8.3 Trusts & Estates

Trusts and estates are important client types with specific legal requirements and fiduciary obligations. Investment advisers must understand trust structures and the duties governing their management.

Trust Fundamentals

Trust Structure

Every trust involves four key elements:

- Grantor: Creates the trust and transfers assets into it; also called Settlor, Trustor, Donor

- Trustee: Manages trust assets according to trust document; Fiduciary

- Beneficiary: Receives benefits from the trust

- Trust Document: Legal instrument governing trust operations; also called Trust Agreement, Declaration of Trust

Income vs. Remainder Beneficiaries

Many trusts distinguish between:

- Income Beneficiaries: Receive income generated by trust assets during trust term

- Remainder Beneficiaries: Receive trust principal when trust terminates

Important: Trustees must balance the interests of BOTH types of beneficiaries (duty of impartiality).

Types of Trusts

Revocable Living Trust

- Can be changed? Yes, grantor can modify or revoke

- Who is trustee? Often the grantor during lifetime

- Probate: Assets AVOID probate at death

- Estate taxes: NO reduction during grantor's lifetime

- At grantor's death: Becomes IRREVOCABLE

Primary Benefit: Probate avoidance, not tax savings. Assets remain in grantor's estate for tax purposes.

Irrevocable Trust

- Can be changed? Generally NO (limited exceptions)

- Who is trustee? Cannot be the grantor

- Probate: Assets avoid probate

- Estate taxes: Assets REMOVED from grantor's estate

- Gift tax: May apply when trust is funded

Primary Benefit: Estate tax reduction and asset protection. The irrevocability is the trade-off for tax benefits.

Other Common Trust Types

- Testamentary Trust: Created through a will; takes effect at death; does NOT avoid probate

- Charitable Remainder Trust (CRT): Income to donor/beneficiary for life; remainder to charity; provides income tax deduction

- Special Needs Trust: Provides for disabled beneficiary without affecting government benefits eligibility

- Spendthrift Trust: Protects assets from beneficiary's creditors; beneficiary cannot assign future payments

The Prudent Investor Rule

The Uniform Prudent Investor Act (UPIA), adopted in 48 states, modernized fiduciary investment standards.

Five Fundamental Changes from Old "Prudent Man" Rule

- Old: Judge each investment individually; UPIA: Evaluate investments as part of TOTAL PORTFOLIO

- Old: Some investments categorically prohibited; UPIA: NO investment is per se prohibited

- Old: Speculation always imprudent; UPIA: Risk/return tradeoff is CENTRAL consideration

- Old: Delegation prohibited; UPIA: Delegation is PERMITTED (even encouraged)

- Old: Preservation of principal paramount; UPIA: Total return approach acceptable

UPIA Core Requirements

1. Portfolio Standard: Consider the portfolio as a whole, not individual investments

2. Risk/Return Analysis: Balance risk and return appropriate for trust purposes

3. Diversification: Required UNLESS imprudent under circumstances

4. Cost Consciousness: Consider investment costs and expenses

5. Delegation Permitted: May delegate to qualified professionals

Judging Prudence

Critical Point: Compliance with the prudent investor rule is determined by facts and circumstances AT THE TIME of the decision, NOT by hindsight.

A trustee who follows proper process is not liable for losses if the market declines after a prudent decision was made.

Trustee Fiduciary Duties

Trustees owe the highest level of duty to beneficiaries:

Duty of Loyalty

- Act solely in the interest of beneficiaries

- No self-dealing

- No conflicts of interest

- Cannot benefit personally from trust transactions

Duty of Care

- Exercise skill and prudence

- Act as a prudent investor would

- Make informed decisions

- Monitor investments regularly

Duty of Impartiality

- Balance interests of income and remainder beneficiaries

- Cannot favor one beneficiary over another

- Consider both current income and long-term growth

Duty to Diversify

- Spread risk across different investments

- Unless trust document specifies otherwise

- Or circumstances make concentration prudent

Duty to Inform

- Keep beneficiaries reasonably informed

- Provide accounting information

- Respond to reasonable requests

Estate Accounts

Types of Estate-Related Accounts

- Executor/Personal Representative: Named in will to administer estate

- Administrator: Court-appointed when no will exists

- Probate Estate: Assets going through court-supervised process

Key Considerations

- Authority derived from court (Letters Testamentary or Letters of Administration)

- Investment restrictions may exist in will or by law

- Goal often to preserve assets during administration

- Timely distribution to heirs

- Both income tax and estate tax implications

On the Exam

Series 65 frequently tests:

- Distinguishing revocable (no tax benefit) from irrevocable (tax benefit) trusts

- Understanding the prudent investor rule evaluates the ENTIRE portfolio

- Knowing that trustees can now delegate investment authority

- Recognizing the duty of impartiality between income and remainder beneficiaries

Key Takeaways

1. Revocable trusts avoid probate but provide NO estate tax benefits

2. Irrevocable trusts remove assets from the estate but cannot be changed

3. UPIA evaluates investments by portfolio performance, not individual securities

4. Diversification is required unless specifically imprudent

5. Prudence is judged at the time of decision, not by hindsight

6. Trustees can delegate but must monitor the delegate