Directed trusts are a relatively new concept, enabled through the enactment of various states’ statutes. Not all states have directed trusts, and not all states’ laws on directed trusts are created equal. To understand directed trusts, a review of the history of a trustee’s duties is helpful.
Duties of a Trustee
Historically, a trustee is a fiduciary with complete responsibility for all aspects of trust administration, including investment management, account distributions, recordkeeping, reporting and taxes. When called upon to act, a trustee has to be competent in all areas of trust administration. Furthermore, once acting, a trustee would displace any previously involved professionals, like financial advisors, family attorneys, etc.
For example, a family may use a financial advisor to manage their investible wealth, but when the family patriarch and matriarch die, the trustee takes over, consolidating the wealth under the trustee’s custody and using its internal investment management team to make investment decisions, thus removing the family’s financial advisor from the picture. There are many reasons why this is appropriate, chief among them being that a trustee owes duties to the beneficiaries that require a different style of investment management than what’s typically provided by a family financial advisor.
Even though trustees are required to perform these duties, there are, however, scenarios in which it’s better for someone with intimate knowledge of a family’s or person’s financial situation to remain in control of that wealth. In this case, you might look to establish a directed trust.
What Is a Directed Trust?
A directed trust is a trust that splits the duties of a trustee between the named trustee and another named party like a family financial advisor or attorney. The creators of the trust can specify that the trustee take instructions (or “directions”) from their chosen financial advisor regarding certain aspects of trust administration like investment management or trust distribution.
Benefits of a Directed Trust
Instead of the trustee bearing responsibility for all aspects of trust administration, the financial advisor is now responsible for investment management, while the trustee is relieved of that duty. Not only does this protect the trustee from any sort of liability involving investment management, but it also helps to ensure that any investments within the trust are managed by someone familiar with the wishes of the creator of the trust.
Another common area of trust administration that gets transferred to another party through a directed trust is discretionary distributions. Historically, when the beneficiary of a trust wanted a distribution from the trust, the beneficiary would have to ask the trustee, and the trustee would decide whether to make the given distribution—taking into account the beneficiary’s personal circumstances, the beneficiary’s financial situation, the size of the trust, other expected trust distributions, and the rights of other beneficiaries to the trust. However, it takes time for the trustee to become familiar with a beneficiary’s personal circumstances. Thus, a directed trust might name a trusted advisor—like a family attorney or close family member who has developed that familiarity over years of working with the family—to direct the trustee when to make distributions. Again, the trustee’s traditional role is bifurcated under this model, and decisions about distributions are made by the directing party, while the trustee must simply follow the directions of the directing party.
Directed Trust Statutes Differ by State
This bifurcation of the trustee’s traditional role must be explicitly authorized by state statutes, which relieve the trustee of liability for following the instructions of the directing party, otherwise the default law requires the trustee to maintain control over all aspects of the trust. But the amount of flexibility given to the trust creator and level of protection afforded to the directed trustee vary from state to state. For example, in Wisconsin, a trustee who follows the instructions of the directing party is still liable for willful misconduct. In South Dakota, the trustee has no liability for following these instructions.
Under the Uniform Trust Code (passed by many states), before following a direction from a directing party, the trustee must determine whether it constitutes a serious breach of a fiduciary duty or is manifestly contrary to the terms of the trust. The construction of the Uniform Trust Code greatly reduces the utility of a directed trust because the trustee must exercise oversight of the directing party, thus defeating the purpose of bifurcating the trustee’s role to a directing party. Statutes like South Dakota’s are much preferable because they relieve the trustee of any liability, thereby enabling the directing party to exercise their powers free from trustee oversight—keeping with a grantor’s desire to use a directing party for that respective area of administration.
Is a Directed Trust Right for Me?
Directed trusts provide many benefits to trust creators. First and foremost, they allow the trust creator to avail themselves of the administrative, recordkeeping and reporting competence of a corporate trustee, while keeping preferred advisors in place to make decisions about investments or distributions. This flexibility allows the creator of the trust to keep in place advisors who are familiar with the family without saddling them with the extensive duties of a trustee. These advisors are able to maintain a family-oriented approach across things like investment management and trust distributions.
If you think a directed trust would be a worthwhile addition to your financial plan, reach out to an advisor today. Our specialists have deep knowledge of various estate planning vehicles and can help determine if this type of trust is right for you.
