually carries out the trust; and the “beneficiary”, who is the person for whom the trust is set up.
A trust is, therefore, essentially a way to hold on to an asset where the title to the asset is held in one person’s name (i.e., the trustee’s name) for the benefit of another person (i.e., the beneficiary).
The trustee occupies a “fiduciary” role with respect to the beneficiaries of the trust — both the current beneficiaries and any “remaindermen” who would receive trust assets upon the death of those entitled to income or principal now. As a fiduciary, the trustee is held to a very high standard, including a duty of honesty, a duty to work scrupulously for the best interests of the beneficiaries, and to avoid conflicts of interest and self-dealing — needless to say, in general this means that the trustee must must pay even more attention to the trust investments and disbursements than he or she would for the trustee’s own personal accounts.
The trustee is generally considered held to a standard called the “prudent investor rule”. This is usually said to mean taking steps to obtain a reasonable return on the investment while making sure to preserve the principal. Investments, therefore, must be prudent or relatively conservative, meaning that the trust assets cannot be placed in speculative or risky investments. In addition, investments must take into account the interests of both current and future beneficiaries.
The trustee must keep detailed and accurate records tracking all of the investments, the income generated and paid, distributions made, and expenditures by the trust. Generally, the trustee must give an account of this information to the beneficiaries at some regular intervals.
While the trustee cannot, strictly speaking, delegate his or her responsibility or decision-making as trustee, the trustee’s functions can be delegated to professionals to render advice and assist with the tasks required. For example, the trustee can hire financial advisors to make investments, accountants to handle taxes and bookkeeping for the trust, and lawyers to advise on legal issues and questions of interpretation.
Trustees are entitled to reasonable fees for their services. For example, New York law provides for statutory commissions for serving as trustee(1). Family members often do not accept fees, although that can depend on the work involved in a particular case, the relationship of the family member, and whether the family member trustee has been chosen due to his or her professional expertise.
The beneficiary can have virtually all the benefits of the enjoyment of the asset — the right to live in a home, the right to receive its income, etc. — without actually having the asset in the beneficiary’s own name. This is very beneficial where the beneficiary is a minor, or is a person who needs to protect the asset from creditors. On the other hand, the beneficiary does not actually own the asset, and cannot impose his wishes on how or when the asset is to be used, invested, or sold. The trustee, by contrast, exercises a lot of control over the asset, and therefore must be a person in whom the creator of the trust has a great deal of confidence.
Different kinds of trusts
There are inter vivos trusts (or living trusts), which take effect while the grantor is alive. These can be revocable (meaning that they can be changed or terminated at any time) or irrevocable (meaning that, generally speaking, they cannot). There are also testamentary trusts that are included in a Will, which take effect after death.
A classic trust set up is where title is held in the name of a parent or other adult for the benefit of a minor child. It is in this example that we can readily see both the benefits and disadvantages of trust ownership. A trust can also be used to avoid probate, to manage various assets, or to allow a beneficiary to receive government benefits even when he or she has received assets that passed into a trust. A constructive trust can even be imposed by a court where it is clear that one person is acting like a trustee and holding title for the benefit of another, where an unfair outcome would otherwise result.
A trust can be a very useful and versatile tool. It can protect minors and other vulnerable people, avoid probate, and save taxes. A trust can even be imposed where appropriate to promote fairness and enforce an oral promise.
Disclaimer: This article is based on NY law and is for general information; it is not legal, tax, or financial advice. Because the complexities and nuances of trusts and estate planning are vast, you must consult a lawyer well versed in these areas of the law to discuss your particular situation.
(1) See New York Surrogate’s Court Practice Act (“SCPA”) § 2309.