How to be a trustee

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particular circumstances from their tax advisor.

Caveat: These are ROUGH meeting notes to help you follow
the audio lectures on this web site. Do not rely on these notes for any
decision making. Similarly, the audio file of this seminar merely presents
general planning ideas for trustees, not specific advice or guidance.

• Introduction – Martin M. Shenkman, Esq., Paramus, New
  Jersey.
• Family dynamics, divorce rate, asset protection
  concerns, aging population, large wealth transfers, all indicate increasing
  frequency of use of trusts.
• Trustee liability and litigation – Melvyn Bergstein,
  Esq. of Walder, Hayden & Brogan, P.A. of Roseland, New Jersey.
• Often it is not possible to avoid estate
  litigation.
• Estate litigation can be the ugliest of all
  litigation. It often arises out of familial relationships and the emotions
  it generates make such litigation both contentious, and intractable. Nit
  infrequently, the genesis of estate litigation starts when the siblings are
  coming out of the womb. Too often many of the parties to estate litigation
  have agendas long in advance of the death. The death of the parent or
  another benefactor triggers and set off a dynamic that is beyond reason. It
  can truly bring out the worst in the people involved.
• Most disputes could be handled quickly.

i. Gather information.

ii. Review the law.

iii. Evaluate the equities.

iv. Arrive at a clinical resolution.

• Unfortunately, the above result often doesn’t
  happen.

i. Emotions of participants.

ii. One or both lawyers may be unprofessional or pursuing
a self interest.

iii. The relationship between the lawyer and their client
may be something other than the clinical and logical relationship it should
be.

iv. Sibling or other rivalries.

v. A myriad of issues can hinder a reasonable resolution
of the estate problems.

• Drafting issues in the documents can be
  significant.

i. Too often the documents (wills, trusts) ignore the
people component.

ii. How have the people lived? Who has what types of
assets? What are the expectations of the family members?

iii. Attorneys should be obliged to be counselors, not
just Scribner’s. Many lawyers see their roles solely as technicians. They
simply execute their clients’ wishes uncritically. Other lawyers see themselves
on the other end of spectrum and function almost like therapists.

iv. As a litigator, one sees documents setting up trusts
which have no human component. The real life problems, the people issues and
depth of emotions, all can be foreseen.

v. The will and trust should reflect the intent of the
testator and grantor. But the “counseling” component should be part of the
lawyer’s role. Ultimately, the lawyer should draft what the client wants.

• Do I Want to be the Trustee?

i. This is the first issue to address.

ii. Ask yourself before accepting the appointment as
trustee whether you really want the role, and whether you can really carry it
out.

iii. The next question, before accepting is to review the
trust document. Find out about the family. What are the family dynamics? Have
these issues been considered? Example: If children of first spouse are trustees
for the second wife’s trust, every dollar they give her will be a dollar they
don’t get. This is almost begging for a problem. Regarding the second wife, if
later has health issues or becomes incompetent, a court may have to intervene
to determine how distributions should be made. But these are the issues that
the trustee to be should evaluate.

iv. **HAVE A MEETING WITH YOUR FIDUCIARIES BEFORE THE
DOCUMENTS ARE ACTIVATED**

v. Have a family meeting to review issues and feelings in
advance.

vi. The concept that people with different points of view
should be allowed to be heard. The fear that this will split up a family is
often an excuse. In many cases airing the issues will avoid worse problems
later.

• A same problem presented to different lawyers is
  likely to get a very different recommendation and perspective from
  each.

• Before accepting a trusteeship, understand the
  circumstances and read the document. Ask the grantor or testator questions
  about what is going on in the family, what their goals are, and other
  questions.

• How Can You get in Trouble as a Trustee – Melvyn
  Bergstein, Esq.

• Use common sense. If it seems “evil” it is likely to
  be bad and you might face dismissal, suit. See NJSA 3B.

• If you receive an order from the court and you don’t
  follow up it will be trouble. Courts tend to be very sensitive to the
  issues facing trusts and protecting beneficiaries’ interests.

