On my website, I answer consumer questions about all aspects of estate planning. Here are the five most frequently asked questions with my answers:
This question is asked by trustees who are looking to get paid for their services and by beneficiaries who feel that their trustees are overcharging. The trustees are entitled to “reasonable” compensation. But what is “reasonable”? This question can be difficult to answer concretely because many elements can go into the selection, including:
the amount of work involved,
any agreement between the grantor and the trustee,
rates prevailing in the community in which the trust property is located, andADVERTISEMENT
The total costs faced by the trust.
As a guideline, professional trustees—banks, trust companies, and attorneys who act as trustees—typically charge 1.0% to 1.5% of the trust’s assets each year, a larger percentage for smaller trusts and a lower percentage for larger owners since working for a $4 million trust wouldn’t differ much for a $2 million trust.
Non-professional trustees can use these percentages as guidelines as well. But they must consider the overall costs of trust. The fees for a professional custodian are often all-inclusive, with no additional investment management fees. If a non-professional trustee employs an investment manager that charges 1.0% of the assets under management, the trustee’s fee must not be another 1.0%. Likewise, if a non-professional trustee is paying for a bookkeeper or attorney to perform jobs that are generally performed at no additional charge by a professional trustee, he/she must deduct his/her fees accordingly. On the other hand, professional trustees generally hire outside accountants to prepare trust income tax returns, so that this cost does not come out of the trustee’s fee.
Things get suspicious when family member trustees perform additional services beyond what a professional trustee would normally provide. It usually includes these real estate, whether prepared for sale after the death of the grantor or managed for rental. Trustees can do a lot of work and should generally be compensated. However, a number of factors often provoke complications. Trustees often throw themselves into action and don’t think about compensation until after the fact. In this case, it is difficult for them to get full payments for their services. They may have created an expectation that they won’t get paid. Other family members may be willing to do the work without pay or less pay. The outside contractor might have done it better. In these cases, it is often best for the trustee to take a payment which may be much less than what the trust would pay a third party. This is also true if the trustee acts as a rental agent. Other than that, there is at least the appearance, if not reality, of self-dealing when the trustee chooses to pay himself rather than someone else to do the same work for the same price.
Sometimes I get questions about professional guardian fees as well, which usually fall into two categories. In one, the beneficiaries wonder why they need to pay so much when all the trustee does is invest the assets, which can easily be in index funds at virtually no cost. The answer is that they often do much more than that, making discretionary distributions to the principal, communicating with beneficiaries about their needs, completing trust accounts, and providing security for trust assets. (You can read more about the duties of a guardian here.)
The other complaint relates to attorneys charging an hourly fee to act as a trustee. Then communication with the guardian becomes costly, especially if the communication does not go well. I find this often comes with smaller trust relationships that other professionals are not willing to put up with because the percentage fee would be too low to make it worth their time. There usually isn’t much that needs to be done about it except to make sure the recipient has a trustee with whom they feel comfortable. Paying the custodian for services and supporting communications is one thing and another to do for those charged.
2. Does the fund have to file its own tax return?
If the trust is revocable, the answer is no. All bank accounts and investments must be in and taxable directly to the grantor’s Social Security number.
If the trust is irrevocable, the answer is probably yes, although there are some exceptions. Some irrevocable trusts own unproductive real estate or other non-income-producing assets. In this case, they do not need to obtain a tax identification number or file an annual tax return.
Irrevocable trusts that generate income must file a return but still often don’t pay any taxes because any income that is distributed to the beneficiaries is taxed on them. The trust files 1,041 income tax returns showing the income, but deducting the amount distributed. It then sends recipients K-1 forms to report income, which is similar to 1099s from banks or investment firms.
3. What information rights do beneficiaries have?
The beneficiary’s right to information depends in large part on whether the trust is revocable or irrevocable. Beneficiaries of revocable trusts generally have no rights at all because the grantor can always change the terms of the trust. Legally, their rights are not “granted” until the grantor dies and the trust becomes irrevocable. (This can sometimes get confusing because the title of the trust may still contain the word ‘revocable’ but since only the grantor can make changes, it has become irrevocable.)
