Income and Remainder Beneficiaries of a Trust
You may become the trustee of a trust that has become irrevocable on the death of the friend of yours who created it. This particular trust provides that your friend’s mother gets the income for her life and that at the mother’s death the entire trust (the remainder) passes to your friend’s son. As trustee, you owe duties to both the mother and to the son. You cannot rely on the specific investments that your friend had previously made. You cannot say say that if these investments were good enough for your friend, they will be good enough for his mother and his son. Your job is to evaluate the appropriateness of these investments and to make investment decisions in light of the new situation.
The mother may prefer you invest in assets that yield a high income. The son may prefer you invest in assets that are very safe, but such assets typically yield much less income. In many trusts, capital appreciation is defined as principal rather than as income. This means that even if assets appreciate in value (ie. stock goes up from $7 per share to $19 per share after your friend’s death)and even if the stock is then sold, the capital gain is not considered income and it does not get distributed to the mother.
The son would like you as trustee to invest in stock because the dividends, which are income and which do get distributed to the mother as the income beneficiary, are typically less than the interest paid on bonds, and because the capital growth in the stock doesn’t get paid to the mother. The mother may want you as trustee to invest in bonds to increase her income, but the principal which goes to the son on the mother’s death will not grow if the only trust investment is in bonds.
Your job as trustee is to balance the different interests of the son and of the mother. First, you need to see if the trust has any specific instructions about investing. Then you need to develop an investment policy statement, with the help of your advisors. Then you need to interview investment advisors to ask them how they propose to assist you in establishing and maintaining this investment policy and you need to understand how they will go about recommending the specific investments. You need to evaluate the qualifications and background of these advisors. One critical element in investing is diversifying the portfolio to minimize risk, so the proposal of each potential advisor needs to detail his or her philosophy on how to implement and maintain a diversified portfolio.
Once the investment advisor or advisors are hired, your job as trustee is to monitor their performance and their adherence to the investment policy. Periodically, you need to meet these advisors and discuss with them whether the policy is producing the intended results and whether the policy should be changed in light of the current situation.
If the trust gave you as trustee discretion to make payments for the needs of the mother and/or the son (it does not in this hypothetical) you need to set up a method for evaluating what those needs are and for evaluating the appropriateness of specific expenditures. A beneficiary can ride the bus or he can lease a car or he can buy an inexpensive car or he can buy an expensive car. Your job as trustee is to consider various options in light of the goals of the trust. The beneficiary may want to spend more now, but your job is to determine the impact of current spending on the ability to take care of the beneficiary when he gets older and on the inheritance that will ultimately be distributed to others when that beneficiary dies.
Many trustees fail to keep records on how they deliberated in making decisions or about what options they considered or about the effect of different options on different beneficiaries. Many beneficiaries fail to show that they balanced the needs of income beneficiaries (such as the mother) against the needs of remainder beneficiaries (such as the son). In this case, this balancing will help the trustee determine what percentage of the portfolio is invested in stocks and what percentage of the portfolio is invested in bonds.
It is no picnic being a trustee. Most trustees do not realize this. A trustee may not wish to develop a formal plan to help him or her to make prudent decisions. A trustee may not wish to document how decisions were made. But if that is the case, it would be better for that trustee to decline to act and to allow the next trustee in line to take the job instead. If a trustee stubbornly moves forward to manage the assets any old way, he or she should not be surprised if some or all of the beneficiaries later attempt to hold the trustee accountable for losses or other damage to the interests of the beneficiaries stemming from (alleged) breaches of duty by the trustee.