Q. I recently read about what is called a directed trust, where an individual has power to direct the trustee on some aspect of the trust, such as investment management, administration, and distribution decisions, powers usually reserved to the trustee. By using this strategy, I understand that control over the assets can remain with a financial advisor that I appoint, while the trustee I select administers the other elements of the trust.It is my understanding that the trustee I appoint and my investment advisor are free to do what they do best, aligning the interest of all parties with mine (as the grantor) and minimizing potential conflicts. Being that I have lots of investments and a business that I run and three adult children who might not agree on things when it comes to these investments, I think it’s a wise idea to split up the administration of my trust in this way. I know that your firm does estate planning and trust and estate administration and financial planning. Can you better explain how directed trusts work and what some of the advantages are? Are there laws I should be aware of in Virginia regarding directed trusts?
Thanks for your help!
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A. As many readers are aware, in a typical trust, the trustee is responsible for both the administration of the property held in trust and how it is invested. In a directed trust, however, these functions are split between the trustee and another person or entity.
Historically, trustees have retained full authority over both the way trust assets were used and the way those assets were invested. Directed trusts can divide investment control and decision powers so that trust assets can sometimes be managed more effectively. In a directed trust, the trustee is not responsible for and does not perform all aspects of trust administration. Instead, the trustee takes direction and instruction from a third party for certain functions of the trust. The directed trustee may be given authority to direct distributions from the trust, direct how the assets in the trust are invested, remove the trustee, or amend or even terminate the trust.
Laws Related to Directed Trusts
Directed trusts have become popular over the last decade. Since directed trusts became statutorily recognized in 1986 in Delaware, other states have followed suit. As of July 2020, the Commonwealth of Virginia adopted the Uniform Directed Trust Act. This new act validates terms of a trust that provide for a trust director, a term that is defined in the Act as “a person that is granted a power of direction by the terms of a trust to the extent the power is exercisable while the person is not serving as a trustee,” and prescribes a set of rules for directed trusts, including allocation of fiduciary duties. Under the new law, you can now establish a trust that provides a power of direction, thereby effectively dividing trustee responsibilities in a number of ways. Most often this involves the appointment of an “investment trustee” and a “distribution trustee.” In these situations, the distribution trustee is usually the primary point of contact for the beneficiary and will direct the investment trustee to make any and all distributions, leaving the investment trustee with the investment decision responsibility. Sometimes, a directed trust may have contract terms, which direct a trustee to follow the investment decisions of an outside financial advisor. This allows the settlor of the trust to ensure the use of their existing financial advisor or advisory firm.” Read the full text of the law here.
Considering a directed trust? Here are some important things to know about directed trusts in Virginia and other states:
1. A directed trust appoints an individual or firm as an advisor who directs the trustee on a discrete aspect of the administration of the trust such as investment management or distributions to beneficiaries.
2. With a directed trust, you can continue to use the services of an advisor with whom the family has a proven relationship.
3. Sometimes families worry about the voting of stock in their family business or a legacy holding that is held in trust. A directed trustee can be someone who has the experience and expertise to objectively assess family needs and, where necessary, make those tough decisions.
4. While having a family member in a decision-making role might seem like a good idea, consider family dynamics and what strains might develop over time. Putting an adult child in charge of asset management or distribution decisions that affect his or her brother or sister can potentially change that relationship forever – and in many cases, not for the better.
5. Trustees of directed trusts face a lower burden of liability because they just carry out the wishes of whomever the trust document appoints. You might use a directed trust when you wish to continue to oversee investments and distributions while leaving the day-to-day trust administration to a third party.
6. Some families form “distribution committees” made up of professionals and family members so that they can corporately approve distributions and more effectively enforce trust restrictions. After all, families generally have the best insights into how beneficiaries are living and can provide the most nuanced instructions.
Trust Administration under the Directed Trust
The primary duties of a directed trustee fall into two main categories, as follows:
Non-discretionary tasks: These may include making income payments monthly, quarterly, or annually or as otherwise directed by the trust. A directed trustee must also pay out certain amounts or percentages of principal as set forth in the trust and attend to all other matters the trust specifically directs. These duties are not optional or discretionary, but must be carried out as stated in the trust document.
Discretionary tasks: The trust document may also charge the trustee with the responsibility to make certain decisions according to his or her own discretion. If the trust is silent on an issue, the trustee’s fiduciary duty may also require him or her to make discretionary decisions. For example, a trust may indicate that the trustee can make principal payments “after considering other sources of income available to the beneficiary,” in which case the trustee should demand extensive documentation from the beneficiary before making a decision.
Actions to Take When Considering a Directed Trust
If you are considering a direct trust, be sure to actively define your intent as it relates to the roles of the advisor versus the trustee. Providing the trustee with a statement of intent can outline those thoughts and explain your wishes. A statement of intent can serve to define the scope of the advisor’s role and also give the trustee additional guidance to allow for personalized management of the trust, especially in the future.
Whether you use a statement of intent, work with an experienced estate planning and estate administration attorney, such as the attorneys at the Farr Law Firm, your trustee, and your advisor (a role we are also highly qualified to assume). In addition, with the increased income tax rates at the federal level as well as in many states, coordinating trust activities among advisors and the trustee can help avoid unnecessary tax consequences.
As you consider whether a directed trust is right for your family, weigh the options. Directed trusts can offer benefits as long as you understand the current and long-term implications, and plan accordingly.
Have You Planned for your Future and for your Loved Ones?
The need to plan in advance and to make necessary updates to your estate planning is more important now than ever. If you have not done your Estate Planning or Retirement Planning or had your Planning documents and Retirement Plan reviewed this year, please call us for an initial consultation:
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About Evan H Farr, CELA, CAP
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