• If you embezzle, waste, misapply funds, commingle
  funds, leave the jurisdiction, neglect your responsibilities, become of
  unsound mind, incapacitated to do business, etc. you can be removed.

• You have to hold your end up. If you are a co-trustee
  or co-fiduciary and don’t fulfill your responsibilities you can be removed
  as trustee.

• Making a “false suggestion” in getting the letters of
  trusteeship, you will be removed. Example, you tell the surrogate your
  client has died and they haven’t.

• If the document contains a contingency that has
  expired you will be removed. This is a limitation on your power and
  right.

• If you change your address and do not give the court
  notice you can be removed.

• If you remove property out of the state without court
  approval you can be removed.

• If you don’t appear for a court citation or summons
  you can be removed. The court can unilaterally dismiss you in such a
  situation. If you cannot be found to be served with a court order you can
  be dismissed.

• If the will or trust agreement has been declared
  invalid in another state you can be removed.

• If you commit a felony or commingle funds you are
  removed or terminated as trustee.

• Conflict of interest issue is important to be wary
  of.

• Most estate litigation is funded out of the proceeds
  of the estate unless the executor is involved in wrongdoing himself. For
  example, if there was undue influence exercised by the executor to get
  appointed, the court may not permit payment of legal fees by the estate.
  This is a variable. Don’t assume you will have all your costs covered, it
  is not assured.

• If the trustee is involved in discretionary
  decision-making, the beneficiary not receiving funds may protest. The
  displacement of the anger onto the executor or trustee is enormous. It too
  often becomes a real battle ground. If a professional makes the decision as
  to distributions, the beneficiary reactions are often beyond reason. Is
  there a face saving middle ground?

• It is essential that the fiduciary (trustee,
  executor, etc.) must believe that each beneficiary is being treated fairly.
  Bring the lawyers and beneficiaries in for a meeting and try to find a
  middle ground.

• The issues are often human problems, not technical
  problems.

• What is more important? Maintaining a family
  relationship or fighting over the “thing” (what is in issue or what is
  being litigated). Often the real problem is the relationship, not the thing
  being litigated.

• If the litigation is frivolous you might possibly
  make the litigant pay the fees. This is difficult.

• Courts are reluctant to dismiss trustees and
  executors. This is hard because this is who the donor or testator
  appointed. You need a high standard of clearly and convincingly to prove
  that the fiduciary has violated one of the statutory basis for removal. It
  is tough to terminate or dislodge the fiduciary.

• Using an Institutional Fiduciary – Sharon Klein,
  Esq., Fiduciary Trust Company International.

• The role of the trustee is to balance the competing
  interests of the current and remainder beneficiaries.

• When you have a conflict and have to make a decision
  that benefits one beneficiary over another. You need to understand the
  conflicts and how they arise.

• Conflicts often arise in 3 areas:

i. Investment arena. How does the trustee invest the trust
assets to balance competing interests.

ii. Distribution field. How and when should a trustee make
distributions and how can the trustee use the unitrust or power to adjust to
balance competing interests.

iii. How is tax burden to be shared? How and what tax
elections should be made? How do you determine which client or beneficiary
bears the brunt of this.

• Conflicts in the Trust Investment Arena – Sharon
  Klein, Esq., Fiduciary Trust Company International, New York, New
  York.

i. Prudent Investor Act governs the investment of trust
assets.

ii. Must formulate overall strategy to meet trust
objectives.

iii. Not individual security selection but rather an
overall allocation based on facts and circumstances, size of trust, anticipated
duration, and other factors listed in the statute.

iv. Trustees must invest for total return – income plus
growth.

v. Must consider income, growth potential, and risk
attributes of each asset.

vi. This creates conflict between income beneficiaries who
are primarily interested in growth, especially if constrained by traditional
definitions of accounting income.

vii. Base line objective of a trustee is to preserve
purchasing power. Trust portfolio must be designed to keep pace with inflation.
Mere preservation of principal is not sufficient unless purchasing power is
preserved.

viii. No investment is inherently too risky, but risk must
be managed.

ix. Must diversify unless determine that it is in best
interests of beneficiaries not to.

x. Delegation of investment responsibility is permitted if
skill and care is exercised in delegating and it is monitored.

xi. Prudent Investor Act sets forth a standard of conduct.
Must document that this has been done.

xii. Different asset classes have different return
expectations. The higher the return generally the higher the volatility. The
role of the trustee in constructing the portfolio is to mix investment classes
to get the best return within the appropriate risk parameters.

