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Three Reasons to Consider Appointing Both an Investment Trustee and a Distribution Trustee

Posted September 19, 2023 at 9:01 AM

Elder Law, Estates & Trusts, News & Events

When creating a trust, it is common to name yourself as the initial trustee who is responsible for all aspects of administering the trust. However, when considering who will take over when you can no longer act because of illness or death, it can be effective to divide the responsibilities between two or more successor trustees. For example, you may decide to have one trustee manage the accounts and property held by the trust and another trustee make decisions about distributions to the trust’s beneficiaries. Here are three important reasons why you may want your trust document to bifurcate the successor trustees’ duties in this way:

1.  Benefit from specialized knowledge or aptitudes.  Trustees have a variety of duties and responsibilities in administering a trust, and it can be beneficial to divide them up between more than one trustee based upon the expertise or skills needed to perform a particular aspect of the trust’s administration. For example, if your sister-in-law is knowledgeable about investments and experienced in making financial decisions, but is not as skilled at handling potentially difficult interpersonal interactions, then it may be beneficial to name her as your investment trustee – a trustee whose sole duty is to make discretionary decisions about the investment of funds held by the trust.

Some trusts call for distributions to be made to beneficiaries at the trustee’s discretion, rather than mandatory distributions of a certain amount or percentage at specific times. For trusts that provide for discretionary distributions, it can be helpful for another trusted person capable of making impartial decisions, skilled at communicating with others, and familiar with the beneficiaries of the trust and their needs to be named the distribution trustee — a trustee responsible for making decisions about whether and when to accumulate or distribute the income or principal of the trust.

This division of responsibilities is particularly advantageous if there are any difficult relationships or potential conflicts between beneficiaries or between one of the trustees and a beneficiary. For example, if your second wife is one of the trustees of the trust but the beneficiaries of the trust are your children from your first marriage, then naming an unrelated third party as the distribution trustee may avoid hard feelings or the perception of unfairness related to distributions. Although it may be more expensive to have two or more trustees instead of a single trustee, the additional expense may be worthwhile to maintain family harmony and avoid damaging relationships.

2.  Gain added asset protection.  Most creditors may not reach a beneficiary’s interest in a trust if the trustee is not required to make distributions. Some creditors may be limited in how much they can reach if distributions are based on an ascertainable standard, such as for the “health, education, maintenance, and support” (known as the “HEMS” standard) of the beneficiary. Depending on state law, this may be true even if the beneficiary is also the sole trustee.

In Maryland, a creditor of a beneficiary-trustee can reach the beneficiary’s beneficial interest in the trust, unless the trust instrument contains either a discretionary distribution provision, a support provision, or a spendthrift provision that prohibits such a reach. See MD Code, Estates and Trusts, § 14.5-501(a). A discretionary distribution provision in a trust gives the trustee the sole discretion to decide when, what, and how to distribute assets to a beneficiary, while a support provision in a trust is a mandatory distribution provision that requires the trustee to distribute income or principal to a beneficiary for their “HEMS.” A spendthrift provision is a clause in a trust that limits the trust assets that can be reached by a beneficiary or their creditors. The clause protects the beneficiary from creditors and any debts they may seek to acquire based on their future inheritance.

However, the general rule is that the less control a beneficiary has over the trust’s accounts and property, the more protection is provided against creditors’ claims. Even if the beneficiary of the trust is also the investment trustee, greater asset protection may be available if a separate distribution trustee is appointed who is empowered to make distributions to the beneficiary in their sole discretion. In some jurisdictions, the trust could also provide that the beneficiary could resign as a trustee and appoint another independent trustee to take their place. This might further enhance the level of asset protection if the beneficiary is concerned that they may become more vulnerable to creditors’ claims in the future.

Note: This asset protection is typically not available for certain creditor claims, such as for child support or alimony or tax debts. The list of “exception creditors” varies by state and should be discussed with your estate planning attorney.

3.  Minimize taxes. When a trustee has complete discretion to make distributions from the trust to themselves or others, the value of the trust’s accounts and property may be included in the trustee’s estate for estate tax purposes, or the trustee may be taxed on the trust income under Internal Revenue Code (I.R.C.) § 678. Depending on the type of trust and the goals the trust is designed to achieve, an independent trustee could be appointed to minimize either estate or income taxes.

Example: To avoid having the property held by the trust included in their estate for estate tax purposes, a trustee who is also a beneficiary may be permitted by the terms of the trust to select an independent distribution trustee, if that distribution trustee is actually independent, i.e., not a related party or a person subordinate to the beneficiary as defined by I.R.C. § 672(c). In this situation, the investment trustee who is also a beneficiary will not have direct control over the amount or timing of the distributions, but they may still retain significant control over who serves as the independent co-trustee. In addition to choosing the independent distribution trustee, the trust document may provide that the beneficiary can replace the independent trustee at any time and for any reason.

Example: If your trust is a non-grantor trust (i.e., a trust that is a separate entity for tax purposes that pays taxes on trust income at the trust level), then it is important for someone other than the grantor (the person who creates the trust) or any party who is related or subordinate to them to be the investment trustee. This is because the power to determine trust investments may be construed as the power to control the beneficial enjoyment of the trust assets under I.R.C. § 674, which would mean the grantor, rather than the trust, must pay taxes on the trust income.

How MM&C Estates & Trusts Attorneys Can Help
If you would like to find out more about whether you should appoint separate investment and distribution trustees, give us a call to set up an appointment. Although having more than one trustee will make the trust more complex, and additional fees may be required for the services provided by the trustees, you may decide that the benefits far outweigh any additional costs. We can help you design your trust in a way that best achieves your goals by maintaining family harmony, protecting assets, and minimizing taxes.  We are more than happy to meet with you by phone, video conference, or in-person.

The attorneys in Miller, Miller & Canby’s Estates & Trusts practice provide extensive estate and legacy planning, asset protection planning, retirement planning, and business planning services to individuals and businesses. To learn more about Miller, Miller & Canby’s Estates & Trusts practice click here.

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