October 2010 issue HOW TO SELECT TRUSTEES As trusts grow more popular, the need to appoint the right trustees becomes crucial. By Ben Mattlin In recent years, trusts have become a popular financial planning tool. Whether they are for wealth transfers, estate planning, creditor protection or other purposes, they “are almost required these days,” says Kevin Mooney, a financial advisor at Jagen Investments in Henderson, Nev. Yet trusts can only be as successful as the trustees who manage them. So picking the right trustees is crucial. That’s not always easy. “A lot of clients may understand their own business models but not the complexities of trusts,” observes David Kleinhandler, a wealth advisor at New York-based DKA. Choosing Family And Friends To help clients choose trustees, it’s important to zero in on trust particulars. If the trust is designed mainly to transfer assets to children or grandchildren, a relative or close family friend would seem a logical choice. But, “This can become an uncomfortable discussion, involving all kinds of family dynamics,” says Lenore “Elle” Hawkins, a director at Creekside Partners, an investment advisor in La Jolla, Calif. “It’s not a black-and-white situation,” says Jeff Fishman, a financial advisor and attorney at JSF Financial in Los Angeles. “If small kids are involved, [a client should] choose someone familiar with the immediate family. That’s the least unsettling option—someone who will try to maintain the kids’ lifestyle. It should not be the same person who takes care of them, though, since there could be a conflict of interest.” If the trust consists primarily of real estate, family businesses or other assets that require ongoing, active maintenance, a family member or close relative probably makes the most sense, too. “Most corporate fiduciaries won’t even want to serve these situations, because of the expenses and liability issues,” says Robert Struble, a lawyer at Meyer, Unkovic & Scott in Pittsburgh. Whoever assumes the trusteeship must also be good with financial matters. “You need to focus on the skills necessary to be a good trustee, not just personalities,” advises Lawrence Richman, an attorney at Neal, Gerber & Eisenberg in Chicago. Family Trustee Shortcomings Selecting a close family member doesn’t guarantee smooth sailing. “Where people make mistakes is in choosing someone they trust who happens to be incapable of fulfilling the requirements of a trustee,” says Michael Kay, a financial planner at Financial Focus in Livingston, N.J. Even if they’re not incapable, relatives might be a little too close to the family and all its issues to be objective. “The good things they bring to the table are knowledge of the family history and circumstances. The bad are the biases, unsettled feuds and prickly emotions,” says John Brennan, an attorney and financial planner at Cape Ann Savings Trust and Financial Services in Gloucester, Mass. The problems can get so bad they poison family relationships. “Thanksgiving dinner will never be the same again,” says Jay Eisenberg, an attorney at Potomac, Md.-based Shulman, Rogers, Gandal, Pordy & Ecker. Being a trustee shouldn’t be taken lightly. “It’s a job, not an honor,” says Richman, the attorney in Chicago. “There’s real work involved.” That’s why trustees—even if they are family—should be compensated. Fishman, the Los Angeles attorney, suggests paying them annually 1% of the value of the assets, at a minimum. “It’s a huge responsibility that takes a lot of time,” he insists. The Benefits Of Professional Trustees For larger, more complex trusts, an institutional trustee may be a better choice. It could be a bank, an independent trust company, a financial advisor or some other objective professional. “I’ve even seen trusts name an investment manager from one institution and a trust officer from another” to avoid competing interests within the same institution, says Laurel Alberty, president of Alberty Financial Planning Services in Atlanta. Institutional trustees also boast expertise and bigger resources. “A corporate trustee represents an entity which has longevity, is unlikely to take sides in family conflicts, can spend whatever time is required on managing the trust, and has investment and money-management skills that a family member may not have,” says Elaine King, a vice president at Gibraltar Private Bank & Trust in Coral Gables, Fla. Professional Trustee Negatives Yet corporate fiduciaries have a down side. For one thing, they’re not familiar with your client or your client’s family. If a beneficiary asks for an extra distribution, the trustee might not know the beneficiary has a history of gambling, for example. Trusts “dictate when and how distributions should be made,” explains Shawn Barberis, an attorney at Lincoln Financial Securities Corp. in Towson, Md. But most “allow trustees to invade principal for beneficiaries’ health, maintenance, education and support.” On the other hand, legitimate needs could be ignored, too. “Particularly if you’re dealing with a large institution, it may not be responsive,” says John Cornish, an attorney at Choate Hall & Stewart in Boston. “Beneficiary requests might have to go through a committee,” he says—with only an impersonal 800 number to call in an emergency. Another thing is that professional trustees can be more expensive. They customarily earn a percentage of the value of the assets plus fees for extra services. The additional cost, however, may be worth it. “Non-professional trustees should hire experts for investment strategy, accounting, tax filing and so forth, if they’re doing their