On the other hand, beneficiaries of irrevocable trusts have substantial rights, including the right to a copy of the trust document, regular (usually annual) accounts for the financial activity of the trust, and in some cases to change trustees. These rights may be affected by the terms of the trust themselves and state law. In addition, these rights generally accrue only to the acquired beneficiaries.
For example, the fund might say “Pay the income to my daughter for life, and then pay the basic income to her children who live on her in equal shares.” The daughter is a clear beneficiary with clear rights. The interests of the grandchildren are somewhat less clear as they have to survive with their mother to get anything, but they may still have the right to see the trust and annual accounting. The trust may also say that if one of the grandchildren dies before the daughter, then his or her share will go to his children – great-grandchildren. They would not have any rights in relation to the trust because their interest only occurs if their father died before their grandmother.
4. Can beneficiaries replace a trustee?
maybe yes. A trust tool may give them this right, although there are often limitations. For example, it may require the consent of all beneficiaries or the new trustee to be a professional, such as a bank, trust company, or attorney.
Whatever the trust may say, state law may also give the beneficiaries the right to remove and replace the trustees, but in that case they will probably have to go to court to make that change. Fortunately, the law in most states is becoming more lenient with the adoption of the Uniform Trust Act. Under the previous law, the beneficiaries had to prove some wrongdoing or incompetence on the part of the trustee. The presumption was in favor of the trustee because the grantor chose the trustee in the first place, and the burden of proof was on the recipients seeking the change. This can be a significant hindrance to overcome especially since the trustee can use the trust’s resources to hire a lawyer in his defense and the beneficiaries will have to pay their own legal fees. (This may be reversed in the case of the trustee’s real infractions, not only incompetence, but beneficiaries cannot be guaranteed to successfully prove this and to receive compensation for their fees).
Fortunately, the Uniform Trust Act recognizes that communication between trustees and beneficiaries is very important for a trust to achieve their purpose and that beneficiaries should not be burdened with a trustee they do not trust. So changing custodians is allowed to collapse the connection as long as all recipients are on the same page. They still have to go to court, but the procedure will be much less expensive and the result is more guaranteed. However, it can be difficult if the beneficiaries are not in agreement.
5. Does a trust avoid wills and estate taxes?
Yes and no. If the trust is funded, meaning that the assets have been renamed the trust, those assets will not have to go through probate until the grantor’s death. However, they are still subject to the estate tax. This is a common misunderstanding. A “will” estate includes only property that passes under the will of the deceased (or under the state’s “non-will” rules in the absence of a will). A property that goes through joint ownership, by designating a beneficiary or trust, avoids expenses and delays in the probate process. However, all such property remains in the taxable estate and potentially subject to property taxes.
Fortunately, with the federal estate tax threshold currently set at $11.7 million (and twice that for married couples), very few estates pay any tax at the federal level. However, 17 states have estate or inheritance taxes with thresholds as low as $1 million in Massachusetts and Oregon. So trust assets can be subject to government estate tax.
However, most trusts established by a deceased person are only taxable on their estate. Trusts are often used to house money so that it is available to the surviving spouse but not taxed upon their death. (Often referred to as a “trust shelter,” “QTIP,” or “A/B” trusts. Trusts established by a third party, such as a parent or grandparent, will not be taxed upon the death of the beneficiary.
This is part five of a five-part series on trust. Other articles are:
Trusts are useful for just about everything in estate planning
What is the difference between an irrevocable trust and an irrevocable trust?
You have been named guardian. Here’s the good news – and the bad news.
7 trust traps you need to know
Harry S. Margolis is a Massachusetts attorney and senior legal planning attorney. Answers consumer questions about estate planning on AskHarry.info, and recently published the Confidence Baby Boomer’s Guide: All-Purpose Estate Planning Tools.