Now that you’ve decided to establish a trust to preserve your family’s legacy, there are many important decisions to make. For example, will you manage the trust assets yourselves or hire an investment advisor? Will you serve as trustee or bring in a corporate trustee to oversee things? And if you select a third-party trustee, will you use a “directed” or “delegated” trust format?
Before we get into the details, you might find it helpful to review the roles involved in trust creation and administration. So we have put together the glossary at the bottom to help you keep track of all parties. Click here to be taken to the section entitled “Who’s who in a trust?”
Briefly, a directed trust allows someone besides the trustee to direct investments, manager hire/fire decisions, and distributions. Thus, trustees of directed trusts face a lower burden of liability because they just carry out the wishes of whomever the trust document appoints. You might select a directed trust when you wish to continue to oversee investments and distributions while leaving the day-to-day trust administration to a third party.
In addition, some families form “distribution committees” made up of professionals and family members so that they can corporately approve distributions and more effectively enforce trust restrictions (see our article on incentive trusts). After all, families generally have the best insights into how beneficiaries are living and can provide the most nuanced instructions.
Finally, some trust companies either require or highly recommend directed trusts in order to limit their own investment responsibility and liability. A trustee is always a fiduciary by law, and directed trusts provide some relief except in cases of extreme negligence or willful mismanagement. You may also want that protection for a family member trustee.
By contrast, a delegated trust gives more power, but also more liability, to the trustee. The trustee is responsible for selecting the investment advisor after performing its own due diligence, overseeing the investments that advisor has selected, and managing distributions according to the trust document. Grantors tend to prefer delegated trusts when they genuinely need help managing assets or hiring/firing professionals and do not mind the additional costs such services involve.
As in directed trusts, trustees in delegated trusts face liability as fiduciaries; however, the burden can be much greater, including liability for poor investment decisions (especially when the trust assets fall under ERISA protections). You can see why a trust company will often shy away from delegated trusts or require strict adherence to strict “prudent investor” rules and thus may not be able to vary from rigid investment models and selections approved by the parent company.
Separating trust administration from investment management
Note that both directed and delegated trusts separate investment management from trust administration. We find that separating these two functions allows you greater freedom in choosing an investment advisor, while preserving the ability to use the trust company with the best fees, domicile, and services.
We are not a law firm and must direct you to your estate attorney for questions specific to your trust document and your state’s laws. Each state will have different rules about using directed trusts and delegated trusts. However, you should know that if you would like to switch from a delegated trust to a directed trust, or vice-versa, it may be possible to re-form the trust and change the domicile of your trust at the same time.
South Dakota offers very trust-friendly laws and is the state we generally prefer for new trusts (and no, you don’t have to reside there). You can read about the benefits of forming your trust in South Dakota in our blog post.
Which trust company should I choose?
Alpha Fiduciary would like to help you determine your need for a trust as well as the kind of trust company you should consider. We have relationships with more than one trust company that can provide trust administration while allowing you to use the investment manager of your choice.
As a fiduciary investment advisor, we are also comfortable developing an investment policy in cooperation with your trustee and managing the assets in line with trust goals.
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Who’s who in a trust?
Grantor(s). These are the people with the assets that go into the trust. They may serve as trustees, as well, and they may self-manage the assets. Or, they can hire those duties out and pay for them with money from the trust. If they establish a “revocable trust,” it can be updated at any time. But an “irrevocable trust” cannot be changed once drafted and made effective. Funds in an irrevocable trust cannot be taken back by the grantors.
Trustee(s). This can be an individual such as the grantor, a family member, a professional like a CPA or attorney, or a trust company. There may be multiple trustees at one time. A trustee has a general responsibility to carry out the terms of the trust, including hiring any services providers needed. The trustee always has a personal fiduciary liability to the trust, but trust terms (e.g., directed trust) can help mitigate some of the risk. The trust document names the trustee(s).
Successor trustee(s): If the first trustee dies, resigns, or is removed for another reason, the trust document can also name a successor trustee. Sometimes a trust company is chosen as successor so that the trust will continue to be administered by a corporate trustee rather than fall into the hands of feuding family members. There can be more than one successor trustee named in the trust document.
Estate attorney. This is the legal professional who writes the trust document to reflect the grantors’ wishes. The attorney also continues to review the document regularly with the grantors, but is not generally required to be involved in the trust management process unless named as trustee. In general, using an attorney as trustee is not ideal, as attorneys cost a lot of money, and most trust activities can be handled by administrative personnel.
Trust company. This is a financial institution that holds assets in custody, performs trust accounting, provides statements, and processes distributions in line with trust specifications. The trustee can be an employee of the trust company. Many trust companies include asset management divisions, but we feel that separating those functions makes the most sense and provides the best experience for beneficiaries.
Investment advisor. This is the professional who chooses investments for the trust, makes trades, and reports performance. The investment advisor may draft an investment policy statement in cooperation with the trustees and works under the oversight of the trustee. The trustee can hire or fire the investment advisor, and the trust can also name the investment advisor that future generations are to use.
Beneficiaries. The persons or entities receiving distributions from the trust. They generally have no involvement except to receive assets, though they may have to fulfill obligations prior to receiving money (see our article about “incentive trusts”).