Investment and Distribution Trustees: Why Would I Need Both?

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 act next, when you can no longer act because of illness or death, it is sometimes helpful to divide the responsibilities between two or more successor trustees. For example, you may decide to have one trustee who manages the trust assets and another trustee who makes decisions about distributions to the trust’s beneficiaries. There are some important reasons why you may want your trust to divide the trustees’ duties in this way.

Benefit from specialized knowledge or skills. Trustees have a variety of duties and responsibilities in administering a trust, and it is sometimes 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 brother is knowledgeable about investments and experienced in making financial decisions but is not as skilled at handling family dynamics and potentially difficult interpersonal interactions, it may be beneficial to name him as your investment trustee, with the sole duty of investing and managing the trust assets.

You could design your trust so that distributions are made to beneficiaries only when the trustee, in their discretion, decide it appropriate, rather than requiring that the trust make mandatory distributions of a certain amount or percentage at specific times. For trusts that provide for discretionary distributions, it may be helpful for another trusted person who is 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. The distribution trustee would be responsible only for making decisions about whether and when to distribute the income or principal of the trust.

This division of responsibilities is particularly helpful 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, 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 investment to maintain family harmony and avoid damaging relationships.

Gain additional asset protection. Most creditors may not reach a beneficiary’s interest in a trust where distributions are made in the discretion of the trustee and are not required. A creditor 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 (HEMS) of the beneficiary. Depending on state law, this may be true even if the beneficiary is also the sole trustee.

However, the general rule is that the less control a beneficiary has over the trust assets, 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 authorized to make distributions to the beneficiary in their sole discretion. In some jurisdictions, the trust could also provide that a beneficiary could resign as a trustee and appoint an independent trustee to take their place. This might increase 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 may not be 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.

Minimize taxes. When a trustee has total discretion to make distributions from the trust to themselves or others, the value of the trust assets 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 it 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, 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 remove and replace the independent trustee at any time and for any reason.

Example: If your trust is a nongrantor trust, a trust that is a separate entity for tax purposes that pays taxes on trust income at the trust level, it is important that someone other than the trustmaker, or any party who is related or subordinate to them, be the investment trustee. The power to determine trust investments may be considered to be the power to control the beneficial enjoyment of the trust assets under I.R.C. § 674, which would mean the grantor, not the trust, must pay taxes on the trust income. 

Let Us Help
If you would like to find out more about whether you should appoint separate investment and distribution trustees, schedule an appointment with us. Although having more than one trustee may 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 to maintain family harmony, protect assets, and minimize taxes.