Importance of Trustee Selection in Charitable Planning

Importance of Trustee Selection in Charitable Planning

What advisors need to understand about CRTs, CLTs and fiduciary responsibility
Article posted in Ethics, Charitable Remainder Trust, Practice on 11 April 2014| comments
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By Randy Fox and Daniel Felix

The creation of an estate plan is a fundamental necessity for families, especially for families of wealth. And while there are many elements that contribute to the ultimate success of the plan, the selection of the appropriate trustee is often given little consideration. Often, a relative or one or all of the children are the default selection(s), with scant attention paid to the long-term consequences or potential conflicts that those selections entail. While families’ assets may survive less-than-ideal trustee selections, many would prefer for their families to thrive rather than merely survive. When families add a philanthropic component to their planning, as many do, the need is critical for a competent trustee who is aware of the complexities and nuances of various charitable planning vehicles.

In the trust environment, the role of “fiduciary” refers to a legal or ethical relationship of trust between two or more parties. The fiduciary can be an individual, a corporate trust company or the trust department of a bank. In such a relationship, good conscience requires the fiduciary to act at all times for the sole benefit and interest of those who trust it.

This definition may clarify the general philosophy that is foundational for the fiduciary in the family trust environment, but it doesn’t automatically translate into the applied practical wisdom to deal with the range of decisions necessary to successfully manage a trust. Further, the charitable trust setting is even more complicated. Several of the typical structures for charitable trusts employ two different classes of beneficiaries. These beneficiary classes occupy positions that are in direct opposition to each other. How is a trustee to confront this issue fairly? By looking at two of the most often used charitable trusts—CRTs and CLTs—you can identify several of the issues a trustee will face as a fiduciary for each type of trust. You’ll also see why it’s essential that the trustee have the expertise and skills reasonably necessary to guide the trust to the best possible result for all concerned.

1. Charitable Remainder Trust (CRT). According to the IRS, there are 109,000 CRTs in force in the United States. The CRT is a “split interest” trust formed under the rules of §664 of the Internal Revenue Code. Generally, CRTs are established during the lifetime of the grantor(s), often a husband and wife. The CRT pays income to the grantors while they are alive; whatever is left at the death of the last of them, the remainder interest passes to charity. Thus, the term split interest: income to one set of beneficiaries, remainder to an entirely different class of beneficiary. There are many rules governing the establishment, contribution to, receipt of income from and tax implications of CRTs. This is the point at which it should become clear that the selection of the proper fiduciary to balance the demands of the income recipients to assure their income and the desire of the charity for the largest amount of corpus (capital) possible. In this circumstance, the trustee must be prepared to serve two very different sets of needs.

Many elements go into the structure and design of a CRT, and all of them have an impact on how it must be managed. These elements include the designation of the following:

  • The payout percent (no less than 5 percent)
  • The assets contributed
  • If and when those assets are sold
  • How assets are invested
  • Which jurisdiction the trust is established in (state law is determinative)
  • The various details on how the trust is to be administered

Each of these elements has consequences. In most cases, the grantor(s) of the CRT become the trustee(s) of their own trust. While it may not be the best strategy, it’s often the most expedient. Are the grantors really the ones best equipped to handle these tasks?

As an alternative, charities have offered to establish, administer and invest CRT assets as long as they were irrevocably named the beneficiary—or at least the majority beneficiary—of the CRT. This strategy created its own set of conflicts and frequently resulted in discord. The conflict of interest should be apparent. Is it possible for a charity to look out for the best interests of the donors’ need for income and their own desire for capital at the same time?

2. Charitable Lead Trust (CLT). The second charitable trust to consider is the CLT. While the CRT leaves its balance to charity, the CLT does the opposite, paying income to charity during its term and leaving the balance to heirs. CLTs are far less common than CRTs—there are over 6,000 in existence currently—but the CLT has become a popular technique for eliminating estate taxes and delaying inheritances in recent years. Thus, many CLTs may have been created but not yet become active. While the CLT is not the mirror image of the CRT for many technical reasons, it does reverse the trustee’s challenge: income must go to charity and principal to heirs. Despite this reversal, the same conflicts arise, in that there are two distinct purposes and those purposes present an inherent opposition. Both require a trustee to have the wisdom of Solomon and/or a trust document that establishes the balance that the trustee is to strike. In fact, Solomon would be well assisted if the trust were to provide some useful detail.

Choosing the right trustee

It is doubtful that the proper trustee for either of these trusts should be a family member. Very few families have members who are equipped with the knowledge, training or emotional capacity to undertake either of these roles. In the context of a blended family, selecting a family member is typically an invitation to disaster, especially after the glue holding them together has loosened with the passing of the senior generation.

As discussed earlier, a charity is ill-equipped for either of these roles for different reasons. Many would infer that the only remaining choices are either a commercial trust company or an attorney. However, there is an additional option: a professional, independent trustee. Let’s look at each option below:

1. Commercial trust company. While there is value in using a commercial trust company, mostly for the presumed (but not guaranteed) quality of institutional continuity and stability, continuity and stability have a negative value when the services are inferior. Further, there are many drawbacks to the commercial trust company. Expense is one—and when it isn’t, service also suffers. Lack of independence is another drawback, due to bundling of asset management. Further, high employee turnover makes impossible the more important quality of personal continuity. Finally, despite glory days in the past, few corporate fiduciaries are trained or encouraged to spend the time to generate wise solutions for beneficiaries. Rather, the unfortunate focus is on overprotection of their own liability exposure. Granite columns may look impressive, but they cost a lot of money—and that money had to come from somewhere.

2. Attorney. And while the attorney might be worthy of consideration, most are too busy practicing their craft to spend the time and effort necessary to be an entirely conscientious trustee. Fewer still have devoted the time and expertise required to develop the very different skill set necessary to administer a trust on an ongoing basis.

3. The independent professional trustee. In contrast, comes equipped with a diplomatic skill set, including good communication and mediation capabilities. He or she is also trained to connect the parties to the higher purpose, that is, the win-win scenario of successfully serving both the family and the charity.

Conclusion

Not being a magician, the independent trustee can’t transform unreasonable heirs or charities. Of course, reasonable grantors should take the character of the other parties into account before setting up any trust. Imagine, then, that someone independent, trained and knowledgeable could serve in a true fiduciary capacity for the CRT or CLT created by the family. If that trustee truly understood the family’s personal goals as well as their charitable goals, and could monitor them as they went through various cycles and changes, the family and the charity could have an ideal outcome.

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