Key Components & Considerations
A major decision you will need to make when crafting your will or setting up a trust is choosing a fiduciary. Examining areas of expertise required is an essential step in identifying the executor of your will or trustee of a trust.
Many people believe that choosing a family member or a close friend to be their fiduciary is a way to show respect and trust. They reason that their closest friends and family members can be counted on to carry out their wishes. This may certainly be the case. But the executor of a will or trustee of a trust may need specialized knowledge or experience. It is important to identify the experience that will be required to determine if an individual, a corporate fiduciary, or a combination of both is best for you.
The types of assets in your trusts and estate and the complexities of your beneficiaries are among the factors that will influence the type of expertise your fiduciaries will need.
Fiduciaries often need experience and knowledge in a wide range of technical and administrative areas including the ability to:
- make tax decisions;
- manage investments;
- negotiate with third parties;
- allocate assets among beneficiaries;
- handle business interests and/or real estate holdings; and
- report all transactions to beneficiaries.
Let’s examine one aspect of technical experience that might be needed: managing complex investments. Trustees need to balance somewhat different tradeoffs than executors.
Generally, trustees must align the management of the assets in the trust so that it takes into consideration the needs of today’s income beneficiaries versus the differing interests of those who will receive the trust principal when the trust terminates in the future. There are some generally accepted allocations between income-oriented and growth-oriented investments that are used to address this issue. Instances may arise, however, that require the trustee to weigh making a judgment as to the best course of action for all beneficiaries.
The Estate: A large estate is composed of three illiquid assets of equal value—a horse farm, a sculpture, and a fully leased warehouse.
The Situation: One of these assets must be sold to pay a tax, and at least one beneficiary has voiced a desire to receive each asset as part of their inheritance.
The Decision: Which asset does the executor sell to pay the tax? Are there other options, such as taking out a loan to pay the tax?
Understanding Liability Exposure
Liability exposure is part of being a fiduciary. Executors of wills and trustees of trusts may be held liable if beneficiaries are negatively affected during administration or if it is determined the fiduciaries have not carried out their responsibilities. When choosing an individual to act as a fiduciary, it is important that they understand the liabilities they may be exposed to and are comfortable taking on that risk.
Many fiduciaries obtain errors and omissions insurance coverage. However, that coverage may not fully reimburse the fiduciary for the time and expense incurred defending a claim, nor the full amount of the claim.
Fiduciaries have responsibilities that require them to remain impartial to the beneficiaries. Settling estates or managing assets in trust can cause significant differences to emerge among beneficiaries.
Trusts are often written with an expectation that they will exist for many years, if not decades or more. The person setting up the trust, known as the grantor, cannot anticipate every circumstance that a beneficiary might encounter. As a result, trustees are often called upon to exercise discretionary authority to provide for a beneficiary.
Even when there is only a single beneficiary, this discretionary decision can be challenging as it requires balancing the beneficiary’s needs today with needs they may have in the future. The layers and nuances of the decision multiply quickly when there are multiple beneficiaries. Having a fiduciary who can act impartially is especially important for those families that include offspring from multiple marriages.
The Trust: Anne, age 68, was married to George, who had two children from a prior marriage, Helen age 44 and Frank age 41. George died a year ago leaving a trust that pays Anne income for life and passes the trust assets to George’s children at her death.
The Situation: Anne has just asked the trustee to invest 75% of the trust assets in high-yield corporate bonds so she can receive as much income as possible.
The Decision: Is that acceptable? Are there any risks to any of the beneficiaries? Is there a liability risk for the trustee if they fulfill Anne’s request?
For estates, and especially for trusts, continuity in the fiduciary’s ability to serve is important. Tenure in office will give the current fiduciary special insight into the state of affairs of the estate or trust.
Sometimes individual executors and trustees can no longer serve as the appointed fiduciary. A replacement must be found if a fiduciary becomes unwilling or unable to serve. Well-drafted documents may address this issue, but there may be situations when a named succession of individuals exhausts the list of possibilities. Every state has a court with the jurisdiction to step in and name a party to fill the void, but that party may lack the special insights of the former fiduciary. And sometimes the named successors do not possess the same level of skills, knowledge, or impartiality of the original fiduciary.
For this reason, many people choose to name a corporate fiduciary because it has a staff of advisors with the skill and knowledge to continuously serve as a fiduciary. Many of those who feel an individual will be their best choice initially will name a corporate fiduciary as their last in line to prevent gaps in the administration of the estate or trust if unforeseen events occur.
The Trust: A trust was established by Suzy’s now-deceased grandparents who believed strongly in the value of education. The trustee has been given broad discretion to provide for the beneficiaries.
The Situation: Suzy requests a distribution from the trust to pay for the private school tuition for her eldest child who is entering ninth grade. Suzy’s two brothers also have children, some older and some younger than Suzy’s eldest. Neither Suzy, her brothers, nor any of their school-age children have ever attended a private school.
The Decision: Should the trustee make the distribution since Suzy’s son is exceptionally bright, and private school might make it easier for him to gain entrance into an elite college, something the grandparents might have wanted? Or should the trustee decline since private school has not been a part of this family’s accustomed standard of living?
Corporate, Individual, or Both?
When deciding whom to name as an executor for your will or trustee for a trust, we believe a good place to start is to identify the complexities involved in administering the will or trust. The next step is to evaluate the level of skills and experience your fiduciary needs. Some sample questions you might want to ask are:
- Will complex tax and investment decisions or actions be required?
- If so, does the fiduciary have the knowledge and experience to make these decisions?
- Will the fiduciary need to hire one or more third-party advisors? If so, do they have the required knowledge to hire effectively? And, is this cost efficient?
- Is the fiduciary comfortable with any liabilities to which they may be exposed?
- Does the fiduciary have the required technical and administrative skills and experience?
- Can the fiduciary act impartially, as well as provide continuity and accountability?
All fiduciaries have an obligation to inform their beneficiaries of the actions they have taken and the assets they hold for their benefit. Informally, on a day-to-day basis this might consist of delivering a statement showing receipts, disbursements, purchases, and sales, or other communications such as tax documents. More formally, fiduciaries may render “an accounting” from time to time, or at the conclusion of their service. In most states this is an explicit process where a particular court in that state reviews and approves the fiduciary accounting with the involvement of the beneficiaries. While a formal accounting can be waived in some cases, in many situations this formal process may afford the fiduciary some degree of relief from liability for the transactions included in the accounting. However, not all individual fiduciaries have the expertise to prepare these formal accountings.
Fiduciaries often require a complex mix of expertise and the ability to act impartially toward all beneficiaries. A key to identifying the best choice for your fiduciary is to understand the skills that will be required and to determine that the fiduciary has the competency level, resources, and willingness to accept the potential liabilities associated with the position. Individuals often serve as estate or trust fiduciaries.
Well-chosen individual fiduciaries may bring special insights into the unique needs of beneficiaries that will allow them to serve successfully.
Corporate fiduciaries may possess technical knowledge and experience that exceeds that of one or more individual fiduciaries. They may also provide a higher level of continuity, dependability, and impartiality than individuals. In cases where individual fiduciaries need to hire advisors to fill in gaps in skills and knowledge necessary to successfully fulfill their responsibilities, it may be more cost efficient to use a corporate fiduciary.
Whether you choose an individual, corporate fiduciary, or a combination of both, we recommend you speak with the important people in your life and your trusted advisors, to help you make the best decision for you.
For more information, please contact your PNC advisor.