Selecting a Trustee: Individual versus Corporate versus Independent

As seen in the Wealth Management 2022 Midyear Outlook.

Establishing a trust is an essential part of estate planning. Although some people think trusts are only for the very wealthy, the truth is that a trust is beneficial for anyone who wants to stay in control during their own possible incapacity and plan for the people and organizations that will share your assets at your death.

While making the decision to set up a trust may be a no-brainer, selecting your trustee requires some careful consideration. The trustee is the individual or corporate entity that manages your trust and distributes your assets to the trust beneficiaries.

As a fiduciary, the trustee must follow the instructions outlined in the trust document, managing, and distributing the trust assets in the best interests of the beneficiaries. The trustee agrees to provide the following services:

• Duty of obedience to adhere to the trust terms
• Duty of prudence and reasonableness in making administrative and investment decisions
• Duty of objectivity in not giving preference to any beneficiary over another equally suited beneficiary
• Duty of transparency to provide trust information and accountings as stated in the trust agreement.

As you can see, it is a significant responsibility and one that comes with potential liability.

Should you choose an individual trustee (usually a close friend or family member), an independent agent, or a corporate entity to handle this responsibility? The answer depends on your individual situation. In this article, we will offer some of the pros and cons of each choice.

We also will discuss how you can mitigate some of the legal risks that come with the position.

What Is an Individual Trustee?

An individual trustee is typically a trusted friend or family member who usually receives no compensation for their role as trustee.

The main advantages of appointing an individual include an inexpensive and uncomplicated trust setup process and low management costs. The main disadvantage is that this person may not have the financial expertise or management skills to handle their duties, in addition to a natural conflict of interest if they are also a beneficiary.

Another big hurdle is when other beneficiaries may question the individual trustee’s impartiality in making decisions. For example, sometimes sibling rivalries and family squabbles come into the spotlight when an individual trustee makes investment decisions that include personal and trust assets.

Succession planning and the transfer of the assets to a new trustee in the event of the death of an individual trustee may also become an issue.

What Is a Corporate Trustee?

On the opposite end of the spectrum from the individual trustee is the corporate trustee.

A corporate trustee is a registered legal entity that is incorporated with the sole purpose of acting as trustee. Like any other company, the corporate trustee has shareholders and directors. In this case, however, the shareholders and directors control the distributions of the trust.

The primary advantages of a corporate trustee are:

• Limited liability: If legal issues with the trust arise, the company is legally responsible, not the individual directors controlling it.
• Easier separation of assets: With a corporate trustee, trust assets and personal assets are held in different names, making them easy to distinguish.
• Asset protection: This clear separation of assets means that an individual’s personal assets are at less risk in the event of a court case.
• Smooth succession: Unlike with the death of an individual trustee, a trust’s assets do not need to be transferred if a director passes away. The other directors appoint a successor, and the work of the trust continues.
• Support services: Corporate trustees support evolving structures, including providing administration for directed trusts and back-office services.

The disadvantages of a corporate trustee are the costs involved in setting up this legal entity and maintaining its records. Another possible drawback is that corporate trustees are likely to be unfamiliar with the goals, desires, and concerns of trust beneficiaries. As a result, their decision-making may appear insensitive to some family members.

What Is an Independent Trustee?

As an alternative to working with a family member, close friend, or corporation, a grantor may opt to hire an independent trustee. In legal terms, an “independent trustee” generally means an individual who has no beneficial interest in the trust.

An independent trustee is a private, professional fiduciary who typically has business relationships with attorneys and accountants and has the expertise needed to manage a trust.

Since this type of trustee operates independently, using them as trustee helps cut through some of the red tape involved with a large corporation. An independent trustee may also have the time to become acquainted with the needs and concerns of the family.

The costs of using an independent trustee may be lower than those associated with a corporate trustee. However, it’s important to keep in mind that an independent trustee may lack some of the services and resources of a corporate trustee which will be hired at the expense of the trust, such as financial advisors, accounting firms, legal firms, and real estate services.

Understanding your options is a huge part of estate planning. Choosing a trustee does not have to be an all-or-nothing decision. One option may be to have both an individual trustee and a corporate trustee. In this scenario, the individual trustee could designate tasks to the corporate trustee, alleviating some of the burdens.

What Are the Risks of Being a Trustee?

Although following the rules of a trust document may seem easy enough at the outset, serving as a trustee can be a daunting responsibility. No matter what type of trustee you choose, they (and you) need to be aware that there is a legal risk that comes along with trustee responsibilities.

Liability claims related to trustee services may include one or more of the following:

• The trustee distributed trust assets to the detriment of one or more beneficiaries.
• The trustee failed to protect trust assets.
• The trustee mismanaged the affairs of the trust.
• The trustee made poor investment decisions or gave poor advice regarding trust assets.
• The trustee did not properly account for the distributions (principal and interest accounting)

Since emotions can run high when inheritances and family relationships are involved, your choice of trustee can make the difference between whether your assets go where you want them to go or not and keep the family peace.

Because of their fiduciary duty, trustees are held to the highest standard of the law, fiduciary duty. If unprotected, they can be risking their personal assets while serving the family.

How Can Your Trustee be Protected from Liability?

Fortunately, there are several ways to protect the trustee:

Indemnity agreement: An indemnity agreement – a legal contract that affirms that one party holds another party harmless from liability in a specific situation -- can provide some comfort to the trustee. However, in the event of a dispute, the trust assets may not be immediately available to provide a defense because of certain allegations.

Professional organizations: Some professional organizations allow their employees to serve as trustees, including lawyers, accountants, and family offices. However, there may be significant gaps between the extensions afforded by the organization’s insurance or significant deductibles.

Co-trustees: Having more than one trustee can lighten the risk for any one trustee. However, if you have co-trustees, they have joint liability even when serving with an institutional trustee, which means each co-trustee is 100% liable for the acts they perform themselves, and for the acts committed by the other co-trustees. Furthermore, if a trustee hires a trust company as agent for trustee, the trustee retains all liability.

Trustee training: There are some educational resources to help your trustee learn more about their responsibilities and how to mitigate their risk. Here are three options to consider.

• Independent Trustee Association
• American Bankers Association trust schools
• Cannon Financial Institute

Trustee liability insurance: Trustee liability insurance, a type of errors and omissions (E&O) insurance, is another way to protect your trustees against claims brought by beneficiaries and other entities.

Hiring a Trustee

Wealth owners spilled blood, sweat, and tears to create their wealth. As part of the process, they hired talented, experienced people to manage complex business situations.

Hiring a trustee needs and deserves the same attention. Every trustee—whether independent or institutional—requires the skills to navigate intricate business dealings and personal relationships. Along with the goal of finding the best trustee to carry out your legacy, you must find ways to support your trustee in this difficult job. They need protection.

We encourage you to consult with your attorney or financial advisor about what options may work best for the needs of your estate.