Posts Tagged ‘principal distributions’

Advice for Trustees: When to Make a Requested Distribution


Let’s imagine that you are the trustee of an irrevocable trust, and you are considering making a distribution from the trust. Perhaps the distribution has been requested by a beneficiary, or a family member. How do you make your decision?

There is surprisingly little written direction for trustees. Partly that is because, until the middle of the twentieth century, trustees were most often professional, trained institutions — like banks and trust companies. Only in the past half century or so has the notion of a family member acting as trustee become common, and there are many more small professional organizations acting as trustee, as well.

That is, of course, a good thing. There is no reason that only large banks are suitable to act as trustee (though there is no doubt that they are the appropriate choice for some trusts), and the democratization of trusteeship, if you will, is a positive legal and social movement. But that does also mean that people without any particular training or background are now being called upon to make decisions about trust distributions.

How do you decide? Here are some items to consider (and not necessarily in order of importance):

  • What do the terms of the trust say? It’s surprising how often the answer is actually in the trust document, but forgotten because no one has looked at the trust for months. Read the trust, looking for reference to the kind of distribution that is proposed.
  • Is it clear that the distribution will be for the benefit of the beneficiary? If the beneficiary’s parents (or children, or neighbors, or creditors) really, really want you to make the distribution, that is not enough — look at the benefit to the beneficiary.
  • How large is the proposed distribution as compared to the size of the trust? It should be much easier to approve purchase of a new home from a trust worth several million dollars than from a trust with a $200,000 balance.
  • Are there other rules to consider? For instance, will the distribution have an effect on the beneficiary’s Medicaid eligibility, or Supplemental Security Income benefits? If so, that doesn’t necessarily mean you can’t make the distribution — but you should be sure that the benefit outweighs the costs.
  • Will other people benefit from the proposed distribution? If you agree to purchase a vehicle for a child with a disability and difficulty getting to doctor’s appointments (for instance), will the vehicle benefit the child’s parents or other family members? Again, that doesn’t mean you are necessarily prohibited from making the distribution, only that you are required to consider those ancillary benefits.
  • How closely is the proposed distribution related to the original purpose of the trust? If the trust was funded by the proceeds from a personal injury lawsuit, for example, it is easier to approve expenditure of funds for an experimental medical treatment than if the trust was set up primarily for education of the beneficiary.
  • What about remainder beneficiaries? Who is scheduled to receive the trust balance upon the death of the current beneficiary? They don’t have a veto right over the proposed distribution, but their interests have to be considered. Does the trust document say you can ignore the remainder beneficiaries? OK — but they are still likely to see an accounting, and they might have questions; you should be prepared to answer.
  • Will the expenditure lead to liability for future costs? If you buy a house (or a car) who will pay the insurance and upkeep/maintenance costs? If someone agrees to pay the ongoing costs, is there a clear understanding about what will happen if they do not follow through?
  • Are you sure your own interests are not tied up in the proposed distribution? If you are a relative of the beneficiary, might the proposed distribution benefit you as well? If, for instance, the beneficiary’s doctor says that a therapy pool would be a good idea, can you assure anyone who asks that you agreed to use trust funds for a pool at your house without considering how nice it would be to have a hot tub? Conversely, can you be sure that your refusal to approve an expenditure was not motivated by your interest in collecting a fee as trustee? If your reaction to those suggestions is even slightly defensive, that should give you additional pause (rather than letting you off the hook).
  • If you approve a significant purchase, have you figured out how to title the new house or car, or whether there needs to be an adjustment in the house’s title after you make significant improvements with trust funds? There are no easy hard-and-fast rules here, except this one: you need to consider the titling of the affected asset, and you should document how you finally resolved the question.

There are more items to consider, but that should give you a sampling. We’re working on a checklist of considerations for trustees — and especially trustees of “special needs” trusts. If you have ideas for additional items to add to the list, please let us know. If you just want to know how that checklist project turns out, let us know about that, too.

Meanwhile, you should keep this in mind: acting as trustee is a challenging, difficult, but rewarding job. It’s important to think through your decisions and document how you got to them, but the key goal is usually the same: can your decisions better the life of the beneficiary of the trust?

Trust for Surviving Spouse Leads to Dispute With Stepchildren


When Albert Findlay (not his real name) died in 2002, he left a trust for the benefit of his wife Sharon. Sharon was named as trustee, and the trust document directed that she was to receive “the entire net income” from the trust for the rest of her life. Albert specifically directed that, as trustee, Sharon would not have any right to take principal out of the trust, but he left at least a half million dollars of investable assets in the trust, so it could be expected to produce some income for Sharon. In addition, the trust included several pieces of investment property — Albert appears to have been a moderately wealthy and successful man.

Albert also had three daughters from his first marriage (that is, they were not Sharon’s children). One of the significant assets in the trust was a 20.28% interest in an apartment building in downtown Prescott, Arizona. Albert’s daughters owned the remaining interest and managed the building.

