Tax Lawyer Blog

A Blog written by the Tax Attorneys for Individuals and Businesses

The Duty of Impartiality and Other Trustee Troubles

Trustees are accountable to both the current income beneficiaries and the remaindermen of a trust, and are often placed in the unenviable position of have to balance the interests of the two. A beneficiary may look forward to inheriting a business, their childhood home, a treasured family heirloom, or a large investment portfolio, and some level of conflict with the person holding the purse strings should be expected — or at least anticipated.

A trustee must be impartial

A significant challenge of prudent investing is in the selection or retention of investments that may provide a greater benefit to either the current income beneficiaries or to the remaindermen. For example, if an investment produces significant income but is otherwise losing value, the remaindermen may have a cause of action against the trustee for failure to exchange the property or withhold income for their benefit. The reverse is also true - if an investment produces little or no income but has appreciated considerably, the trustee will be faced with having to consider exchanging the property and/or allocating some of the sale proceeds to the income beneficiaries.

Trustee troubles

The relationship between trustees and beneficiaries is like that of step-parent and child. The trustee is typically selected by the parent, and the children have little or no recourse to extract themselves from an arrangement that does not suit them personally. Trustees must therefore be especially careful to maintain meticulous records and follow the guidelines and rules set forth by the trustor and The Uniform Prudent Investor Act (UPIA).

When a beneficiary sues a trustee, the challenge is usually made for one or more of the following reasons:

  • The trustee did not properly safeguard the assets in the trust
  • The trustee managed the trust in a way that disproportionately benefitted certain beneficiaries and not others, and/or
  • The trustee used the trust funds to pay their own personal expenses, or to support someone else who is not a named beneficiary of the trust.

Even the most diligent and prudent trustees may face troubles that have nothing to do with their actions. Anticipated inheritances can bring out the worst in people, and trustees are often caught in the midst of squabbling relatives despite their best efforts. This role is not for the faint-hearted.

San Francisco estate planning attorneys

The attorneys and accountants at Moskowitz, LLP work with individual and corporate trustees, as well as private professional fiduciaries. If you are seeking legal counsel to draft your estate plan, or are a trustee seeking assistance with the administration of an estate, contact our San Francisco office for a consultation.

Guidelines for Making Prudent Investment Decisions

When the creator of a trust is living, they can manage their trust and invest it however they wish. When a named trustee assumes control of a trust, however, they have a number of investment obligations and duties. A trustee’s obligations are set forth in The Uniform Prudent Investor Act (UPIA) and include making prudent investment decisions, diversifying trust assets, keeping administrative costs down, and being impartial with respect to the current income beneficiaries and remaindermen.

A trustee must make prudent investment decisions

Under the UPIA, a trustee is obligated to invest trust assets with the care, skill and caution of a prudent investor, and to design an investment portfolio that optimizes returns and acceptable risks (“Modern Portfolio Theory” or “MPT”). Exceptional investment skills are not required, merely average intelligence and the discretion to make sound investments. To do this, the trustee must consider the following:

  • General economic conditions
  • The effects of inflation and deflation
  • The expected tax consequences of their investment decisions or strategies
  • The role of each of their investments and actions within the overall trust portfolio
  • The total expected return from income and capital appreciation
  • The beneficiaries’ other resources
  • The needs for liquidity, regular income, and the preservation or appreciation of capital, and
  • Any particular relationship or value of an asset to the trust or to any of the beneficiaries.

There is no specific requirement for a particular investment return, but prudence must be exhibited in the course of the investment process. Under the revised Uniform Principal and Income Act of 1997, a trustee may delegate their investment strategy and individual decisions to qualified financial advisors, and they generally do so. A trustee must, however, carefully select their advisors, and continually evaluate their decisions and overall investment performance.

A trustee must diversify trust assets

The UPIA also states that a trustee must employ an investment strategy that suits the purpose of the trust and which balances risk and return. Part of this requirement is the duty to ensure proper diversification of investments and due diligence in the management of the trust corpus.

Trust investments are viewed as a whole, and a trustee will generally not be liable if a single asset performs poorly. Furthermore, a single speculative investment is unlikely to be an issue if it is small and facilitates the diversification of the trust assets. A prudent trustee should have documentation showing that the investment was part of an overall, successful investment portfolio.

If the trust directs the trustee to retain specific assets, such as a house or a business, the trustee is generally not obligated to seek out more productive investments. However, if circumstances change that may affect the interests of income or remainder beneficiaries, courts in some jurisdictions have held that the trustee should seek out other investments that better meet their fiduciary duty of prudent investing (see Part III).

A trustee must keep costs down

Trustees are obligated to minimize investment expenses and risk, and to keep both administration costs and taxes down. Note that trust companies serving as trustees are usually permitted to combine the assets of different small trusts to facilitate lower costs and diversification of investments – of course, all while keeping track of whose money is whose!

In Part III, we will conclude our series on the Prudent Investment of Trust Assets with a discussion of impartiality to the income beneficiaries and remaindermen.