• How do you construct a portfolio that complies with
  the prudent investor act.

i. Each portfolio has a yield component and a capital
appreciation component, and the aggregate of the two is the total return.

ii. Must keep pace with inflation so must evaluate returns
versus inflation.

iii. A trust which is 65% fixed income and 35% equities
provides the minimum exposure to equities necessary to keep pace with
inflation. This might imply that every trust should have some exposure to
equities.

iv. Consider taxes and fees in making the asset
allocation.

• Power to Adjust and Unitrust.

i. Depending on State

1. Power to adjust.

2. Unitrust election.

3. Choice between power to adjust and unitrust
regimes.

ii. New Jersey – power to adjust between 3-5%. Prior to
that there was a 4% safe harbor. The change was made to conform to IRS
regulations that a 3-5% adjustment between income and principle is deemed
reasonable.

iii. Delaware – power to adjust and flexible unitrust
regime between 3-5%.

iv. Varies by state.

v. Unitrust has fixed percentage

• Principal and Income Act and Prudent Investor
  Act.

• How do you determine what to do?

i. New Jersey gives you a band from 3-5% to adjust.

ii. How do you determine what to do?

iii. Start the analysis.

1. If you had a balanced portfolio with a 7.6% rate of
return.

2. What if could get a 10.3% rate of return in a growth
portfolio.

3. But look at components of return and note that most of
the return at that level is in the growth portion.

4. If yield declines because portfolio is invested for
growth, might be able to give current beneficiary (income beneficiary) the same
return by making an adjustment from principle to income.

• How do you allocate tax burden?

i. Allocation of capital gains is a significant factor.
Who bears the tax burden is a significant decision. With a unitrust regime you
are locked in to whatever capital gains tax treatment the trustee elects in the
first year of the trust.

ii. In contrast with a power to adjust you can adjust to
deal with this.

iii. Consider how trust is invested. If the bond portfolio
is tax exempt then the income is not taxable to the income beneficiary. If the
bond portfolio is in taxable instruments the current beneficiary may have to
bear this tax.

iv. Huge impact over duration of trust from what might be
small tweaks in this.

• When you appoint a family member or friend as
  trustee, most individual trustees don’t appreciate responsibilities and
  liabilities of being a trustee. Most individuals serve as trustee as a
  favor. There is a minefield of pitfalls.

i. Stock concentration can be a problem.

ii. Even if the trust instrument absolves her of
responsibility from retaining a concentrated block of stock, case law has still
held the trustee responsible (liable) even when the trust had permitted it.

iii. Must document:

1. Why the concentrated position is being held.

2. Demonstrate that you are monitoring the stock.

3. Language in the trust.

• Consider the Astor case and Atkins case. Many issues
  plague use of individual trustees.

• To minimize liability as a trustee the cases and law
  teaches us:

i. Carefully examine the individual facts and
circumstances of the trust, beneficiaries, etc.

ii. Do not blindly rely on protection in the trust
instrument.

iii. Must maintain communication with beneficiaries.

iv. Must carefully maintain records.

• Investment Policy Statement (“IPS”) – Greg Plechner,
  Greenbaum and Orecchio, Inc., Old Tappan, New Jersey.

• From a fiduciary perspective a portfolio should be
  created that accomplishes the objectives which a trustee has.

• What is the process to create an IPS?

• Make certain that there is understanding of what the
  investment manager’s role is and what methodologies will be used to
  accomplish those goals and this should be embodied in an IPS.