job properly—and those expenses come out of the trust,” asserts Eisenberg, the Potomac, Md., attorney. The Best Of Both Worlds Since both a family member and a professional trustee can come with advantages and disadvantages, many grantors choose one of each to serve as co-trustees. “Co-trustees can have different responsibilities, and there isn’t typically an added expense,” explains Mark McLennon, a vice president at Northwestern Mutual Life Insurance Co. in Milwaukee, Wis. Sometimes the institutional co-trustee is based in another state so the clients can take advantage of favorable tax and trust laws. Delaware, for example, is a popular location for trusts. The other co-trustee could then be someone closer to home. How To Choose Potential trustees should be screened carefully, whether they are friends or professionals. Referrals from attorneys, accountants and the like are a must. Clients should “interview candidates about how they would handle certain trust matters, their experience and qualifications, their fees and staff resources,” suggests Gregory Dubnansky, a wealth advisor at the Provident Bank in Jersey City, N.J. Generally, trust attorneys shouldn’t be considered for trusteeships if they’re also creating your trust documents. But CPAs, financial advisors and others familiar with the grantor’s finances are fair game. The trustee decision shouldn’t be etched in stone, either. After all, things change. “You might allow people to automatically become a trustee or co-trustee when they attain a certain age, or remove them when they become too old,” says Richman, the Chicago attorney. Similarly, if a trust designates a relative by marriage, the designation could be revoked if there is a divorce. “It would be unusual not to provide what we call back-stop trustees,” says Terence Nunan, a lawyer at Rutter Hobbs & Davidoff in Los Angeles. “So if your brother isn’t available, for example, number two would be X and number three Y.” Trustee Succession If a trustee doesn’t match expectations, the grantor can pick someone new. Or that right can be ceded to someone else, such as a spouse. “It’s fairly common for trustees to select their own successors,” says Nunan. But problems arise if a trustee tries to sell the position to the highest bidder. An alternative is to give that power to some or all of the beneficiaries. “This can be problematic, however, if a beneficiary abuses the authority by threatening a trustee with removal if he or she doesn’t grant a requested distribution,” says Paul McCawley, an attorney at Greenberg Traurig in Fort Lauderdale, Fla. But, “Mere dissatisfaction is usually not enough,” notes Neal Brodsky, an attorney at LeClairRyan in Norfolk, Va. If worse comes to worst, trustees can be taken to court. That’s expensive, though, especially considering “trustees can defend themselves out of trust assets,” admonishes Cornish, the Boston attorney. “The best way to keep a trustee on his or her toes is to have the removal and replacement option readily available.” Potential Pitfalls Indeed, keeping trustees on their toes is important. Trust mismanagement can be devastating. “At worst, the trustee could rob the trust,” says Brian Frank, a trust and financial advisor with Morgan Stanley in Atlanta. Or the trust could become disqualified if the trustee is negligent. That would mean the assets incur hefty tax penalties and legal expenses and the grantor’s wishes are thwarted. Even the checks and balances of co-trustees don’t solve all potential problems. Co-trustees might lock horns, or one of them could have shortcomings. “The most fundamental duty of a trustee is loyalty,” insists Debra Anderson, a senior vice president at MassMutual Trust Co. in Enfield, Conn. “Trustees must always act solely in the interest of the beneficiaries.” That’s not as simple as it sounds. “Because fees are usually tied to the amount of assets under management, trustees have an incentive to keep assets rather than distribute them,” says Melissa Olszak, a financial planner at Lake Street Advisors in Portsmouth, N.H. Yet institutional trustees may be safer than friends and relatives. “They are examined by federal and state authorities and [have] internal audits,” says David Rahn, president of First Foundation Bank in Irvine, Calif. “You can also sue them for restitution, since they have deeper pockets than individuals.” Safeguards One way to head off trustee disasters: have them provide regular accounting, suggests Dick Bennett, a partner at Savant Capital Management in Rockford, Ill. Most trusts require reporting at least annually, some more frequently. “It can be formal or informal, but transparency is critical,” says Robert DiQuollo, president of Brinton Eaton, a wealth advisory firm in Madison, N.J. Beneficiaries should do their part, too. “Mismanagement is more likely to occur if the beneficiaries are kept in the dark,” says Luke Sotir, an attorney at Highland Financial Group and a financial advisor at AXA Advisors in Wellesley, Mass. Bonding trustees is another safeguard. “If the trustee does steal, you can get restitution from the bonding company,” explains William Abrams, an attorney at Abrams Garfinkel Margolis Bergson in New York. Some people even hire an independent trust protector to mediate between trustees and beneficiaries, says Allan Zachariah, a wealth manager at Pathstone Family Office in Englewood, N.J. The best protection, however, is careful planning at the outset. “Draft the documents with a competent attorney who specializes in trusts,” asserts Ted Sarenski, chair of the PrimePlus ElderCare Task Force in Syracuse, N.Y.