Trusts
A trust involves any arrangement by which legal title to property is transferred from one person to be administered by a trustee for another person’s benefit. The trustee is the person holding the trust property. Anyone legally capable of holding title to, and dealing in, property can be a trustee. A settlor is the person who creates a trust by a written trust declaration, and may transfer initial assets into the trust. A settlor is also referred to as a trustor, grantor, or a donor. If the settlor of a trust fails to name a trustee, or if a named trustee cannot or will not serve, the trust does not fail. The appropriate court can appoint a trustee.
Duties of Trustee
As obvious as it may sound, a trustee’s basic duty is one of trust. Specifically, a trustee must act with honesty, good faith, and prudence in administering the trust and exercise a high degree of loyalty toward the trust beneficiary. The standard of care is the degree of care a prudent person would exercise in his or her personal affairs. The duty of loyalty requires that the trustee act in the exclusive interest of the beneficiary. A trustee must keep clear and accurate accounts of the trust’s administration and furnish complete and accurate information to the beneficiary while keeping trust assets separate from his or her own assets. A trustee also has a duty to pay to an income beneficiary the net income of the trust assets at reasonable intervals. In addition, a trustee has a duty to distribute the risk of loss from investments by reasonable diversification and a duty to dispose of assets that do not represent prudent investments. Investments in federal, state, or municipal bonds; corporate bonds; and shares of preferred or common stock may be prudent investments under particular circumstances.
Powers
When a settlor creates a trust, he or she may prescribe the trustee’s powers and performance. Generally, state law applies only to the extent that it does not conflict with the terms of the trust. When state law does apply, it is most likely to restrict the trustee’s investment of trust funds. Typically, state statutes restrict trustees to investments in conservative debt securities such as government, utility, and railroad bonds and first-mortgage loans on realty. It is common, however, for a settlor to grant a trustee discretionary investment power. In that circumstance, any statute may be considered only advisory, with the trustee’s decisions subject in most states to the prudent person rule.
A difficult question concerns the extent to which a trustee has the discretion to invade the principal and distribute it to an income beneficiary if the income is found to be insufficient to provide for the beneficiary in an appropriate manner. A similar question concerns the extent of a trustee’s discretion to retain trust income and add it to the principal, if the income is found to be more than sufficient to provide for the beneficiary in an appropriate manner. Generally, the income beneficiary should be provided with a somewhat predictable annual income, but with a view to preserving the principal. A trustee may therefore make individualized adjustments in annual distributions.
Allocating Expenses between Principal and Income
Frequently, a settlor will provide one beneficiary with a life estate and another beneficiary with the remainder interest in a trust. For example, a farmer may create a testamentary trust providing that the farm’s income be paid to his or her surviving spouse and that on the surviving spouse’s death, the farm be given to their children. Among the income and principal beneficiaries, questions may arise concerning the apportionment of receipts and expenses for the farm’s management, as well as the trust’s administration between income and principal. Even when income and principal beneficiaries are the same, these questions may occur. To the extent that a trust instrument does not provide instructions, a trustee must refer to applicable state law. The general rule is that ordinary receipts and expenses are chargeable to the income beneficiary, whereas extraordinary receipts and expenses are allocated to the principal beneficiaries. The receipt of rent from trust realty would be ordinary, as would the expense of paying the property’s taxes; but the cost of long-term improvements and proceeds from the property’s sale would be extraordinary.
Express Trusts
An inter vivos trust is executed by a grantor during his or her lifetime. A testamentary trust is created by will on the settlor’s death (if the will is invalid, the trust is invalid). The legal responsibilities of the trustees are the same in both: preserve the trust property, make it productive, and typically pay the income to the beneficiaries.
Implied Trusts
Two types of implied trusts are constructive and resulting trusts. A resulting trust arises from the conduct of the parties. A constructive trust is an equitable remedy that enables plaintiffs to recover property (and sometimes damages) from defendants who would otherwise be unjustly enriched.
Special Types of Trusts
A charitable trust (designed to benefit part of all of the public) must be created for a charitable, educational, religious, or scientific purpose. A spendthrift trust prevents a beneficiary from using his/her trust funds imprudently by limiting the beneficiary’s rights to draw on trust funds and to transfer of the right to future payments. A Totten trust is created when one person deposits money in his or her own name in trust for another.