Already the description of Albert’s estate plan should give some clues about what ended up going wrong. In our experience, clients have a hard time imagining what the family dynamics will actually look like after their deaths. We can guess that Albert might have had such a failure of vision. Would Sharon handle the trust properly? Would she get along with her step-daughters? Would any of them, financially enmeshed as they were, seek to take advantage of the others? Would all of them understand their obligations to one another, providing information and responding reasonably when asked?

It is not clear from the court record (you predicted that there would be a court proceeding, didn’t you?) who acted first, but in the few years after Albert’s death several things happened:

  1. Two of his daughters, as managers of the apartment complex, took out a loan against the building. They did not put the proceeds into the limited liability company running the rental building. The building did not generate sufficient income to make the loan payments, and the property was ultimately lost to a foreclosure.
  2. Sharon began automatically transferring $3,000 per month from the trust to her personal checking account, regardless of how much income the trust produced. The value of the stocks held in the trust began to decline.
  3. Albert’s daughters requested accounting information for the trust, but Sharon did not comply for months. In fact, she did not provide any detailed account information until court proceedings had been filed.
  4. The daughters attempted to sell one of the other assets held jointly among them and Sharon’s trust; Sharon objected to some of the terms of the proposed sale and it did not go through. The daughters then formed a new limited liability company and transferred their share of that asset to the new LLC. Meanwhile, they received an offer on the struggling apartment building (before the foreclosure) but rejected it without consulting Sharon.
  5. Once litigation began, Sharon hired an attorney and paid about $70,000 in legal fees from the trust. She actually initiated the lawsuit, seeking damages for her stepdaughters’ handling of the apartment building. They countersued, asking that she be removed as trustee, ordered to account and ordered to return money she should not have taken from the trust.
  6. Meanwhile, Sharon was receiving trust checks for rental payments on another trust asset, a commercial rental building. She deposited those checks into her personal account directly, and reported the income on her own income tax return rather than showing it as trust income. In fact, Sharon didn’t even have a trust checking account set up for most of the time she acted as trustee.

The trial court heard testimony from the warring parties, and ended up removing Sharon as trustee (a non-family member took over after her removal), ordering her to return trust money she should not have received, and directing her attorney to return $70,000 in legal fees paid by the trust. Sharon appealed.

The Arizona Court of Appeals affirmed most of the trial judge’s findings, but disagreed about how much Sharon should have been entitled to receive from the trust. The trial judge had ordered Sharon to return everything she had received above the “distributable net income” (DNI) of the trust — that calculation was wrong, said the appellate court. DNI is a tax-related calculation — it is the maximum amount of the income tax deduction available to a trust for distributions to an income beneficiary — and “income” for trust accounting purposes is a different (and often somewhat larger) number, according to the Court of Appeals.

The appellate court sent the dispute back to the trial judge for further hearings to calculate the amount that Sharon owes back to the trust. It also directed the trial judge to conduct proceedings to determine whether Albert would have wanted his trust used to pay for administrative items like legal fees. In the first hearing, the judge had refused to allow Albert’s lawyer to testify about what he might have intended in that regard.

Two other holdings by the Court of Appeals are worth mentioning. First, the appellate judges noted that Sharon’s decision to sell the stocks held in the trust when she took over is not, by itself, evidence of any wrongdoing. Even though the value of the stock holdings had apparently gone down during her administration, that is not necessarily actionable. A trustee is not an insurer, but has a duty to manage trust assets prudently. The trial judge will need to inquire further into the kinds of changes made before deciding to order Sharon to return funds.

Finally, the appellate court noted that there is not necessarily any problem with naming a trustee who has an interest in the trust’s administration. In fact, it is common to name beneficiaries as trustees — they then have a duty to the other beneficiaries, but that does not mean that someone in Sharon’s position is precluded from seeking to assert her own interests in the trust. The trial court will need to review the earlier ruling to make sure that the “conflict of interest” analysis was not too sweeping in its application. Favour v. Favour, February 11, 2014.

It is a challenge to describe a court opinion like the Favour holding without dropping into technical jargon. But perhaps it is more useful and interesting to think about how the litigation — and the outcome — might have been avoided in the first instance. We have a few ideas to suggest — though we are quick to note that we never discussed Albert’s wishes with him, and he might have rejected any or all of these:

  1. Naming a beneficiary as trustee is not at all objectionable, and (as the appellate court notes) it is commonly done. But if the trust’s author intends that everyone be treated scrupulously fairly, it might make more sense to name a disinterested person (or organization) — even a professional — as trustee.
  2. It is uncommon to see modern trusts that require distribution of all income but preclude distribution of any principal. That is an invitation to this kind of dispute, since the characterization of income and principal can be subject to interpretation. It also puts the income and remainder beneficiaries at odds — income beneficiaries are not interested in growth of investment value, and remainder beneficiaries would rather skip current income in favor of that growth.
  3. Putting fractional shares of investment assets into the trust is another way to encourage disagreement — particularly when other trust beneficiaries have management authority over the fractional interests.
  4. Once any level of conflict arose, it might have been appropriate for Sharon to consider application of Arizona’s “total return unitrust” statutory authority. Using that approach, she might have set a presumptive rate of distribution from the trust regardless of the actual income — and reduced the possibilities of disagreement between herself and her stepdaughters.
  5. Including some sort of dispute resolution mechanism in a trust — especially a trust like this one, involving a surviving spouse and stepchildren from an earlier marriage — might make sense as a way of minimizing conflict, avoiding court proceedings and reducing legal expenses.
  6. A trustee has a duty to report to remainder beneficiaries. Someone should have explained that to Sharon early, and pushed her toward satisfying that obligation. Delaying or avoiding her duty did not work to her benefit in the long run.