• Old approach of paying out income and preserving
  principal has given way to total return in a more modern view.

• As wealth increases clients often become risk
  adverse. Is this appropriate for a trustee? Cannot ignore the risk of
  inflation.

• What is an IPS?

i. Written document.

ii. Prepared by the investment advisor or portfolio
manager.

iii. Describes goals and objectives for investment.

iv. Client for a trust is the trustee.

v. Purpose is to create transparency as to how assets of
trust will be managed.

• IPS Contents.

i. Prepare financial plan, analyze cash flows, review
insurance coverage, and create long term projections addressing client
goals.

ii. End result of the process is a target rate of return
necessary to accomplish goals.

iii. This is how you go from financial planning to
investment management.

iv. Define the asset allocation model to achieve that
target rate of return.

v. Establish management procedures to achieve this
objective.

vi. Show communication of returns, and other matters
pertaining to tax, performance and other management objectives.

vii. Time horizon – how long will this IPS be valid.

viii. Agreed upon components may include various
matters.

ix. Which accounts will be managed. What is included and
what is not.

x. Constraints and restrictions on account.

xi. Background data.

xii. Variance limits.

xiii. Signature of all parties to IPS.

• Review of Sample IPS.

i. Time horizon, plus extension.

ii. Accounts to be managed. Market value of account.

iii. Cash flow. What deposits are anticipated to come into
the account. This information is used in re-balancing of portfolio. Risk is
managed by re-balancing of portfolio. In rough terms, sell the winners and buy
the losers in order to maintain balance.

iv. Withdrawals that are anticipated (cash out flows).
Default cash position of say 1%.

v. Who is actually managing and directing investment
philosophy and policy, e.g. the trust agreement.

vi. Fees. Expenses.

vii. Purchasing power rate of return.

1. Rate of risk must increase to get better rate of
return. But if you can eliminate uncompensated risk you can achieve the same
return with less risk and exposure. Diversification can often accomplish
this.

2. Diversification use to be within an asset class, but
modern portfolio theory stresses diversification across different asset
classes.

3. Net return.

viii. Restrictions on portfolio design.

ix. Additional cash holdings to fund distributions.

x. Define and express range of methodologies available to
come up with a target rate of return.

1. One is a risk free rate of return and layering
different target rates of return on top of this based on different factors.
What methodology is being used. Example, if you say bonds will get a 5% rate of
return, what methodology is used to come up with this assumption.

2. Portfolio design is part of the IPS.

xi. Distinction between asset class investment (passive)
and active management (ability of individual to outguess or outperform the
capital market rate of return).

xii. Timing. When it will be implemented.

xiii. Re-balancing of the portfolio. This is a
re-alignment of the target allocations from current back to the target
allocations. Example: once per quarter? More frequently?

xiv. Understanding that a deviation from the target design
could change risk and return parameters.

• Portfolio asset mix.

i. Some advisers use target portfolios, some use
customized. Consider taxable versus tax free, risk tolerance, age and other
factors.

ii. Quantify risk, e.g., standard deviation. This can
guide and explain the different scenarios of downside risk, etc.

iii. In one of 20 years what is the worst downside you
might experience with the particular investment mix.

iv. 100 year storm scenario – what is the worst case in 1,
2, 3 and 5 year scenarios.

v. All this can become part of the investment policy
statement.

• IPS creates a mutual understanding between the owner
  (trustee) and manager (investment advisor, wealth manager, etc.).

• Trustees should have an investment policy statement
  to communicate ultimate goals.

• Insurance, Insurance Trusts, Insurance Reviews –
  Steven A. Fishman, Norwood Financial Group, LLC, Paramus, New Jersey.

• Report, background, of TOLI – “trust owned life
  insurance”.

• TOLI is a popular estate, financial, asset
  protection, tax and other planning tool.

• Life insurance can be used to create cash where it
  did not previously exist and where and most importantly, when, needed.

• $15 Trillion dollars of trust owned life insurance in
  force in 1999.

