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Know the negatives of having family members as trustees

by Amelia Burke | Contributor
March 30, 2022

Selecting a trustee is one of the most important estate planning decisions you make. Many individuals consider choosing a family member instead of a professional to fulfill this role, but this should be avoided in most situations. Naming a family member as your trustee increases the likelihood of fighting and litigation. Family members are often unaware of or choose to ignore the strict fiduciary duties that trustees must follow.

As the creator of a trust, a grantor has the responsibility to choose a successor trustee. The successor trustee must act in a fiduciary role to manage trust assets and property. You can choose to name a family member or a professional, like a bank or corporate trustee. Who you decide to fill this role is one of the most important estate planning decisions that you will make.

Your first thought may be to name a family member as the trustee. Because you have a strong personal relationship with the family member, you assume that they will administer the trust fairly and have a deep understanding of your wishes. There are few people that individuals trust more than their spouses, children and other close family members. Furthermore, you may assume (sometimes incorrectly) that the cost of administering your trust will be lower if you pick a family member trustee instead of a professional trustee.

However, you should think twice before naming a family member to act as your trustee. As discussed in the article Keeping It in The Family: Pitfalls of Naming a Family Member as a Trustee, naming a family member as trustee often has disastrous consequences.

What are the risks of naming family members as trustees?

Mixing money and family rarely turns out well. Almost always, the beneficiaries of a trust are family. Therefore, when you ask a family member to act as the trustee, you are asking them to manage assets for the benefit of the other family members and sometimes even themselves. This situation can lead to complicated dynamics and cause fighting and resentment within the family. In some cases, fights over the distribution of trust property can tear a family apart forever. This outcome is most likely to occur when the trustee is a surviving spouse and children from a prior marriage are among the beneficiaries.

Naming a family member can even lead to an expensive and lengthy court battle. Beneficiaries and other interested parties can bring lawsuits if the trustee breaches their fiduciary duties. Compared to a professional trustee, a family member is more likely to breach their fiduciary duties, whether because of inexperience, lack of financial and legal knowledge or personal biases. The effect of litigation on family relationships can be devastating. Even if the trustee prevails, the court battle can be expensive and damaging to family relationships.

What are common breaches of fiduciary duty by family member trustees?

Being a trustee is not an easy job and is more complicated than many assume. Trustees are both the title holders and active managers of the trust property, which often includes stocks, bonds and real estate. As a fiduciary, a trustee must act in the best interests of the beneficiaries and strictly adhere to specific duties, including the duty of loyalty, prudence and impartiality. Because they are in a fiduciary relationship, trustees are held to a much higher standard than if they were managing their own property.

It is more likely that a trustee will breach their fiduciary duty when a family member is in this role. Family members are often unaware of their fiduciary duties because of a lack of knowledge and training. They often have no idea about the legal responsibilities that come with being a trustee. Even if they know their legal obligations, family members usually do not have the professional financial training required to adhere to them. Sometimes, they choose to ignore their fiduciary duties, whether due to personal biases and conflicts or various other reasons.

Some of the most common breaches of fiduciary duty by family member trustees are listed below.

1. Self-dealing.

The duty of loyalty prohibits trustees from engaging in transactions involving self-dealing. Self-dealing occurs when the trustee is both the buyer and the seller in a transaction. Common examples of self-dealing when there is a family member trustee include:

  • Selling or leasing trust property to the trustee.
  • Trustees borrowing trust property.
  • Selling the trustee's property to the trust.

The ban on self-dealing can be especially problematic when the trustee and trust own shares in a family-run business.

Even if the self-dealing was done with good faith (as is often the case), the beneficiaries have the right to void the transaction.

2. Conflicts of interest.

Under the duty of loyalty, trustees must avoid conflicts of interest. Conflicts of interest occur when a trustee's personal interests conflict with their duties as a trustee. Trustees must avoid conflicts of interest because it is difficult to act fairly and in the best interest of the beneficiaries when those interests conflict with your own.

Conflicts of interest can be confusing and a grey area, especially when a family member is both the trustee and one of the beneficiaries. If a trustee ignores conflicts of interest, it can lead to litigation.

3. Retain unproductive and underproductive property.

Unless directed otherwise, a trustee must remove unproductive or underproductive property (property that produces little or no income) from the trust as soon as reasonably possible. The trustee should invest the property to make it productive. If the trustee fails to do so, it is a breach of their fiduciary duty of prudence. For example, a trustee should not leave trust property in a checking account. Instead, they should invest it to get a better rate of return.

Often trustees who are family members are unaware of this requirement, especially if the property is still increasing in value.