With remand to the trial court, it may not be too late for Sharon and her stepdaughters to work out some less-costly resolution of their dispute. But some part of the cost (and the breakdown in the interpersonal dynamics) has to be laid at Albert’s door — he could have reduced the conflicts and helped his family avoid disputes by a little more careful thought about the drafting, funding and future of his trust plans.


Remainder Beneficiaries Not Entitled to Trust Beneficiary’s Financial Info

Imagine with us for a moment: you are the trustee of an irrevocable trust created by a now-deceased woman for the benefit of her daughter. The trust says that her daughter is to receive all the income generated by the trust. You are also given the discretion to give the daughter some of the trust’s principal if she needs it. When the daughter dies, whatever is left in the trust will go to her nieces and nephews, the grandchildren of the original trust settlor.

You have just gotten a letter from the daughter, asking you for an additional $3,000 per month to pay for her care. You know that the remainder beneficiaries — the nieces and nephews — might object to that extra distribution. What should you do?

That is essentially the problem faced by Citigroup Trust, which is trustee of just such a trust. It was established by Esther Caplan for the benefit of her daughter, and it is administered in Arizona. After Citigroup began making regular distributions to the daughter, one of her nephews questioned whether the trustee should be giving her additional funds. Eric Bistrow told Citigroup that he wanted more information about his aunt’s finances, and that he wondered whether the trust was funding a too-lavish standard of living.

To make sure that they understood the daughter’s needs, Citigroup requested (and got) tax returns and a budget. They decided to keep making the distributions, but also to ask the Arizona courts for direction.

Citigroup filed what in Arizona trust law is called a “Petition for Instructions.” They essentially asked the probate judge to tell them whether they were right to make the discretionary distributions of principal.

In the course of the proceedings, Mr. Bistrow and his attorney asked to look at his aunt’s budget, tax returns and financial information. Citigroup declined, saying that the information was private and should not be shared. How, then, would Mr. Bistrow know that they had properly considered her financial needs? The trustee suggested that it would give the records to the probate judge, and let him review them privately; if there were concerns or questions, the judge could make the decision to share them, or some portion of them.

The probate judge agreed, looked at the records, and approved the past and proposed future distributions to Ms. Caplan’s daughter. It also confirmed that Mr. Bistrow and the other nephews and nieces were entitled to statements showing how much was actually distributed, as well as how much was earned by the trust and what other expenses it incurred.

The nieces and nephews appealed, arguing that they were not being given enough input into the decision to distribute trust principal to their aunt. Their position was that they should be notified before any distributions could be made, that they should be given full financial information, and that they should be given an opportunity to weigh in on their aunt’s need for funds.

Not so, ruled the Arizona Court of Appeals. Mr. Bistrow and the other remainder beneficiaries are entitled to be treated fairly. They are entitled to know what the trustee is doing. They are entitled to ask the courts to intervene if they think the trustee has exceeded its authority. They are not, however, entitled to see their aunt’s financial records, or to vote on whether the trustee should exercise its discretion to make distributions to her. In Re the Matter of Esther Caplan Trust, September 1, 2011.

The Caplan case is focused on a narrow question, but it has broader application. It also raises (but does not answer) a number of interesting questions. It gives important guidance to trustees on how to safely exercise the discretion given by a trust document.

What are some of the lessons of Caplan? A few come to mind:

  1. Asking for court review of decisions which might be challenged should always be considered. It may be that the amount in controversy is too small to justify court involvement, or that the trustee’s decision is simply unassailable, or that the remainder beneficiaries are agreeable. But in any case in which there might be disagreement, the Petition for Instructions is a good safeguard for the trustee.
  2. Remainder beneficiaries are important, and their interests need to be considered in administering a trust. But the income beneficiary’s interest is usually paramount. Remainder beneficiaries are not in charge of trust administration.
  3. Notwithstanding that remainder beneficiaries are not in charge, they are still entitled to sufficient information so that they can determine if their interests are being adequately protected. But “sufficient information” is not the same thing as “complete information.” It may sometimes (rarely, but occasionally) be appropriate for a trustee to withhold sensitive or personal information. Usually, it would be wise to identify the information which is not being shared, so that the remainder beneficiaries can make a reasoned decision about whether to challenge that determination, too.
  4. Creative thinking can come up with solutions that protect everyone’s interests and violate none. Giving the judge a chance to review the financial records in camera (privately) was just such a creative solution.
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