• 40% reduction in premiums are common from review of
  policies that have been outstanding policies.

• There are a myriad of new policies and underwriting.
  Life insurance is often cheaper now than five years ago because of
  increasing longevity. Insurance companies understand health issues better
  than in the past and are more willing to underwrite policies for people
  with health issues that in past years would have been declined.

• Product design has become more sophisticated: no
  lapse universal life, etc. and etc.

• What do you need for a life insurance review:

i. Policy.

ii. Correspondence.

iii. Premium notices (some show dividends).

iv. In force illustration.

1. Should receive at the end of every policy
anniversary.

2. Planned premium should be reflected. That is the amount
of money the insured was getting billed.

3. Cash value.

a. Year prior.

b. Is it declining?

4. Cost of actual insurance.

a. If cost exceeds payment the differential may come out
of cash value.

5. Forecast, if you pay planned premiums when the policy
will expire.

• Options.

i. Continue policy.

ii. Cash in policy.

iii. Sell policy with a life settlement.

• Policy audit.

i. Not a proposal to buy life insurance.

ii. Obtain an in-force ledger for the actual policy.

iii. Payment projections.

iv. Evaluate cash value.

1. What is payment on cash value?

2. If cash value goes up what happens to death benefit?
Does it increase or stay the same?

3. When does death benefit expire?

4. How long is coverage guaranteed.

• What if a premium is missed?

i. To have a policy reinstated requires new
underwriting.

• Beneficiary claims.

i. Beneficiaries have sued trustees on the basis that they
did not shop insurance policies and premiums so that less coverage was obtained
than could have been for the premiums paid.

• 1035 Exchange of one policy for another.

• Evaluate whether changing the policy or coverage will
  benefit the beneficiaries. What are the current goals?

• Evaluate benefits of sale of policy and compare that
  value to the cash value of the policy. Does the insured want the policy
  sold? Is that relevant to the beneficiaries or trustee?

• Income Tax Considerations of Trust Planning – An
  Overview – Donald Scheier, E.A., Withum Smith + Brown, Morristown, New
  Jersey.

• Death of trustee.

i. Accounting prepared.

ii. Formal accounting approved by court versus an informal
accounting.

• What is situs of trust?

i. Which state income tax should be paid.

ii. If filed incorrectly, what if statute of limitation
has run? May only be able to file for refunds for past 3 years.

• You cannot prepare a tax return without reviewing the
  trust document.

i. Don’t simply rely on last year’s income tax return.
SALY (same as last year,) is not sufficient.

ii. You need to review the trust document to determine
what you have to file for income tax purposes.

• Review applicable tax and related laws to ascertain
  what should be done.

• How do you determine what to charge?

• Summary sheet for a trust should be prepared.

i. Name of the trust. Sometimes the manner in which a tax
return is filed may differ with name on SS-4 (EIN), or how it is known.
Whatever the ID number was filed under should be what is on the income tax
return.

ii. Name and addresses of trustees. This is important for
situs issue, see below.

iii. Situs.

1. Where was the instrument written? Must state
clearly.

2. What is the tax situs. This is not a simple question.
The fact that a trust was written in New Jersey doesn’t make it taxed in New
Jersey. It is a New Jersey resident trust if set up by someone in New
Jersey.

a. Key cases: Potter and Pennoyer. If you have a New
Jersey grantor and name a New York trustee and a New Jersey person is the
beneficiary, this is not a New Jersey taxable trust.

b. Original cases did not make the residency of the
beneficiaries a factor, but it is the domicile of the trustee that is
determinative currently.

c. The above assumes no source income in New Jersey.

i. Income earned from a business or from real or tangible
property located in New Jersey.

d. See instructions on NJ-1041.

3. New York Trust.

a. Section 605.

b. If no New York source income and no trustees in New
York, even if set up by New York resident and a New York resident trust it is
not a New York taxable trust.

4. If done wrong consider filing amended income tax
returns with the state but the statute of limitations may affect the ability to
get it.