4. Failure to make prudent investments.

Under the duty of prudence, trustees must invest trust assets with the care, skill and caution of a prudent investor. This means they must avoid speculative investments, monitor the performance of trust investments and reduce industry and firm risk by diversification. Typically, family member trustees are not trained investors. To fulfill their duty of prudence, they must get the help of a professional financial advisor or investment manager.

5. Failure to diversify investments.

Trustees must reduce risk by diversifying the investments of trust property. Often trustees inherit a trust with an unbalanced portfolio. They must take steps within a reasonable time to diversify the portfolio. Because they generally lack knowledge and training, family member trustees are much more likely to breach this duty. If the trust assets lose value, the beneficiaries or other interested parties can sue the trustee for failing to diversify.

6. Violate the duty of impartiality.

Trustees are required to treat every beneficiary fairly when they make both investment and distribution decisions. There are certain situations where it is more likely that family member trustees will violate their duty of impartiality, including:

  • When there are intergenerational conflicts between beneficiaries. What is in the best interest of a very young beneficiary may conflict with what is in the best interest of an older beneficiary.
  • When there is a spray, sprinkle or another type of discretionary trust.
  • When the trustee is also a beneficiary, especially when a surviving spouse trustee is an income beneficiary and children from a prior marriage are remainder beneficiaries. The spouse trustee may decide to maximize income to the detriment of the estate's growth.

7. Family members are unaware or ignore administrative duties.

Trustees are subject to various administrative duties, including the duty to earmark, the duty not to commingle, the duty not the delegate, the duty to keep accurate records, the duty to inform and the duty to account. For example, the duty to inform requires that trustees promptly respond to a request from a beneficiary for information relating to the administration of the trust. They have to be able to accurately account for every dollar.

Many family members are unaware of these requirements or do not understand that they must be strictly followed. Keeping accurate records can be very time-consuming, and many trustees do not see the harm in keeping less than detailed records if they are performing their job with good intentions. However, a beneficiary acting fairly and honestly can still be sued for breaching their administrative duties.

What happens when a family member trustee breaches their fiduciary duties?

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When a trustee fails in their duties, such as those discussed, it is called a breach of fiduciary duty. When a breach of fiduciary duty occurs, it can have devastating consequences, especially when the trustee is a family member. For starters, it often leads to fighting and a breakdown of relationships. Many relationships never recover.

For serious breaches, a beneficiary can sue. The resulting litigation is often expensive and time-consuming. If the beneficiary is successful in their claim, the court can remove the trustee or subject the trustee to a surcharge. When the court orders a surcharge, the trustee must pay back the beneficiaries for the loss they caused. They have to dig into their own pocket to compensate the beneficiary for any mistakes that they made.

A grantor can waive certain fiduciary duties, but you can never be sure how courts will interpret waivers, even if valid. Professional trustees have years of experience administering trusts and have a deep understanding of their fiduciary duty and its requirements under the law.

When is it particularly dangerous to name a family member as a trustee?

There are certain situations where it is particularly dangerous to name a family member as your trustee, including support trusts, discretionary trusts and when the trustee is given the power to decant.

1. Support trusts.

In a support trust, the trustee is directed to disperse funds from the trust's income or principal that is sufficient to provide for a beneficiary's “comfortable maintenance and support.” There is no exact amount or percentage for “comfortable maintenance and support,” and it's usually based on the beneficiary's current standard of living.

Because there is a discretionary element, the trustee and beneficiary can disagree on what constitutes “comfortable maintenance and support.” For example, resentment can build if a beneficiary feels they should receive more than what the trustee is dispersing. The likelihood of a disagreement only increases when complex family dynamics are involved.

2. Discretionary trusts.

Discretionary trusts authorize trustees to exercise broad discretion over the distribution of trust principal and income. For example, the grantor can give the trustee the power to:

  • Distribute assets unequally among the beneficiaries;
  • Accumulate trust income instead of distributing it to the beneficiaries; or
  • Terminate the trust prematurely.

Because the trustee is given so much power and decision-making ability, it can lead to conflicts between family members.

3. Decanting.

Decanting occurs when the trustee distributes some or all of the trust property into a new trust for the same beneficiaries but with updated provisions. Decanting a trust does not require court involvement. The trustee must be given the power to decant the trust.

For example, consider a trust that allows the beneficiary to withdraw principal when they reach the age of 30. If the trustee is given the power to decant the trust, the trustee could decant the trust property into a new trust with updated provisions that give the beneficiary no ability to withdraw funds. The trustee may decide to do this for various reasons, including if the beneficiary has an addiction or gambling problem. It is easy to see how this could cause conflicts, especially if the beneficiary believes that the trustee is going against the settlor's wishes.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

Phone - 844.445.3422
Email - info@legacyassuranceplan.com
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